<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(x) Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended: December 31, 1997
or
( ) Transition Report Pursuant to Section 13
or 15(d) of the Securities Exchange Act of 1934
Commission file number: 0-18702
THE S.E.C.T.O.R. STRATEGY FUND(SM) L.P.
(Safety of Equity Capital; Targeting Overall Return)
----------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 13-3568563
------------------------------ -------------------
(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
C/O MERRILL LYNCH INVESTMENT PARTNERS INC.
MERRILL LYNCH WORLD HEADQUARTERS
WORLD FINANCIAL CENTER
SOUTH TOWER, 6TH FLOOR, NEW YORK, NY 10080-6106
------------------------------------------------
(Address of principal executive offices)
Registrant's telephone number, including area code: (212) 236-5662
--------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None
<TABLE>
<S> <C>
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Limited Partnership Units
-------------------------
(Title of Class)
</TABLE>
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Aggregate market value of the voting and non-voting common stock held by non-
affiliates of the registrant: the registrant is a limited partnership; as of
February 1, 1998, limited partnership units with an aggregate value of
$23,502,726 were outstanding and held by non-affiliates.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant's "1997 Annual Report and Independent Auditors' Report," the
annual report to security holders for the fiscal year ended December 31, 1997,
is incorporated by reference into Part II, Item 8, and Part IV hereof and filed
as an Exhibit herewith.
<PAGE>
THE S.E.C.T.O.R. STRATEGY FUND(SM) L.P.
ANNUAL REPORT FOR 1997 ON FORM 10-K
Table of Contents
-----------------
PART I
------
<TABLE>
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PAGE
----
<S> <C>
Item 1 Business................................................................................... 2
Item 2 Properties................................................................................. 7
Item 3 Legal Proceedings.......................................................................... 8
Item 4 Submission of Matters to a Vote of Security Holders........................................ 8
PART II
-------
Item 5 Market for Registrant's Common Equity and Related Stockholder Matters..................... 8
Item 6 Selected Financial Data................................................................... 9
Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations..... 12
Item 7A Quantitative and Qualitative Disclosures About Market Risk................................ 16
Item 8 Financial Statements and Supplementary Data............................................... 16
Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure...... 16
PART III
--------
Item 10 Directors and Executive Officers of the Registrant........................................ 16
Item 11 Executive Compensation.................................................................... 18
Item 12 Security Ownership of Certain Beneficial Owners and Management............................ 19
Item 13 Certain Relationships and Related Transactions............................................ 19
PART IV
-------
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K............................ 20
</TABLE>
ii
<PAGE>
PART I
ITEM 1: BUSINESS
--------
(a) General Development of Business:
------------------------------
The S.E.C.T.O.R. Strategy Fund(SM) L.P. (Safety of Equity Capital;
Targeting Overall Return) (the "Partnership" or the "Fund") was organized under
the Delaware Revised Uniform Limited Partnership Act on April 30, 1990 and began
trading operations on July 16, 1990. The Fund made only the initial offering of
its units of limited partnership interest ("Units"); Units may be redeemed as of
the end of each calendar month. The Partnership engages in the speculative
trading of a portfolio of futures and forward contracts and related options in
the currencies, interest rates, stock index, metals, agricultural and energy
sectors of the world futures markets. The Fund's objective is achieving
substantial capital appreciation even while assuring investors of at least a
predetermined minimum Net Asset Value per Unit as of the Principal Assurance
Date.
Merrill Lynch Investment Partners Inc. (the "General Partner" or
"MLIP") is the general partner of the Partnership and selects and allocates the
Fund's assets among professional advisors ("Trading Advisors" or "Advisors"),
each unaffiliated with MLIP and each of which trades independently of the
others. MLIP also determines what percentage of the Fund's assets to allocate
to trading and what percentage to hold in reserve. Merrill Lynch Futures Inc.
(the "Commodity Broker" or "MLF") is the Partnership's commodity broker. The
General Partner is a wholly-owned subsidiary of Merrill Lynch Group, Inc.,
which, in turn, is a wholly-owned subsidiary of Merrill Lynch & Co., Inc.
("ML&Co."). The Commodity Broker is an indirect wholly-owned subsidiary of
ML&Co. (ML&Co. and its affiliates are herein sometimes referred to as "Merrill
Lynch.")
In addition to its trading accounts, the Partnership maintains a
cash account. From time to time, the General Partner allocates and reallocates
Partnership assets among its trading and cash accounts in an attempt to increase
profit potential while limiting the downside risks associated with futures and
forward trading (in order to prevent ML&Co. from incurring any obligations under
its guarantee of a minimum Net Asset Value per Unit, as described below).
Initially, the General Partner allocated approximately 30% of the Partnership's
assets to cash and approximately 70% to the trading accounts. As of December 31,
1997, approximately 100% was allocated to trading.
The total initial capitalization of the Partnership as of January 4,
1993 was $125,853,001. Through December 31, 1997, Units with an aggregate Net
Asset Value of $148,850,842 have been redeemed including December 31, 1997
redemptions which were actually paid in January 1998. The Partnership's
capitalization was $26,576,283, and the Net Asset Value of a Unit sold as of
July 16, 1990 for $100 was $194.53.
The Fund is a "principal protected" commodity pool. ML&Co. provides
the guarantee described below under Item 1(c), "Narrative Description of
Business -- ML&Co.'s 'Principal Protection' Undertaking to the Fund" -- that the
Net Asset Value per Unit will equal at least $150.06 as of September 30, 1999
(the "Principal Assurance Date"). Originally, the Fund's Principal Assurance
Date was set at five years after trading commenced. Effective October 1, 1995,
the Fund restarted its trading program for a new Time Horizon of two years'
duration. A third Time Horizon, also two years in length, was begun as of
October 1, 1997. This guarantee does not prevent substantial investor losses,
but rather serves only as a form of "stop loss," limiting the maximum loss which
investors who retain their Units until the Principal Assurance Date can incur.
In order to protect ML&Co. from any liability under its guarantee, at such time,
if any, as the Net Asset Value per Unit were to decline to 110% or less of the
present value of the guaranteed minimum Net Asset Value per Unit discounted back
from the current Principal Assurance Date, MLIP would terminate trading
altogether in order to ensure that ML&Co. incurred no financial obligation to
the Fund under ML&Co.'s guarantee of the minimum Net Asset Value per Unit.
Through December 31, 1997, the highest month-end Net Asset Value per
Unit was $199.62 (February, 1997) and the lowest was $102.26 (July, 1990).
-1-
<PAGE>
(b) Financial Information about Industry Segments:
--------------------------------------------
The Partnership's business constitutes only one segment for financial
reporting purposes, i.e., a speculative "commodity pool."
(c) Narrative Description of Business:
--------------------------------
GENERAL
The Fund trades in futures, options on futures and forward contracts
in major sectors of the world economy, with the objective of achieving
substantial capital appreciation over time, while assuring investors of at least
a predetermined minimum Net Asset per Unit as of the Principal Assurance Date.
The General Partner is the Partnership's trading manager, with
responsibility for selecting Advisors to manage the Partnership's assets,
allocating and reallocating Fund assets among these Advisors and determining the
percentage of the Partnership's assets committed to trading from time to time.
Although considered as a whole, the Partnership trades in a
diversified range of international markets, certain of the Trading Advisors,
considered individually, concentrate primarily on trading in a limited portfolio
of markets. The different "sectors" included in the Partnership's portfolio,
and the extent to which the portfolios traded by two or more Trading Advisors
may overlap, varies substantially over time.
The Fund accesses certain of the Trading Advisors not by opening
individual managed accounts with them, but rather through investing in private
funds sponsored by MLIP through which the trading accounts of different MLIP-
sponsored funds managed by the same Advisor and pursuant to the same strategy
are consolidated.
MLIP may from time to time direct certain individual Advisors to
manage their Fund accounts as if they were managing up to 50% more equity than
the actual capital allocated to them. This additional leverage is subject to
the condition that the Fund as a whole will not trade as if it had in excess of
20% more equity than actual capital.
One of the objectives of the Fund is to provide diversification for a
limited portion of the risk segment of the Limited Partners' portfolios.
Commodity pool performance has historically often demonstrated a low degree of
performance correlation with traditional stock and bond holdings. Since it
began trading, the Fund's returns have, in fact, frequently been significantly
non-correlated (not, however, negatively correlated) with the United States
stock and bond markets.
ML&CO.'S "PRINCIPAL PROTECTION" UNDERTAKING TO THE FUND
ML&Co., the parent company of the Merrill Lynch organization, which
includes the General Partner and the Commodity Broker, has agreed to contribute
sufficient capital to the Partnership so that it will have adequate funds, after
adjustment for all liabilities to third parties, that the Net Asset Value per
Unit will be no less than $150.06 as of the third Principal Assurance Date
(September 30, 1999). This guarantee, which is effective only as of the
Principal Assurance Date, is a guarantee only of the return of a subscriber's
initial investment, and not on a present value basis, not a guarantee of profit.
This guarantee is a general, unsecured obligation of ML&Co.
OPERATION OF THE PARTNERSHIP AFTER THE SECOND PRINCIPAL ASSURANCE DATE
When the Fund reached its first Principal Assurance Date, MLIP
"restarted" the Fund's trading program and the ML&Co. guarantee for a two year
period ending September 30, 1997. As of October 1, 1997, MLIP again "restarted"
the Fund's trading program and the ML&Co. guarantee for an additional two year
period ending September 30, 1999. MLIP may determine to dissolve the
Partnership as of the current Principal Assurance Date
-2-
<PAGE>
(September 30, 1999), to extend the ML&Co. guarantee for a certain period of
time (again resetting the minimum Net Asset Value per Unit guaranteed by ML&Co.)
or to continue to operate the Fund without a "principal protection" feature.
All investors will be given notice by no later than August 15, 1999 as to what
the operation of the Fund (if any) will be after the current Principal Assurance
Date.
USE OF PROCEEDS AND INTEREST INCOME
General. The Fund's assets are used as security for and to pay the
-------
Fund's trading losses as well as its expenses and redemptions. The primary use
of the Fund's capital is to permit the Advisors to trade on a speculative basis
in a wide range of different futures, forwards and options on futures markets,
while allocating to the Partnership's cash account such amounts as MLIP deems
appropriate in order to protect ML&Co. from any liability under its guarantee.
While being used for this purpose, the Fund's assets are also generally
available to earn interest, as more fully described below under "-- Available
Assets."
Market Sectors. The Partnership trades in a diversified group of
--------------
markets under the direction of multiple independent Advisors. These Advisors
can, and do, from time to time materially alter the allocation of their overall
trading commitments among different market sectors. Except in the case of
certain trading programs which are purposefully limited in the markets which
they trade, there is essentially no restriction on the commodity interests which
may be traded by any Advisor or the rapidity with which an Advisor may alter its
market sector allocations.
The Fund's financial statements contain information relating to the
market sectors traded by the Fund. There can, however, be no assurance as to
which markets may be included in the Fund's portfolio or as to in which market
sectors the Fund's trading may be concentrated at any one time or over time.
Market Types. The Fund trades on a variety of United States and
------------
foreign futures exchanges. Applicable exchange rules differ significantly among
different countries and exchanges. Substantially all of the Fund's off-exchange
trading takes place in the highly liquid, institutionally-based currency forward
markets. The forward markets are generally unregulated, and in its forward
trading the Fund does not deposit margin with respect to its positions. The
Partnership's forward currency trading is executed exclusively through the
Foreign Exchange Service Desk (the "F/X Desk") operated by MLIP and certain of
its affiliates, with MLF as the "back-to-back" intermediary to the ultimate
counterparties, which include Merrill Lynch International Bank ("MLIB").
As in the case of its market sector allocations, the Fund's
commitments to different types of markets -- U.S. and non-U.S., regulated and
unregulated -- differ substantially from time to time as well as over time. The
Fund has no policy restricting its relative commitments to any of these
different types of markets.
The Fund's financial statements contain information relating to the
types of markets traded by the Fund. There can, however, be no assurance as to
in which markets the Fund may trade or the Fund's trading may be concentrated at
any one time or over time.
Custody of Assets. All of the Fund's assets are currently held in
-----------------
customer accounts at Merrill Lynch.
Available Assets. The Fund earns interest, as described below, on its
----------------
"Available Assets," which can be generally described as the cash actually held
by the Fund or invested in short-term Treasury bills. Available Assets are held
primarily in U.S. dollars, and to a lesser extent in foreign currencies, and are
comprised of the following: (a) the Fund's cash balance in the offset accounts
(as described below) -- which includes "open trade equity" (unrealized gains and
losses on open positions) on United States futures contracts, which is paid into
or out of the Fund's account on a daily basis; (b) short-term Treasury bills
purchased by the Fund; and (c) the Fund's cash balance in foreign currencies
derived from its trading in non-U.S. dollar denominated futures and options
contracts, which includes open trade equity on those exchanges which settle
gains and losses on open positions in such contracts prior to the closing
-3-
<PAGE>
out of such positions. Available Assets do not include, and the Fund does not
earn interest on, the Fund's gains or losses on its open forward, commodity
option and certain foreign futures positions since such gains or losses are not
collected or paid until such positions are closed out.
The Partnership's Available Assets may be greater than, less than or
equal to the Fund's Net Asset Value (on which the redemption value of the Units
is based) primarily because Net Asset Value reflects all gains and losses on
open positions as well as accrued but unpaid expenses.
The interest income arrangements for the Partnership's U.S. dollar
Available Assets differ from those applicable to its non-U.S. dollar Available
Assets. Interest income, once accrued by the Fund, is subject to the risk of
trading losses.
Interest Earned on the Fund's U.S. Dollar Available Assets. The
----------------------------------------------------------
Fund's U.S. dollar Available Assets are held in cash in offset accounts and in
short-term Treasury bills purchased from dealers unaffiliated with Merrill
Lynch. Offset accounts are non-interest bearing demand deposit accounts
maintained with banks unaffiliated with Merrill Lynch. An integral feature of
the offset arrangements is that the participating banks specifically acknowledge
that the offset accounts are MLF customer accounts, not subject to any Merrill
Lynch liability.
MLF credits the Partnership, as of the end of each month, with
interest at the effective daily 91-day Treasury bill rate on the average daily
U.S. dollar Available Assets held in the offset accounts during such month. The
Fund receives all interest paid on the short-term Treasury bills in which it
invests.
The use of the offset account arrangements for the Partnership's U.S.
dollar Available Assets may be discontinued by Merrill Lynch whether or not
Merrill Lynch otherwise continues to maintain its offset arrangements. The
offset arrangements are dependent on the banks' continued willingness to make
overnight credits available to Merrill Lynch, which, in turn, is dependent on
the credit standing of ML&Co. If Merrill Lynch were to determine that the
offset arrangements had ceased to be practicable (either because ML&Co. credit
lines at participating banks were exhausted or for any other reason), Merrill
Lynch would thereafter attempt to invest all of the Fund's U.S. dollar Available
Assets to the maximum practicable extent in short-term Treasury bills. All
interest earned on the U.S. dollar Available Assets so invested would be paid to
the Fund, but MLIP would expect the amount of such interest to be less than that
available to the Fund under the offset account arrangements. The remaining U.S.
dollar Available Assets of the Fund would be kept in cash to meet variation
margin payments and pay expenses, but would not earn interest for the Fund.
The banks at which the offset accounts are maintained make available
to Merrill Lynch interest-free overnight credits, loans or overdrafts in the
amount of the Fund's U.S. dollar Available Assets held in the offset accounts,
charging Merrill Lynch a small fee for this service. The economic benefits
derived by Merrill Lynch -- net of the interest credits paid to the Fund and the
fee paid to the offset banks -- from the offset accounts have not exceeded 3/4
of 1% per annum of the Fund's average daily U.S. dollar Available Assets held in
the offset accounts. These revenues to Merrill Lynch are in addition to the
Brokerage Commissions and Administrative Fees paid by the Fund to MLF and MLIP,
respectively.
Interest Paid by Merrill Lynch on the Fund's Non-U.S. Dollar Available
----------------------------------------------------------------------
Assets. Under the single currency margining system implemented for the
- ------
Partnership, the Partnership itself does not deposit foreign currencies to
margin trading in non-U.S. dollar denominated futures contracts and options. MLF
provides the necessary margin, permitting the Fund to retain the monies which
would otherwise be required for such margin as part of the Fund's U.S. dollar
Available Assets. The Fund does not earn interest on foreign margin deposits
provided by MLF. The Fund does, however, earn interest on its non-U.S. dollar
Available Assets. Specifically, the Fund is credited by Merrill Lynch with
interest at the local short-term rate on realized and unrealized gains on non-
U.S. dollar denominated positions for such gains actually held in cash by the
Fund. Merrill Lynch charges the Fund Merrill Lynch's cost of financing realized
and unrealized losses on such positions.
-4-
<PAGE>
In order to avoid the expense of daily currency conversions, the Fund
holds foreign currency gains and finances foreign currency losses on an interim
basis until converted into U.S. dollars and either paid into or out of the
Fund's U.S. dollar Available Assets. Foreign currency gains or losses on open
positions are not converted into U.S. dollars until the positions are closed.
Assets of the Fund while held in foreign currencies are subject to exchange rate
risk.
The General Partner has determined that there may have been a
miscalculation in the interest credited to the Fund for a period prior to
November 1996. Accordingly, Merrill Lynch has credited certain amounts to the
Fund's investors (directly, not by crediting the Fund itself). For current
Merrill Lynch clients, this credit, which includes compounded interest, appears
on the December 1997 account statements. The total amount of the adjustment was
approximately $2,891,000.
CHARGES
The following table summarizes the charges incurred by the Fund during
1995, 1996 and 1997.
<TABLE>
<CAPTION>
1995 1996 1997
---------------------- ----------------- ----------------------
% OF
AVERAGE
% OF AVERAGE MONTH- % OF AVERAGE
COST DOLLAR MONTH-END DOLLAR END NET DOLLAR MONTH-END
- ---- AMOUNT NET ASSETS AMOUNT ASSETS AMOUNT NET ASSETS
------ ---------- ------ ------ ------ ----------
<S> <C> <C> <C> <C> <C> <C>
Brokerage $3,480,701 9.30% $2,636,241 8.21% $1,936,603 6.75%
Commissions
Administrative - - 75,321 0.23 55,331 0.19
Fees
Profit Shares 1,084,170 2.90 457,989 1.43 158,988 0.56
---------- ----- ---------- ---- ---------- ----
Total $4,564,871 12.20% $3,169,551 9.87% $2,150,922 7.50%
========== ====== ========== ===== ========== =====
</TABLE>
_______________
____________________
The foregoing table does not reflect the bid-ask spreads paid by the
Fund on its forward trading, or the annual benefits which may be derived by
Merrill Lynch from the deposit of certain of the Fund's U.S. dollar Available
Assets in offset accounts. See Item 1(c), "Narrative Description of Business --
Use of Proceeds and Interest Income."
The Fund's average month-end Net Assets during 1995, 1996 and 1997
equaled $37,436,445, $32,095,064 and $28,696,419 respectively.
During 1995, 1996 and 1997, the Fund earned $1,954,622, $1,364,326 and
$1,118,910 in interest income, or approximately 5.22%, 4.25% and 3.90% of the
Fund's average month-end Net Assets.
-5-
<PAGE>
As of January 1, 1996, the 9.0% per annum Brokerage Commissions paid
by the Fund to MLF were recharacterized as 8.75% per annum Brokerage Commissions
and a 0.25% per annum Administrative Fee paid by the Fund to MLIP. This
recharacterization had no economic effect on the Fund.
The variations in charges is primarily due to placing assets in Trading
LLCs (See Item 7).
______________________________
DESCRIPTION OF CURRENT CHARGES
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<CAPTION>
RECIPIENT NATURE OF PAYMENT AMOUNT OF PAYMENT
- --------- ----------------- -----------------
<S> <C> <C>
MLF Brokerage Commissions A flat-rate monthly commission of 0.729 of 1% (a 8.75%
annual rate) of the Fund's month-end assets committed to
trading. As of December 31, 1997, 100% of the Fund's
assets were allocated to trading.
During 1995, 1996 and 1997, the round-turn (each
purchase and sale or sale and purchase of a single futures
contract) equivalent rate of the Fund's flat-rate Brokerage
Commissions was approximately $86, $118 and $114,
respectively.
MLF Use of Fund assets Merrill Lynch may derive an annual benefit from the
deposit of certain of the Fund's U.S. dollar Available
Assets in offset accounts; such benefit to date has not
exceeded 3/4 of 1% of such average daily U.S. dollar
Available Assets.
MLIP Administrative Fees The Fund pays MLIP a monthly Administrative Fee equal
to 0.020833 of 1% of the Fund's month-end assets
committed to trading (0.25% annually). MLIP pays all of
the Fund's routine administrative costs.
MLIB Bid-ask spreads Under MLIP's F/X Desk arrangements, MLIB receives
bid-ask spreads on the forward trades it executes with the
Fund.
Other Bid-ask spreads The counterparties other than MLIB with which the F/X
Counterparties Desk deals also each receive bid-ask spreads on the
forward trades executed with the Fund.
MLIP F/X Desk service fees Under the F/X Desk arrangements, MLIP or another
Merrill Lynch entity receives a service fee equal, at current
exchange rates, to approximately $5.00 to $12.50 on each
purchase or sale of each futures contract-equivalent
forward contract executed with counterparties other than
MLIB.
</TABLE>
-6-
<PAGE>
<TABLE>
<CAPTION>
RECIPIENT NATURE OF PAYMENT AMOUNT OF PAYMENT
- --------- ----------------- -----------------
<S> <C> <C>
MLIB EFP differentials MLIB or an affiliate receives a differential spread for
exchanging the Fund's spot currency positions (which are
acquired through the F/X Desk, as described above) for
equivalent futures positions.
Trading Advisors Profit Shares Prior to January 1, 1997, all Advisors received quarterly
Profit Shares ranging from 15% to 25% (depending on the
Trading Advisor) of any New Trading Profit achieved by
their Fund account. As of January 1, 1997, a number of
Advisors agreed to receive only annual Profit Shares.
Profit Shares are also paid upon redemption of Units. New
Trading Profit is calculated separately in respect of each
Advisor, irrespective of the overall performance of the
Fund. The Fund may pay substantial Profit Shares during
periods when it is incurring significant overall losses.
MLF; Extraordinary expenses Actual costs incurred; none paid to date, and expected to
Others be negligible.
</TABLE>
REGULATION
The General Partner, the Trading Advisors and the Commodity Broker are
each subject to regulation by the Commodity Futures Trading Commission, (the
"CFTC") and the National Futures Association. Other than in respect of its
periodic reporting requirements under the Securities Exchange Act of 1934, the
Partnership itself is generally not subject to regulation by the Securities and
Exchange Commission. However, MLIP itself is registered as an "investment
adviser" under the Investment Advisers Act of 1940.
(i) through (xii) -- not applicable.
(xiii) The Partnership has no employees.
(d) Financial Information about Foreign and Domestic Operations
-----------------------------------------------------------
and Export Sales:
----------------
The Partnership does not engage in material operations in foreign
countries, nor is a material portion of the Partnership's revenues derived from
customers in foreign countries. The Partnership does, however, trade, from the
United States, on a number of foreign commodity exchanges.
ITEM 2: PROPERTIES
----------
The Partnership does not use any physical properties in the
conduct of its business.
The Partnership's only place of business is the place of business of
the General Partner (see Item 10 herein). The General Partner performs all
administrative services for the Partnership from the General Partner's offices.
-7-
<PAGE>
ITEM 3: LEGAL PROCEEDINGS
-----------------
ML&Co. -- the sole stockholder of Merrill Lynch Group, Inc. (which is
the sole stockholder of MLIP) -- as well as certain of its subsidiaries and
affiliates have been named as defendants in civil actions, arbitration
proceedings and claims arising out of their respective business activities.
Although the ultimate outcome of these actions cannot be ascertained at this
time and the results of legal proceedings cannot be predicted with certainty, it
is the opinion of management that the result of these matters will not be
materially adverse to the business operations of financial condition of MLIP or
the Fund.
MLIP itself has never been the subject of any material litigation.
On June 24, 1997, the CFTC accepted an Offer of Settlement from MLF
and others, in a matter captioned "In the Matter of Mitsubishi Corporation and
Merrill Lynch Futures Inc., et al.," CFTC Docket No. 97-10, pursuant to which
MLF, without admitting or denying the allegations against it, consented to a
finding by the Commission that MLF had violated Section 4c(a)(A) of the
Commodity Exchange Act, relating to wash sales (the CFTC alleged that the
customer entered nearly simultaneous orders without the intent to engage in a
bona fide trading transaction), and CFTC Regulation 1.37(a), relating to
recordkeeping requirements. MLF agreed to cease and desist from violating
Section 4c(a)(A) of the Act and Regulation 1.37(a), and to pay a civil monetary
penalty of $175,000.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
The Partnership has never submitted any matters to a vote of its
Limited Partners.
PART II
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
-------------------------------------------------------------
MATTERS
-------
(a) Market Information:
------------------
There is no trading market for the Units, nor will one develop.
Rather, Limited Partners may redeem Units as of the end of each month at Net
Asset Value. Units redeemed prior to the applicable Principal Assurance Date are
not entitled to any benefits under the ML&Co. guarantee.
(b) Holders:
-------
As of December 31, 1997, there were 1,264 holders of Units,
including the General Partner.
(c) Dividends:
---------
The Partnership has made no distributions since trading
commenced, nor does the General Partner presently intend to make any
distributions in the future.
-8-
<PAGE>
ITEM 6: SELECTED FINANCIAL DATA
-----------------------
The following selected financial data has been derived from the audited
financial statements of the Partnership.
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED
INCOME STATEMENT DATA DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
- --------------------- 1997 1996 1995 1994 1993
------------- ------------- ------------- ------------- ------------
<S> <C> <C> <C> <C> <C>
Revenues:
Realized Gain (Loss) ($100,337) $ 3,756,114 $10,514,336 ($1,230,908) $17,144,009
Change in Unrealized (Loss) Gain 105,173 (284,224) (1,160,384) (504,496) 247,039
----------- ----------- ----------- ------------ -----------
Total Trading Results 4,836 3,471,890 9,353,952 (1,735,404) 17,391,048
Interest Income 1,118,910 1,364,326 1,954,622 1,793,843 1,486,414
----------- ----------- ----------- ------------ -----------
Total Revenues 1,123,746 4,836,216 11,308,574 58,439 18,877,462
----------- ----------- ----------- ------------ -----------
Expenses:
Brokerage Commissions 1,936,603 2,636,241 3,480,701 4,498,435 5,826,942
Administrative Fees 55,331 75,321 -- -- --
Profit Shares 158,988 457,989 1,084,170 529,654 1,564,454
----------- ----------- ----------- ------------ -----------
Total Expenses 2,150,922 3,169,551 4,564,871 5,028,089 7,391,396
----------- ----------- ----------- ------------ -----------
Income from Investments 968,354 2,032,587 - - -
----------- ----------- ----------- ------------ -----------
Net Income (Loss) ($58,822) $ 3,699,252 $ 6,743,703 ($4,969,650) $11,486,066
=========== =========== =========== ============ ===========
December 31, December 31, December 31, December 31, December 31,
BALANCE SHEET DATA 1997 1996 1995 1994 1993
- ------------------ ----------- ----------- ----------- ------------ -----------
FUND NET ASSET VALUE $26,576,283 $31,949,032 $34,684,047 $ 41,096,545 $59,464,495
NET ASSET VALUE PER UNIT $194.53 $194.47 $173.02 $145.09 $159.95
</TABLE>
The variations in income statement line items is primarily due to
placing assets in Trading LLCs (See Item 7).
-9-
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
MONTH-END NET ASSET VALUE PER UNIT*
- ------------------------------------------------------------------------------------------------------------------
JAN. FEB. MAR. APR. MAY JUNE JULY AUG. SEPT. OCT. NOV. DEC.
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1993 $133.60 $140.26 $140.79 $145.07 $146.00 $148.84 $157.18 $161.47 $159.67 $159.00 $157.00 $159.95
- ------------------------------------------------------------------------------------------------------------------
1994 $152.94 $147.23 $150.83 $147.70 $152.86 $156.40 $155.52 $150.29 $152.71 $150.36 $149.40 $145.09
- ------------------------------------------------------------------------------------------------------------------
1995 $143.16 $151.75 $158.05 $161.56 $161.66 $158.32 $157.85 $163.55 $167.25 $167.26 $170.88 $173.02
- ------------------------------------------------------------------------------------------------------------------
1996 $181.96 $170.88 $173.16 $175.80 $173.86 $176.00 $171.33 $175.62 $177.79 $185.94 $195.14 $194.47
- ------------------------------------------------------------------------------------------------------------------
1997 $198.92 $199.62 $198.24 $192.04 $184.00 $184.90 $196.21 $184.18 $187.57 $186.07 $188.49 $194.53
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
*Pursuant to CFTC policy, monthly performance is presented only from January 1,
1993 even though Units were outstanding prior to such date.
-10-
<PAGE>
THE S.E.C.T.O.R. STRATEGY FUND(SM) L.P.
DECEMBER 31, 1997
TYPE OF POOL: SELECTED-ADVISOR/PUBLICLY-OFFERED/"PRINCIPAL PROTECTED"/(1)/
INCEPTION OF TRADING: July 16, 1990
AGGREGATE SUBSCRIPTIONS: $125,853,001
CURRENT CAPITALIZATION: $26,576,283
WORST MONTHLY DRAWDOWN/(2)/: (6.13)% (8/97)
WORST PEAK-TO-VALLEY DRAWDOWN/(3)/: (11.35)% (9/93-1/95)
_____________
NET ASSET VALUE PER UNIT, DECEMBER 31, 1997: $194.53
<TABLE>
<CAPTION>
-----------------------------------------------------------
MONTHLY RATES OF RETURN/(4)/
-----------------------------------------------------------
MONTH 1997 1996 1995 1994 1993
-----------------------------------------------------------
<S> <C> <C> <C> <C> <C>
JANUARY 2.29% 5.17% ( 1.33)% (4.39)% (0.30)%
-----------------------------------------------------------
FEBRUARY 0.35 (6.09) 6.00 (3.73) 4.99
-----------------------------------------------------------
MARCH (0.69) 1.33 4.15 2.44 0.37
-----------------------------------------------------------
APRIL (3.13) 1.53 2.22 (2.08) 3.05
-----------------------------------------------------------
MAY (4.19) (1.11) 0.06 3.50 0.64
-----------------------------------------------------------
JUNE 0.49 1.23 (2.07) 2.32 1.94
-----------------------------------------------------------
JULY 6.12 (2.65) (0.30) (0.57) 5.60
-----------------------------------------------------------
AUGUST (6.13) 2.50 3.61 (3.36) 2.73
-----------------------------------------------------------
SEPTEMBER 1.84 1.24 2.26 1.61 (1.12)
-----------------------------------------------------------
OCTOBER (0.80) 4.58 0.01 (1.54) (0.42)
-----------------------------------------------------------
NOVEMBER 1.30 4.95 2.16 (0.64) (1.25)
-----------------------------------------------------------
DECEMBER 3.20 (0.35) 1.25 (2.89) 1.88
-----------------------------------------------------------
COMPOUND ANNUAL 0.03% 12.40% 19.25% (9.29)% 19.36%
RATE OF RETURN
-----------------------------------------------------------
</TABLE>
(1) Pursuant to applicable CFTC regulations, a "Multi-Advisor" fund
is defined as one that allocates no more than 25% of its trading assets (i.e.,
assets committed to trading) to any single manager. As the Fund may allocate
more than 25% of its trading assets to one or more Advisors, it is referred to
as a "Selected-Advisor" fund. Applicable CFTC regulations define a "Principal
Protected" fund as one which is designed to limit the loss of participants'
initial investment. MLIP's trading leverage policies and the ML&Co. guarantee
limit Limited Partners' losses on their Units to the time value of their
investments over the Time Horizon from the beginning of trading to the Principal
Assurance Date.
(2) Worst Monthly Drawdown represents the largest negative Monthly
Rate of Return experienced since January 1, 1993 by the Fund; a drawdown on is
measured on the basis of month-end Net Asset Value only, and does not reflect
intra-month figures.
(3) Worst Peak-to-Valley Drawdown represents the greatest percentage
decline since January 1, 1993 from a month-end cumulative Monthly Rate of Return
without such cumulative Monthly Rate of Return being equaled or exceeded as of a
subsequent month-end. For example, if the Monthly Rate of Return was (1)% in
each of January and February, 1% in March and (2)% in April, the Peak-to-Valley
Drawdown would still be continuing at the end of April in the amount of
approximately (3)%, whereas if the Monthly Rate of Return had been approximately
3% in March, the Peak-to-Valley Drawdown would have ended as of the end of
February at approximately the (2)% level.
(4) Monthly Rate of Return is the net performance of the Fund during
the month of determination (including interest income and after all expenses
have been accrued or paid) divided by the total equity of the Fund as of the
beginning of such month.
-11-
<PAGE>
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
-----------------------------------------------------------------------
OF OPERATIONS
-------------
OPERATIONAL OVERVIEW; ADVISOR SELECTIONS
The Fund's results of operations depend on MLIP's ability to select
Advisors and the Advisors' ability to trade profitably. MLIP's selection
procedures, as well as the Advisors' trading methods, are confidential, so that
substantially the only available information relevant to the Fund's results of
operations is its actual performance record to date. However, because of the
speculative nature of its trading, the Fund's past performance is not
necessarily indicative of its future results.
MLIP's decision to terminate or reallocate assets among Trading
Advisors is based on a combination of numerous factors. Advisors are, in
general, terminated primarily for unsatisfactory performance, but other factors
- -- for example, a change in MLIP's or an Advisor's market outlook, apparent
deviation from announced risk control policies, excessive turnover of positions,
changes in principals, commitment of resources to other business activities,
etc. -- may also have a role in the termination or reallocation decision. The
market judgment and experience of MLIP's principals is an important factor in
its allocation decisions.
MLIP has no timetable or schedule for making Advisor changes or
reallocating, and generally makes a medium- to long-term commitment to all
Advisors selected. There can be no assurance as to the frequency or number of
Advisor changes that may take place in the future, or as to how long any Advisor
will manage assets for the Partnership.
RESULTS OF OPERATIONS
GENERAL. MLIP believes that multi-advisor futures funds should be
-------
regarded as medium- to long-term (i.e., three to five year) investments, but it
is difficult to identify trends in the Fund's operations and virtually
impossible to make any predictions regarding future results based on the results
to date. An investment in the Fund may be less successful over a longer than
over a shorter period.
Markets with sustained price trends tend to be more favorable to
managed futures investments than whipsaw, choppy markets, but (i) this is not
always the case, (ii) it is impossible to predict when price trends will occur
and (iii) different Advisors are affected differently by trending markets as
well as by particular types of trends.
MLIP attempts to control credit risk in the Fund's futures, forward
and options trading (the Fund does not trade derivatives other than futures and
forward contracts and options thereon) by trading only through MLF. MLF acts
solely as a broker or counterparty to the Fund's trades; it does not advise with
respect to, or direct, any such trading.
MLIP attempts to control the market risk inherent in the Fund's
trading by MLIP's multi-advisor strategy and Trading Advisor selections. MLIP
reviews the positions acquired by the Advisors on a daily basis in an effort to
determine whether the overall positions of the Fund may have become what MLIP
analyzes as being excessively concentrated in a limited number of markets -- in
which case MLIP may, as of the next month-end or quarter-end, adjust the Fund's
Advisor combination and/or allocations so as to attempt to reduce the risk of
such over-concentration occurring in the future. MLIP also adjusts the
percentage of each series' capital allocated to trading, with the principal
objective of protecting ML&Co. from any liability under its guarantee of a
$150.06 minimum Net Asset Value per Unit as of the Principal Assurance Date.
The market risk to the Fund is limited by the combination of its "principal
protection" feature and multi-advisor strategy.
The Units began trading with 70% of their capital committed to
trading. As of December 31, 1997 that percentage was 100%. MLIP determinations
as to what percentage of the Fund's assets to allocate to trading from time to
time -- again, a determination primarily dictated by MLIP's objective of
ensuring that ML&Co. is never required to make any payments under its guarantee
that the Net Asset Value per Unit will be at least $150.06 as of the Principal
Assurance Date -- has a material impact on the performance of the Fund.
-12-
<PAGE>
MLIP may consider making distributions to investors under certain
circumstances (for example, if substantial profits are recognized); however,
MLIP has not done so to date and does not presently intend to do so.
The variations in both the statement of financial condition and the
income statement line items is primarily due to the Partnership placing assets
under the management of certain of the Advisors not through opening managed
accounts with them but rather through investing in a private limited liability
company ("Trading LLC") sponsored by MLIP. The only members of the Trading LLC
are commodity pools sponsored by MLIP. The Trading LLC trades under the
management of a single Advisor pursuant to a single strategy and at a uniform
degree of leverage. Placing assets with an Advisor through investing in a
Trading LLC rather than a managed account has no economic effect on the
Partnership, except to the extent that the Partnership benefits from the Advisor
not having to allocate trades among a number of different accounts (rather than
acquiring a single position for the Trading LLC as a whole).
The results of the Partnership's Trading LLC investments are reflected
in the Partnership's financial statements as "Income from Investments." These
investments are reflected in the financial statements at fair value based upon
the net asset value of the Partnership's interest in the Trading LLCs. Fair
value is equal to the market value of the net assets of the Trading LLC. The
resulting difference between cost and fair value is reflected on the Statement
of Operations as income or loss from investments.
PERFORMANCE SUMMARY
1995
In 1995, prevailing price trends in several key markets enabled the
Advisors to trade profitably for the Fund. Although trading in many of the
traditional commodity markets may have been lackluster, the currency and
financial markets offered exceptional trading conditions. After months
characterized by very difficult trading environments, solid price trends across
many markets (including U.S. Treasury and non-dollar bond markets) began to
emerge during the first quarter of 1995. In the second quarter, market
volatility once again began to affect trading, as many previously strong price
trends began to weaken and, in some cases, reverse. The U.S. dollar hit new
lows versus the Japanese yen and Deutschemark before rebounding sharply. In
addition, there were strong indications that the U.S. economy was slowing which,
when coupled with a failure of the German Central Bank to lower interest rates,
stalled a rally in the German bond market. During the third quarter, there was
a correction in U.S. bond prices after several months of a strong uptrend.
Despite exposure to the global interest-rate markets, the Fund's long positions
in Treasury bonds had a negative impact on the Fund. Throughout August and into
September, the U.S. dollar rallied sharply against the Japanese yen and the
Deutschemark as a result of the coordinated intervention by major central banks
and widespread recognition of the growing banking crisis in Japan. Despite
continued price volatility during the final quarter of 1995, the Trading
Advisors were able to identify several trends in key markets. U.S. Treasury
bond prices continued their strong move upward throughout November, due both to
weak economic data and optimism on federal budget talks. As the year ended, the
yield on the 30-year Treasury bond was pushed to its lowest level in more than
two years.
1996
1996 began with the East Coast blizzard, continuing difficulties in
federal budget talks and an economic slowdown having a negative impact on many
markets. The Fund was profitable in January due to strong profits in currency
trading as the U.S. dollar reached a 23-month high against the Japanese yen. In
February, however, the Fund incurred its worst monthly loss due to the sudden
reversals in several strong price trends and considerable volatility in the
currency and financial markets. During March, large profits were taken in the
crude oil and gasoline markets as strong demand continued and talks between the
United Nations and Iraq were suspended. This trend continued into the second
quarter, during which strong gains were also recognized in the agricultural
markets as a combination of drought and excessive rain drove wheat and grain
prices to historic highs. In the late summer and early fall months, the Fund
continued to trade profitably as trending prices in a number of key markets
favorably impacted the Fund's performance. In September heating oil hit a five-
year high on soaring prices in Europe, and the Fund was also able to capitalize
on downward trends in the metals markets. Strong trends in the currency and
global bond markets produced significant
-13-
<PAGE>
gains in October and November, but the year ended with declining performance as
December witnessed the reversal of several strong upward trends and increased
volatility in key markets.
1997
Trend reversals and extreme market volatility, affected by such
factors as the Asian flu and El Nino, were characteristic of most of 1997.
However, the year proved to be a profitable one overall for the Fund as trends
in several key markets enabled the Trading Advisors to profit despite the
significant obstacles. Although trading results in several sectors may have
been lackluster, the global currency and bond markets offered noteworthy trading
opportunities, which resulted in significant profits in these markets during the
year. Additionally, the currency and interest rate sectors of the Fund's
portfolio represented its largest percentage of market commitments.
In currency markets, the U.S. dollar rallied and started 1997 on a
strong note, rising to a four-year high versus the Japanese yen and two-and-a-
half year highs versus the Deutsche mark and the Swiss franc. However, the
dollar underwent two significant corrections during the year. The first
correction occurred in the Spring against the Japanese yen, due to the G7
finance ministers' determination that a further dollar advance would be counter-
productive to their current goals. From August through mid-November, the dollar
corrected against the Eurocurrencies in advance of a well-advertised tightening
by the Bundesbank. By mid-December the dollar had bounced back to new highs
against the yen and was rallying against the mark.
Global interest rate markets began the year on a volatile note, as
investors evaluated economic data for signs of inflation. By the middle of the
year, economic data in key countries was positive indicating lower inflation and
igniting a worldwide rally in the bond markets. Specifically, investor
sentiment was particularly strong in the U.S., where prices on the 30-year
Treasury bond and 10-year Treasury note rose to their highest levels in over two
years. This followed a largely positive economic report delivered by Federal
Reserve Chairman Greenspan in testimony before Congress. Effects of the plunge
in the Hong Kong stock market in late October spread rapidly throughout the
world's financial markets, including global bond markets. After continued
volatility in subsequent months made trading difficult, 1997 interest rate
trading ended on a positive note when U.S. and Japanese bond markets rallied as
a flight to safety from plunging stock markets around the world occurred in
December.
In energy markets, a slump in crude oil prices was characteristic of
its lackluster performance from the beginning of the year. Early in 1997,
volatility returned in the energy markets, reflecting the impact of a winter
significantly warmer than normal. By mid-year, the decline in prices reversed
sharply as Saudi Arabia and Iran, together representing about 45% of OPEC's oil
production, joined forces to pressure oil-producing nations to stay within OPEC
production quotas. In December, financial and economic problems in Asia reduced
demand for oil, and, in combination with ample supplies, resulted in crude oil
prices declining once again.
Performance Overview
The principal variables which determine the net performance of the
Partnership are gross profitability and interest income. During all periods set
forth under "Selected Financial Data," the interest rates in many countries were
at unusually low levels. This negatively impacted revenues because interest
income is typically a major component of commodity pool profitability. In
addition, low interest rates are frequently associated with reduced fixed-income
market volatility, and in static markets the Fund's profit potential generally
tends to be diminished. On the other hand, during periods of higher interest
rates, the relative attractiveness of a high risk investment such as the
Partnership may be reduced as compared to high yielding and much lower risk
fixed-income investments.
The Partnership's Brokerage Commissions and Administrative Fees are a
constant percentage of assets charge. The only Fund costs (other than the
insignificant F/X Desk service fees and EFP differentials as well as bid-ask
spreads on forward contracts) which are not based on a percentage of the Fund's
assets are the Profit Shares payable to the Trading Advisors on an Advisor-by-
Advisor basis. During periods when Profit Shares are a high percentage of net
trading gains, it is likely that there has been substantial performance non-
correlation among the Advisors (so that the total Profit Shares paid to those
Advisors which have traded profitably are a high percentage, or perhaps even in
excess,
-14-
<PAGE>
of the total profits recognized, as other Advisors have incurred offsetting
losses, reducing overall trading gains but not the Profit Shares paid to the
successful Advisors) -- suggesting the likelihood of generally trendless, non-
consensus markets.
The events that primarily determine the Fund's profitability are those
that produce sustained and major price movements. The Advisors are generally
more likely to be able to profit from sustained trends, irrespective of their
direction, than from static markets. During the course of the Partnership's
performance to date, such events have ranged from Federal Reserve Board
reductions in interest rates, the apparent refusal of Iraq to arrive at a
settlement which would permit it to sell oil internationally, the inability of
the U.S. government to agree upon a federal budget and a combination of drought
and excessive rain negatively impacting U.S. agricultural harvesting as well as
planting. While these events are representative of the type of circumstances
which materially affect the Fund, the specific events which will do so in the
future can not be protected or identified.
Unlike many investment fields, there is no meaningful distinction in
the operation of the Fund between realized and unrealized profits. Most of the
contracts traded by the Fund are highly liquid and can be closed out at any
time. Furthermore, the profits on many open positions are effectively realized
on a daily basis through the payment of variation margin.
Except in unusual circumstances, factors -- regulatory approvals, cost
of goods sold, employee relations and the like -- which often materially affect
an operating business have virtually no impact on the Fund.
LIQUIDITY AND CAPITAL RESOURCES
The Fund's costs are generally proportional to its asset base, and,
within broad ranges of capitalization, the Advisors' trading positions (and the
resulting gains and losses) should increase or decrease in approximate
proportion to the size of the Fund account managed by each of them,
respectively.
Inflation per se is not a significant factor in the Fund's
profitability, although inflationary cycles can give rise to the type of major
price movements that can have a materially favorable or adverse impact on the
Fund's performance.
Changes in the level of prevailing interest rates could have a
material effect on the Fund's trading leverage. Interest rates directly affect
the calculation of the discounted value (discounted back from the Principal
Assurance Date) of the guaranteed minimum Net Asset Value per Unit and,
accordingly, the assets which a given series of Units has available for trading.
In its trading to date, the Fund has from time to time had substantial
unrealized gains and losses on its open positions. These gains or losses are
received or paid on a periodic basis as part of the routine clearing cycle on
exchanges or in the over-the-counter markets (the only over-the-counter market
in which the Fund trades is the inter-bank forward market in currencies). In
highly unusual circumstances, market illiquidity could make it difficult for
certain Advisors to close out open positions, and any such illiquidity could
expose the Fund to significant losses, or cause it to be unable to recognize
unrealized gains. However, in general, there is no meaningful difference
between the Fund's realized and unrealized gains.
THE YEAR 2000 COMPUTER ISSUE
Merrill Lynch's modifications for Year 2000 systems compliance are
proceeding according to plan and are expected to be completed in early 1999.
Based on information currently available, the remaining expenditures are
estimated at $200 million and will cover hardware and software upgrades, systems
consulting, and computer maintenance. These expenditures are not expected to
have a material adverse impact on Merrill Lynch's financial position, results of
operations, or cash flows in future periods. However, the failure of Merrill
Lynch's securities exchanges, clearing organizations, vendors, clients, or
regulators to resolve their own processing issues in a timely manner could
result in a material financial risk. Merrill Lynch is devoting necessary
resources to address all Year 2000 issues in a timely manner.
-15-
<PAGE>
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
NOT APPLICABLE.
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
-------------------------------------------
The financial statements required by this Item are included in Exhibit
13.01.
The supplementary financial information ("selected quarterly financial
data" and "information about oil and gas producing activities") specified by
Item 302 of Regulation S-K is not applicable.
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
---------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
There were no changes in or disagreements with accountants on
accounting or financial disclosure.
PART III
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- ------------------------------------------------------------
(a,b) Identification of Directors and Executive Officers:
--------------------------------------------------
As a limited partnership, the Partnership itself has no officers or
directors and is managed by the General Partner. Trading decisions are made by
the Trading Advisors on behalf of the Partnership.
The directors and executive officers of MLIP as of February 1, 1998
and their respective business backgrounds are as follows.
The following are the principal officers and directors of MLIP:
John R. Frawley, Jr. Chairman, Chief Executive Officer, President and
Director
Jeffrey F. Chandor Senior Vice President, Director of Sales,
Marketing and Research and Director
Joseph H. Moglia Director
Allen N. Jones Director
Stephen G. Bodurtha Director
Michael A. Karmelin Chief Financial Officer, Vice President and
Treasurer
Steven B. Olgin Vice President, Secretary and Director of
Administration
John R. Frawley, Jr. was born in 1943. Mr. Frawley is Chairman, Chief
Executive Officer, President and a Director of MLIP and Co-Chairman of Merrill
Lynch Futures Inc. ("MLF"). He joined Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("MLPF&S") in 1966 and has served in various positions, including
Retail and Institutional Sales, Manager of New York Institutional Sales,
Director of Institutional Marketing, Senior Vice President of Merrill Lynch
Capital Markets and Director of International Institutional Sales. Mr. Frawley
holds a Bachelor of Science degree from Canisius College. Mr. Frawley served on
the CFTC's Regulatory Coordination Advisory Committee from its formation in 1990
through its dissolution in 1994. Mr. Frawley is currently serving his fourth
consecutive one-year term as Chairman of the Managed Funds Association
(formerly, the Managed Futures
-16-
<PAGE>
Association), a national trade association that represents the managed futures,
hedge funds and fund of funds industry. Mr. Frawley is also a Director of that
organization. Mr. Frawley currently serves on a panel created by the Chicago
Mercantile Exchange and The Board of Trade of the City of Chicago to study
cooperative efforts related to electronic trading, common clearing and the
issues regarding a potential merger.
Jeffrey F. Chandor was born in 1942. Mr. Chandor is Senior Vice
President, the Director of Sales, Marketing and Research and a Director of MLIP.
He joined MLPF&S in 1971 and has served as the Product Manager of International
Institutional Equities, Equity Derivatives and Mortgage-Backed Securities as
well as Managing Director of International Sales in the United States, and
Managing Director of Sales in Europe. Mr. Chandor holds a Bachelor of Arts
degree from Trinity College, Hartford, Connecticut.
Joseph H. Moglia was born in 1949. He is a director of MLIP. In
1971, he graduated from Fordham University with a Bachelor of Arts degree in
Economics. He later received his Master of Science degree from the University
of Delaware. He taught at the high school and college level for sixteen years.
Mr. Moglia joined MLPF&S in 1984, and has served in a number of senior roles,
including Director of New York Fixed Income Institutional Sales, Director of
Global Fixed Institutional Sales, and Director of the Municipal Division. He is
currently Senior Vice President and Director of the Investment Strategy and
Product Group in Merrill Lynch Private Client, and Director of Middle Markets.
Allen N. Jones was born in 1942. Mr. Jones is a Director of MLIP and,
from July 1995 until January 1998, Mr. Jones was Chairman of the Board of
Directors of MLIP. Mr. Jones graduated from the University of Arkansas with a
Bachelor of Science, Business Administration degree in 1964. Since June 1992,
Mr. Jones has held the position of Senior Vice President of MLPF&S. From June
1992 through February 1994, Mr. Jones was the President and Chief Executive
Officer of Merrill Lynch Insurance Group, Inc. ("MLIG") and remains on the Board
of Directors of MLIG and its subsidiary companies. From February 1994 to April
1997, Mr. Jones was the Director of Individual Financial Services of the Merrill
Lynch Private Client Group. In April 1997, Mr. Jones became the Director of
Private Client marketing.
Stephen G. Bodurtha was born in 1958. Mr. Bodurtha is a Director of
MLIP. In 1980, Mr. Bodurtha graduated from Wesleyan University, Middletown,
Connecticut with a Bachelor of Arts degree in Government, magna cum laude. From
1980 to 1983, Mr. Bodurtha worked in the Investment Banking Division of Merrill
Lynch. In 1985, he was awarded his Master of Business Administration degree
from Harvard University, where he also served as Associates Fellow (1985-1986).
From 1986 to 1989, Mr. Bodurtha held the positions of Associate and Vice
President with Kidder, Peabody & Co., Incorporated where he worked in their
Financial Futures & Options Group. Mr. Bodurtha joined MLPF&S in 1989 and has
held the position of First Vice President since 1995. He has been the Director
in charge of MLPF&S's Structured Investments Group since 1995.
Michael A. Karmelin was born in 1947. Mr. Karmelin is Chief Financial
Officer, Vice President and Treasurer of MLIP. Prior to joining MLIP in April
1997, Mr. Karmelin was Chief Financial Officer of Merrill Lynch, Hubbard Inc.
("ML Hubbard"), a sponsor of real estate limited partnerships. Mr. Karmelin
joined ML Hubbard in January 1994 and was a Vice President of ML Hubbard. From
May 1994 to April 1997, he was the Chief Financial Officer of ML Hubbard,
responsible for its accounting, treasury and tax functions. Prior to joining ML
Hubbard, Mr. Karmelin held several senior financial positions with ML&Co and
MLPF&S from December 1985 to December 1993, including Vice President/Senior
Financial Officer Corporate Real Estate and Purchasing, Manager Commitment
Control/Capital Budgeting, and Senior Project Manager/Project Analysis. Prior
to joining ML&Co., Mr. Karmelin was employed at Avco Corporation for 17 years,
where he held a variety of financial positions. Mr. Karmelin holds a B.B.A.
degree in Accounting from Baruch College, C.U.N.Y. and a Master of Business
Administration degree in Corporate Strategy and Finance from New York
University. Mr. Karmelin passed the Certified Public Accounting examination in
1974 and is a member of the Treasury Management Association, the Institute of
Management Accountants and The Strategic Leadership Forum.
-17-
<PAGE>
Steven B. Olgin was born in 1960. Mr. Olgin is Vice President,
Secretary and the Director of Administration of MLIP. He joined MLIP in July
1994 and became a Vice President in July 1995. From 1986 until July 1994, Mr.
Olgin was an associate of the law firm of Sidley & Austin. In 1982, Mr. Olgin
graduated from The American University with a Bachelor of Science degree in
Business Administration and a Bachelor of Arts degree in Economics. In 1986, he
received his Juris Doctor degree from The John Marshall Law School. Mr. Olgin
is a member of the Managed Funds Association's Government Relations Committee
and has served as an arbitrator for the NFA. Mr. Olgin is also a member of the
Committee on Futures Regulation of the Association of the Bar of the City of New
York.
Messrs. Moglia and Bodurtha became Directors in January 1998.
As of December 31, 1997, the principals of MLIP had no investment in
the Fund, and MLIP's general partner interest in the Fund was valued at
$489,837.
MLIP acts as general partner to twelve public futures funds whose
units of limited partnership interest are registered under the Securities
Exchange Act of 1934: The Futures Expansion Fund Limited Partnership, The
Growth and Guarantee Fund L.P., ML Futures Investments II L.P., ML Futures
Investments L.P., John W. Henry & Co./Millburn L.P., The S.E.C.T.O.R. Strategy
Fund(SM) II L.P., The S.E.C.T.O.R. Strategy Fund(SM) V L.P., The S.E.C.T.O.R.
Strategy Fund(SM) VI L.P., ML Global Horizons L.P., ML Principal Protection L.P.
(formerly, ML Principal Protection Plus L.P.), ML JWH Strategic Allocation Fund
L.P. and the Fund. Because MLIP serves as the sole general partner of each of
these funds, the officers and directors of MLIP effectively manage them as
officers and directors of such funds.
(c) Identification of Certain Significant Employees:
-----------------------------------------------
None.
(d) Family Relationships:
--------------------
None.
(e) Business Experience:
-------------------
See Item 10(a)(b) above.
(f) Involvement in Certain Legal Proceedings:
----------------------------------------
None.
(g) Promoters and Control Persons:
-----------------------------
Not applicable
ITEM 11: EXECUTIVE COMPENSATION
----------------------
The directors and officers of the General Partner are remunerated by
the General Partner. The Partnership does not itself have any officers,
directors or employees. The Partnership pays Brokerage Commissions to an
affiliate of the General Partner and Administrative Fees to the General Partner.
The General Partner or its affiliates may also receive certain economic benefits
from holding the Fund's dollar Available Assets in offset accounts, as described
in Item 1(c) above. The directors and officers receive no "other compensation"
from the Partnership, and the directors receive no compensation for serving as
directors of the General Partner. There are no compensation plans or
arrangements relating to a change in control of either the Partnership or the
General Partner.
-18-
<PAGE>
ITEM 12: SECURITY OWNERSHIP OF CERTAIN OWNERS AND MANAGEMENT
---------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners:
-----------------------------------------------
As of December 31, 1997, no person or "group" is known to be or have
been the beneficial owner of more than five percent of the Units.
(b) Security Ownership of Management:
--------------------------------
As of December 31, 1997, the General Partner owned 2,518 Units
(unit-equivalent general partnership interests), which was less than 2% of the
total Units outstanding.
(c) Changes in Control:
------------------
None.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
----------------------------------------------
(a) Transactions with Management and Others:
---------------------------------------
The General Partner acts as administrative and trading manager of the
Fund. The General Partner provides all normal ongoing administrative functions
of the Partnership, such as accounting, legal and printing services. The
General Partner, which receives the Administrative Fees, pays all expenses
relating to such services.
(b) Certain Business Relationships:
------------------------------
MLF, an affiliate of the General Partner, acts as the principal
commodity broker for the Partnership.
In 1997 the Partnership accrued: (i) Brokerage Commissions of
$1,936,603 to the Commodity Broker, which included $325,521 in consulting fees
accrued by the Commodity Broker to the Trading Advisors; and (ii)
Administrative Fees of $55,331 to MLIP. Through its investments in Trading
LLCs, the following fees were paid: (i) Brokerage Commissions of $614,361 to the
Commodity Broker, which included $281,648 in consulting fees accrued by the
Commodity Broker to the Trading Advisors; and (ii) Administrative Fees of
$17,552 to MLIP. In addition, MLIP and its affiliates may have derived certain
economic benefits from maintaining a portion of the Fund's assets in "offset
accounts," as described under Item 1(c), "Narrative Description of Business --
Use of Proceeds and Interest Income -- Interest Earned on the Fund's U.S. Dollar
Available Assets" and Item 11, "Executive Compensation" herein, as well as from
the Fund's F/X Desk and "exchange of futures for physical" ("EFP") trading.
See Item 1(c), "Narrative Description of Business -- Charges" and
"Description of Current Charges" for a discussion of other business dealings
between MLIP affiliates and the Partnership.
(c) Indebtedness of Management:
--------------------------
The Partnership is prohibited from making any loans, to management or
otherwise.
(d) Transactions with Promoters:
---------------------------
Not applicable.
-19-
<PAGE>
PART IV
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
---------------------------------------------------------------
(a)1. Financial Statements: Page
-------------------- ----
Independent Auditors' Report 1
Statements of Financial Condition as
of December 31, 1997 and 1996 2
For the years ended December 31, 1997, 1996 and 1995
Statements of Income 3
Statements of Changes in Partners' Capital 4
Notes to Financial Statements 5-13
(a)2. Financial Statement Schedules:
-----------------------------
Financial statement schedules not included in this Form 10-K have been
omitted for the reason that they are not required or are not applicable or that
equivalent information has been included in the financial statements or notes
thereto.
(a)3. Exhibits:
--------
The following exhibits are incorporated by reference or are
filed herewith to this Annual Report on Form 10-K:
Designation Description
- ----------- -----------
3.01(i) Amended and Restated Certificate of Limited Partnership of
the Registrant, dated July 27, 1995.
Exhibit 3.01(i): Is incorporated herein by reference from Exhibit 3.01(d)
- --------------- contained in the Registrant's report on Form 10-Q for the
Quarter Ended June 30, 1995.
3.01(ii) Limited Partnership Agreement of the Partnership.
Exhibit 3.01(ii): Is incorporated herein by reference from Exhibit 3.01(a)
- ---------------- contained in Amendment No. 1 (as Exhibit A) to the
Registration Statement (File No. 33-34432) filed on May 25,
1990 on Form S-1 under the Securities Act of 1933 (the
"Registrant's Registration Statement").
10.01(o) Form of Advisory Agreement between the Partnership, Merrill
Lynch Investment Partners Inc., Merrill Lynch Futures Inc.
and each Trading Advisor.
Exhibit 10.01(o): Is incorporated herein by reference from Exhibit 10.01(o)
- ---------------- contained in the Registrant's report on Form 10-Q for the
Quarter Ended June 30, 1995.
10.02(a) Form of Consulting Agreement between each Trading Advisor of
the Partnership and Merrill Lynch Futures Inc.
Exhibit 10.02(a): Is incorporated herein by reference from Exhibit 10.02(a)
- ---------------- contained in the Registrant's Registration Statement.
-20-
<PAGE>
10.03(a) Form of Customer Agreement between the Partnership and
Merrill Lynch Futures Inc.
Exhibit 10.03(a): Is incorporated herein by reference from Exhibit 10.03(a)
- ---------------- contained in the Registrant's Registration Statement.
10.05 Merrill Lynch & Co., Inc. Guarantee.
Exhibit 10.05: Is incorporated herein by reference from Exhibit 10.05
- ------------- contained in the Registrant's Registration Statement.
10.06 Foreign Exchange Desk Service Agreement among Merrill Lynch
Investment Bank, Merrill Lynch Investment Partners Inc.,
Merrill Lynch Futures Inc. and the Fund.
Exhibit 10.06: Is incorporated herein by reference from Exhibit 10.06
- ------------- contained in the Registrant's report on Form 10-K for the
year ended December 31, 1996.
10.07(a) Form of Advisory and Consulting Agreement Amendment among
Merrill Lynch Investment Partners Inc., each Advisor, the
Fund and Merrill Lynch Futures Inc.
Exhibit 10.07(a): Is incorporated herein by reference from Exhibit 10.07(a)
- ---------------- contained in the Registrant's report on Form 10-K for the
year ended December 31, 1996.
10.07(b) Form of Amendment to the Customer Agreement among the
Partnership and MLF.
Exhibit 10.07(b): Is incorporated herein by reference from Exhibit 10.07(b)
- ---------------- contained in the Registrant's report on Form 10-K for the
year ended December 31, 1996.
13.01 1997 Annual Report and Independent Auditors' Report.
Exhibit 13.01: Is filed herewith.
- -------------
13.01(a) 1997 Annual Reports and Independent Auditors' Reports for the
following Trading Limited Liability Companies sponsored by
Merrill Lynch Investment Partners' Inc.:
ML Millburn Global L.L.C.
ML Sjo Prospect L.L.C.
ML Chesapeake Diversified L.L.C.
ML JWH Financial and Metals Portfolio L.L.C.
Exhibit 13.01(a): Is filed herewith.
- ----------------
28.01 Prospectus of the Partnership dated June 1, 1990.
Exhibit 28.01: Is incorporated by reference as filed with the Securities and
- ------------- Exchange Commission pursuant to Rule 424 under the Securities
Act of 1933 (File No. 33-34432) filed on June 7, 1990.
(b) Report on Form 8-K:
------------------
No reports on Form 8-K were filed during the fourth quarter of
1997.
-21-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
THE S.E.C.T.O.R. STRATEGY FUND(SM) L.P.
(SAFETY OF EQUITY CAPITAL; TARGETING OVERALL RETURN)
By: MERRILL LYNCH INVESTMENT PARTNERS INC.
General Partner
By: /s/ John R. Frawley, Jr.
------------------------
John R. Frawley, Jr.
Chairman, Chief Executive Officer, President and Director
(Principal Executive Officer)
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, this report has been signed on March 25, 1998 by the
following persons on behalf of the Registrant and in the capacities indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ John R. Frawley, Jr. Chairman, Chief Executive Officer, President and Director March 25, 1998
- --------------------------
John R. Frawley, Jr. (Principal Executive Officer)
/s/ Michael A. Karmelin Vice President, Chief Financial Officer and Treasurer March 25, 1998
- --------------------------
Michael A. Karmelin (Principal Financial and Accounting Officer)
/s/ Jeffrey F. Chandor Senior Vice President, and Director of Sales, March 25, 1998
- --------------------------
Jeffrey F. Chandor Marketing and Research, and Director
/s/ Allen N. Jones Director March 25, 1998
- --------------------------
Allen N. Jones
(Being the principal executive officer, the principal financial and accounting
officer and a majority of the directors of Merrill Lynch Investment Partners
Inc.)
MERRILL LYNCH INVESTMENT General Partner of Registrant March 25, 1998
PARTNERS INC.
By: /s/ John R. Frawley, Jr.
----------------------------
John R. Frawley, Jr.
</TABLE>
-22-
<PAGE>
THE S.E.C.T.O.R. STRATEGY FUND(SM) L.P.
1997 FORM 10-K
INDEX TO EXHIBITS
-----------------
Exhibit
-------
Exhibit 13.01 1997 Annual Report and Independent Auditors' Report
Exhibit 13.01(a) 1997 Annual Reports and Independent Auditors' Reports for
the following Trading Limited Liability Companies
sponsored by Merrill Lynch Investment Partners' Inc.:
ML Millburn Global L.L.C.
ML Sjo Prospect L.L.C.
ML Chesapeake Diversified L.L.C.
ML JWH Financial and Metals Portfolio L.L.C.
-23-
<PAGE>
EXHIBIT 13.01
THE S.E.C.T.O.R. STRATEGY FUND(SM) L.P.
(A Delaware Limited Partnership)
Financial Statements for the years ended
December 31, 1997, 1996 and 1995
and Independent Auditors' Report
<PAGE>
To: The Limited Partners of THE S.E.C.T.O.R. STRATEGY FUND(SM) L.P.
The S.E.C.T.O.R. Strategy Fund(SM) L.P. (the "Fund" or "Partnership") ended its
eighth fiscal year of trading on December 31, 1997 with a Net Asset Value
("NAV") per Unit of $194.53, representing an increase of 0.03% from the December
31, 1996 NAV per Unit of $194.47. During 1997, trading profits were generated
in the currency, interest rate, metals and stock index markets while losses were
incurred in energy and agriculture trading. (Trading results include that of
the Advisors, as well as, the Trading LLCs (defined in Note 6 to the financial
statements)).
Trend reversals and extreme market volatility, affected by such factors as the
Asian flu and El Nio, were characteristic of most of 1997. However, the year
proved to be a profitable one overall for the Fund as trends in several key
markets enabled the Trading Advisors to profit despite the significant
obstacles. Although trading results in several sectors may have been
lackluster, the global currency and bond markets offered noteworthy trading
opportunities, which resulted in significant profits in these markets during the
year. Additionally, the currency and interest rate sectors of the Fund's
portfolio represented its largest percentage of market commitments.
In currency markets, the U.S. dollar rallied and started 1997 on a strong note,
rising to a four-year high versus the Japanese yen and two-and-a-half year highs
versus the Deutsche mark and the Swiss franc. However, the dollar underwent two
significant corrections during the year. The first correction occurred in the
Spring against the Japanese yen, due to the G7 finance ministers' determination
that a further dollar advance would be counter-productive to their current
goals. From August through mid-November, the dollar corrected against the
Eurocurrencies in advance of a well-advertised tightening by the Bundesbank. By
mid-December the dollar had bounced back to new highs against the yen and was
rallying against the mark.
Global interest rate markets began the year on a volatile note, as investors
evaluated economic data for signs of inflation. By the middle of the year,
economic data in key countries was positive indicating lower inflation and
igniting a worldwide rally in the bond markets. Specifically, investor
sentiment was particularly strong in the U.S., where prices on the 30-year
Treasury bond and 10-year Treasury note rose to their highest levels in over two
years. This followed a largely positive economic report delivered by Federal
Reserve Chairman Greenspan in testimony before Congress. Effects of the plunge
in the Hong Kong stock market in late October spread rapidly throughout the
world's financial markets, including global bond markets. After continued
volatility in subsequent months made trading difficult, 1997 interest rate
trading ended on a positive note when U.S. and Japanese bond markets rallied as
a flight to safety from plunging stock markets around the world occurred in
December.
In energy markets, a slump in crude oil prices was characteristic of its
lackluster performance from the beginning of the year. Early in 1997,
volatility returned in the energy markets, reflecting the impact of a winter
significantly warmer than normal. By mid-year, the decline in prices reversed
sharply as Saudi Arabia and Iran, together representing about 45% of OPEC's oil
production, joined forces to pressure oil-producing nations to stay within OPEC
production quotas. In December, financial and economic problems in Asia reduced
demand for oil, and in combination with ample supplies, resulted in crude oil
prices declining once again.
<PAGE>
Although the overall return for the Fund might have paled in comparison to some
of the popular market indices during 1997, a significant observation is worth
noting. From the time the Dow Jones industrial average hit its high of 8259.31
in August through the end of the year, it declined 4.25% with a continued
increase in volatility. Conversely, the Fund, which has been designed with the
objective of producing returns non-correlated to traditional debt and equity
markets, steadily improved performance during the same time period. We
appreciate your continued investment in the Fund and look forward to 1998 and
the trading opportunities it may bring.
Sincerely,
John R. Frawley, Jr.
President
MERRILL LYNCH INVESTMENT PARTNERS INC.
(General Partner)
FUTURES TRADING IS SPECULATIVE AND INVOLVES A HIGH DEGREE OF RISK. PAST
PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.
<PAGE>
THE S.E.C.T.O.R. STRATEGY FUND(SM) L.P.
(A Delaware Limited Partnership)
- --------------------------------
TABLE OF CONTENTS
- -------------------------------------------------------------------------------
Page
----
INDEPENDENT AUDITORS' REPORT 1
FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 1997, 1996 AND 1995:
Statements of Financial Condition 2
Statements of Operations 3
Statements of Changes in Partners' Capital 4
Notes to Financial Statements 5-13
<PAGE>
INDEPENDENT AUDITORS' REPORT
- ----------------------------
To the Partners of
The S.E.C.T.O.R. Strategy Fund(SM) L.P.:
We have audited the accompanying statements of financial condition of The
S.E.C.T.O.R. Strategy Fund(SM) L.P. (a Delaware limited partnership; the
"Partnership") as of December 31, 1997 and 1996, and the related statements of
operations and changes in partners' capital for each of the three years in the
period ended December 31, 1997. These financial statements are the
responsibility of the Partnership'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. 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, these financial statements present fairly, in all material
respects, the financial position of The S.E.C.T.O.R. Strategy Fund(SM) L.P. as
of December 31, 1997 and 1996, and the results of its operations for each of the
three years in the period ended December 31, 1997 in conformity with generally
accepted accounting principles.
DELOITTE & TOUCHE LLP
February 6, 1998
New York, New York
<PAGE>
THE S.E.C.T.O.R. STRATEGY FUND(SM) L.P.
(A Delaware Limited Partnership)
-----------------------------
STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1997 AND 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASSETS 1997 1996
---------------- ----------------
<S> <C> <C>
Accrued interest (Note 2) $ 88,083 $ 89,553
Equity in commodity futures trading accounts:
Cash and option premiums 19,393,407 20,280,086
Net unrealized profit on open contracts 703,331 598,158
Investment (Note 6) 6,996,472 7,321,993
Receivable from investment (Note 6) 162,042 4,251,647
---------------- ----------------
TOTAL $ 27,343,335 $ 32,541,437
================ ================
LIABILITIES AND PARTNERS' CAPITAL
LIABILITIES:
Redemptions payable $ 532,040 $ 229,669
Brokerage commissions payable (Note 2) 147,339 153,046
Administrative fees payable (Note 2) 4,210 4,373
Profit Shares payable (Note 3) 83,463 205,317
---------------- ----------------
Total liabilities 767,052 592,405
---------------- ----------------
PARTNERS' CAPITAL:
General Partner (2,518 Units and 2,518 Units) 489,837 489,672
Limited Partner (134,097 Units and 161,771 Units) 26,086,446 31,459,360
---------------- ----------------
Total partners' capital 26,576,283 31,949,032
---------------- ----------------
TOTAL $ 27,343,335 $ 32,541,437
================ ================
NET ASSET VALUE PER UNIT
(Based on 136,615 and 164,289 Units outstanding) $ 194.53 $ 194.47
================ ================
</TABLE>
See notes to financial statements.
-2-
<PAGE>
THE S.E.C.T.O.R. STRATEGY FUND(SM) L.P.
(A Delaware Limited Partnership)
-------------------------------
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
-------------- ---------------- ---------------
<S> <C> <C> <C>
REVENUES:
Trading profits (loss):
Realized $ (100,337) $ 3,756,114 $10,514,336
Change in unrealized 105,173 (284,224) (1,160,384)
-------------- ---------------- ---------------
Total trading results 4,836 3,471,890 9,353,952
Interest income (Note 2) 1,118,910 1,364,326 1,954,622
-------------- ---------------- ---------------
Total revenues 1,123,746 4,836,216 11,308,574
-------------- ---------------- ---------------
EXPENSES:
Profit Shares (Note 3) 158,988 457,989 1,084,170
Administrative fees (Note 2) 55,331 75,321 -
Brokerage commissions (Note 2) 1,936,603 2,636,241 3,480,701
-------------- ---------------- ---------------
Total expenses 2,150,922 3,169,551 4,564,871
-------------- ---------------- ---------------
INCOME FROM INVESTMENT (Note 6) 968,354 2,032,587 -
-------------- ---------------- ---------------
NET INCOME (LOSS) $ (58,822) $ 3,699,252 $ 6,743,703
============== ================ ===============
NET INCOME (LOSS) PER UNIT:
Weighted average number of Units
outstanding (Note 4) 151,089 181,635 238,599
============== ================ ===============
Net income (loss) per weighted average
General Partner and Limited Partner Unit $ (0.39) $ 20.37 $ 28.26
============== ================ ===============
</TABLE>
See notes to financial statements.
-3-
<PAGE>
THE S.E.C.T.O.R. STRATEGY FUND(SM) L.P.
(A Delaware Limited Partnership)
------------------------------
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Units of
Partnership Limited General
Interest Partners Partner Total
-------------- --------------- ------------ ---------------
<S> <C> <C> <C> <C>
PARTNERS' CAPITAL
DECEMBER 31, 1994 283,248 $ 40,564,659 $ 531,886 $ 41,096,545
Redemptions (82,788) (12,963,852) (192,349) (13,156,201)
Net income - 6,647,877 95,826 6,743,703
-------------- --------------- ------------ ---------------
PARTNERS' CAPITAL
DECEMBER 31, 1995 200,460 34,248,684 435,363 34,684,047
Redemptions (36,171) (6,434,267) - (6,434,267)
Net income - 3,644,943 54,309 3,699,252
-------------- --------------- ------------ ---------------
PARTNERS' CAPITAL
DECEMBER 31, 1996 164,289 31,459,360 489,672 31,949,032
Redemptions (27,674) (5,313,927) - (5,313,927)
Net income (loss) - (58,987) 165 (58,822)
-------------- --------------- ------------ ---------------
PARTNERS' CAPITAL
DECEMBER 31, 1997 136,615 $ 26,086,446 $ 489,837 $ 26,576,283
============== =============== ============ ===============
</TABLE>
See notes to financial statements.
-4-
<PAGE>
THE S.E.C.T.O.R. STRATEGY FUND(SM) L.P.
(A Delaware Limited Partnership)
------------------------------
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
------------
The S.E.C.T.O.R. Strategy Fund(SM) L.P. (the "Partnership") was organized
under the Delaware Revised Uniform Limited Partnership Act on April 30, 1990
and commenced trading activities on July 16, 1990. The Partnership engages in
the speculative trading of futures, options on futures and forward contracts
on a wide range of commodities. Merrill Lynch Investment Partners Inc.
(formerly, ML Futures Investment Partners Inc.) ("MLIP" or the "General
Partner"), a wholly-owned subsidiary of Merrill Lynch Group, Inc. which, in
turn, is a wholly-owned subsidiary of Merrill Lynch & Co., Inc. ("Merrill
Lynch"), is the general partner of the Partnership and Merrill Lynch Futures
Inc. ("MLF"), also a Merrill Lynch affiliate, is its commodity broker. The
General Partner has agreed to maintain a general partner's interest of at
least 1% of the total capital of the Partnership. The General Partner and
each Limited Partner share in the profits and losses of the Partnership in
proportion to their respective interests in it.
MLIP selects independent advisors (the "Advisors" or the "Trading Advisors")
to manage the Partnership's assets, and allocates and reallocates the
Partnership's trading assets among existing, replacement and additional
Advisors.
MLIP also determines what percentage of the Partnership's total capital to
allocate to trading from time to time, attempting to balance the desirability
of reducing the opportunity costs of the Partnership's "principal protection"
structure by allocating 100% (or more) of the Partnership's assets to trading
against the necessity of preventing Merrill Lynch from ever being required to
make any payments to the Partnership under the Merrill Lynch guarantee (see
Note 5).
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 revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Revenue Recognition
-------------------
Commodity futures, options on futures and forward contract transactions are
recorded on the trade date, and open contracts are reflected in net
unrealized profit on open contracts in the Statements of Financial Condition
at the difference between the original contract value and the fair value.
The change in net unrealized profit (loss) on open contracts from one period
to the next is reflected in change in unrealized in the Statements of
Operations. Fair value is based on quoted market prices on the exchange or
market on which the contract is traded.
-5-
<PAGE>
Operating Expenses
------------------
MLIP pays for all routine operating costs (including legal, accounting,
printing, postage and similar administrative expenses) of the Partnership.
MLIP receives an administrative fee as well as a portion of the brokerage
commissions paid to MLF by the Partnership as reimbursement for the foregoing
expenses.
Income Taxes
------------
No provision for income taxes has been made in the accompanying financial
statements as each Partner is individually responsible for reporting income
or loss based on such Partner's respective share of the Partnership's income
and expenses as reported for income tax purposes.
Distributions
-------------
The Unitholders are entitled to receive, equally per Unit, any distribution
which may be made by the Partnership. No such distributions had been made as
of December 31, 1997.
Redemptions
-----------
A Limited Partner may require the Partnership to redeem some or all of such
Partner's Units at Net Asset Value as of the close of business on the last
business day of any month upon ten calendar days' notice.
Dissolution of the Partnership
------------------------------
The Partnership will terminate on December 31, 2010, or at an earlier date if
certain conditions occur, as well as under certain other circumstances as set
forth in the Limited Partnership Agreement.
2. RELATED PARTY TRANSACTIONS
The Partnership's U.S. dollar assets are held at MLF in cash. On the cash
held at MLF, the Partnership receives interest from Merrill Lynch at the
prevailing 91-day U.S. Treasury bill rate. Merrill Lynch may derive certain
economic benefits, in excess of the interest which Merrill Lynch pays to the
Partnership, from possession of such cash.
Merrill Lynch credits the Partnership with interest on the Partnership's non-
U.S. dollar-denominated assets based on local short-term rates. Merrill
Lynch charges the Partnership Merrill Lynch's cost of financing realized and
unrealized losses on the Partnership's non-U.S. dollar-denominated positions.
The General Partner has determined that there may have been a miscalculation
in the interest credited to the Partnership for a period prior to November
1996 (such period may extend prior to that covered by these financial
statements). Accordingly, the General Partner credited current and former
investors who maintained a Merrill Lynch customer account in December 1997
with interest which was compounded. Former investors who do not maintain a
Merrill Lynch customer account will be credited as their response forms are
processed. The total amount of the adjustment is approximately $2,891,000.
Since this amount was paid directly to investors by the General Partner, it
is not reflected in these financial statements. The General Partner has
determined that interest has been calculated appropriately since November
1996.
-6-
<PAGE>
The Partnership paid brokerage commissions to MLF at a flat monthly rate
equal to .75 of 1% (a 9% annual rate) of the Partnership's month-end assets
allocated to trading. Effective January 1, 1996, the percentage was reduced
to .729 of 1% (an 8.75% annual rate) of the Partnership's month-end assets
allocated to trading and the Partnership began to pay MLIP a monthly
administrative fee of .021 of 1% (a .25% annual rate) of the Partnership's
month-end assets allocated to trading (this recharacterization had no
economic effect on the Partnership). Assets allocated to trading are not
reduced, for purposes of calculating brokerage commissions and administrative
fees, by any accrued brokerage commissions, administrative fees, Profit
Shares or other fees or charges.
The General Partner estimates that the round-turn equivalent commission rate
charged to the Partnership during the years ended December 31, 1997, 1996 and
1995 was approximately $114 , $118 and $86, respectively (not including, in
calculating round-turn equivalents, forward contracts on a futures-equivalent
basis).
MLF pays the Trading Advisors annual Consulting Fees ranging up to 4% of the
Partnership's month-end assets allocated to them for management, after
reduction for a portion of the brokerage commissions.
The Partnership trades forward contracts through a foreign exchange service
desk (the "F/X Desk") established by MLIP. The F/X Desk gives the
Partnership access to counterparties in addition to (but also including)
Merrill Lynch International Bank ("MLIB"). MLIP or another Merrill Lynch
entity charges a service fee equal to, at current exchange rates,
approximately $5.00 to $12.50 on each purchase or sale (not round-turn) of a
futures contract-equivalent face amount of a given currency traded in the
forward markets. No service fees are charged on trades awarded to MLIB
(which receives bid-ask spreads on such trades).
In its exchange of futures for physical ("EFP") trading with Merrill Lynch,
the Partnership acquires spot or forward (collectively, "cash") currency
positions through the F/X Desk in the same manner and on the same terms as in
the case of the Partnership's other F/X Desk trading. When the Partnership
exchanges these positions for futures, there is a differential between the
prices of the two positions. This differential reflects, in part, the
different settlement dates of the cash and the futures contracts and
prevailing interest rates, but also includes a pricing spread in favor of
MLIB or another Merrill Lynch entity. The Advisors, to date, have made
little use of EFPs.
The Partnership's F/X Desk service fee and EFP differential costs have, to
date totaled no more than .25 of 1% per annum of the Partnership's average
month-end assets.
3. AGREEMENTS
The Partnership and the Advisors have each entered into Advisory Agreements.
The Advisory Agreements generally terminate one year after they are entered
into, subject to certain renewal rights exercisable by the Partnership. The
Advisors determine the commodity futures and forward contract trades to be
made on behalf of their respective Partnership accounts, subject to certain
Partnership trading policies and to certain rights reserved by the General
Partner.
In the case of the Trading LLC, as defined in Note 6, the Trading LLC entered
into the Advisory Agreements with the Advisor.
-7-
<PAGE>
Profit Shares, generally ranging from 15% to 25% of any New Trading Profit,
as defined, recognized by each Advisor considered individually irrespective
of the overall performance of the Partnership, either as of the end of each
calendar quarter or year, are paid to each of the Advisors. Profit Shares are
also paid out in respect of Units redeemed as of the end of interim months,
to the extent of the applicable percentage of any New Trading Profit
attributable to such Units.
4. WEIGHTED AVERAGE UNITS
The weighted average number of Units outstanding was computed for purposes of
disclosing net income or loss per weighted average Unit. The weighted
average number of Units outstanding at December 31, 1997, 1996 and 1995
equals the Units outstanding, as of such date, adjusted proportionately for
Units redeemed based on the respective length of time each was outstanding
during such period.
5. MERRILL LYNCH & CO., INC. GUARANTEE
Merrill Lynch has guaranteed to the Partnership that it will have sufficient
Net Assets as of the Principal Assurance Date, that the Net Asset Value per
Unit as of such Principal Assurance Date will equal, after adjustment for all
liabilities to third parties, not less than the minimum assured Net Asset
Value per Unit. Effective October 1, 1997, the Partnership restarted its
trading program for an additional Time Horizon, as defined, of two years'
duration, with a new Principal Assurance Date of September 30, 1999 and a
minimum assured Net Asset Value per Unit of $150.06.
6. INVESTMENT
The Partnership places assets under the management of certain of the Advisors
not through opening managed accounts with them but rather through investing
in a private limited liability company ("Trading LLC") sponsored by MLIP.
The only members of the Trading LLC are commodity pools sponsored by MLIP.
The Trading LLC trades under the management of a single Advisor pursuant to a
single strategy and at a uniform degree of leverage. Placing assets with an
Advisor through investing in a Trading LLC rather than a managed account has
no economic effect on the Partnership, except to the extent that the
Partnership benefits from the Advisor not having to allocate trades among a
number of different accounts (rather than acquiring a single position for the
Trading LLC as a whole).
The investment is reflected in the financial statements at fair value based
upon the Partnership's interest in the Trading LLC. Fair value is equal to
the market value of the net assets of the Trading LLC. The resulting
difference between cost and fair value is reflected on the Statement of
Operations as income or loss from investments.
At December 31, 1997 and 1996, the Partnership had an investment in the ML
JWH Financial and Metals Portfolio L.L.C. ("JWH LLC") of $6,996,472 and
$7,321,993 , respectively.
-8-
<PAGE>
Total revenues and fees with respect to such investment are set forth as
follows:
<TABLE>
<CAPTION>
For the year ended Total Brokerage Administrative Profit Income from
December 31, 1997 Revenues Commissions Fees Shares Investment
<S> <C> <C> <C> <C> <C>
$ 1,710,140 $ 614,361 $ 17,552 $ 109,873 $ 968,354
============= ============== ============== ============ ==============
For the year ended Total Brokerage Administrative Profit Income from
December 31, 1996 Revenues Commissions Fees Shares Investment
$ 2,622,561 $ 244,376 $ 6,982 $ 338,616 $ 2,032,587
============= ============== ============== ============ ==============
</TABLE>
Condensed statements of financial condition as of December 31, 1997 and 1996
and statements of income for the periods ended December 31, 1997 and 1996 for
JWH LLC are set forth as follows:
1997 1996
----------------- ------------------
Assets $ 62,481,438 $ 80,825,364
================= ==================
Liabilities $ 1,122,533 $ 19,848,210
Members' Capital 61,358,905 60,977,154
----------------- ------------------
Total $ 62,481,438 $ 80,825,364
================= ==================
Revenues $ 15,279,401 $ 19,365,949
Expenses 6,714,041 4,426,261
----------------- ------------------
Net Income $ 8,565,360 $ 14,939,688
================= ==================
-9-
<PAGE>
7. FAIR VALUE AND OFF-BALANCE SHEET RISK
The Partnership trades futures, options on futures and forward contracts in
interest rates, stock indices, commodities, currencies, energy and metals.
The Partnership's total trading results by reporting category for the years
ended December 31, 1997, 1996 and 1995 were as follows:
Total Trading Results
------------------------------------------------------
1997 1996 1995
---------------- --------------- ---------------
Interest Rates and
Stock Indices $ (30,260) $ 42,816 $ 5,101,222
Commodities (265,231) 693,244 809,839
Currencies 1,301,214 1,306,971 4,360,203
Energy (950,072) 1,265,776 (53,028)
Metals (50,815) 163,083 (864,284)
---------------- --------------- ---------------
$ 4,836 $ 3,471,890 $ 9,353,952
================ =============== ===============
Market Risk
-----------
Derivative instruments involve varying degrees of off-balance sheet market
risk, and changes in the level or volatility of interest rates, foreign
currency exchange rates or market values of the financial instruments or
commodities underlying such derivative instruments frequently result in
changes in the Partnership's unrealized profit (loss) on such derivative
instruments as reflected in the Statements of Financial Condition. The
Partnership's exposure to market risk is influenced by a number of factors,
including the relationships among the derivative instruments held by the
Partnership as well as the volatility and liquidity of the markets in which
the derivative instruments are traded.
The General Partner has procedures in place intended to control market risk,
although there can be no assurance that they will, in fact, succeed in doing
so. The procedures focus primarily on monitoring the trading of the Advisors
selected from time to time by the Partnership, adjusting the percentage of
the Partnership's total assets allocated to trading, calculating the Net
Asset Value of the Advisors' respective Partnership accounts as of the close
of business on each day and reviewing outstanding positions for over-
concentrations--both on an Advisor-by-Advisor and on an overall Partnership
basis. While the General Partner does not itself intervene in the markets to
hedge or diversify the Partnership's market exposure (although the General
Partner does adjust the percentage of the Partnership's total assets
allocated to trading), the General Partner may urge Advisors to reallocate
positions, or itself reallocate Partnership assets among Advisors (although
typically only as of the end of a month) in an attempt to avoid over-
concentration. However, such interventions are unusual. Except in cases in
which it appears that an Advisor has begun to deviate from past practice or
trading policies or to be trading erratically, the General Partner's basic
risk control procedures consist simply of the ongoing process of Advisor
monitoring and selection, with the market risk controls being applied by the
Advisors themselves.
One important aspect of the General Partner's risk controls is its
adjustments to the leverage at which the Partnership trades. By controlling
the percentage of the Partnership's assets allocated to trading, the General
Partner can directly affect the market exposure of the Partnership. Leverage
control is the principal means by which the General Partner hopes to be able
to ensure that Merrill Lynch is never required to make any payments under its
guarantee that the Net Asset Value per Unit will equal no less than $100 as
of the Principal Assurance Date.
-10-
<PAGE>
Fair Value
----------
The derivative instruments traded by the Partnership are marked to market
daily with the resulting unrealized profit (loss) recorded in the Statements
of Financial Condition and the related profit (loss) reflected in trading
revenues in the Statements of Operations.
The contract/notional values of open contracts as of December 31, 1997 and
1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------------- ------------------------------------------------
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
-------------------------------------------- ----------------------------------------------------
<S> <C> <C> <C> <C>
Interest Rates
& Stock Indices $ 82,771,267 $ 65,284,299 $ 42,735,419 $ 6,385,831
Commodities 745,270 8,158,197 904,420 3,430,113
Currencies 17,541,232 36,204,865 19,592,956 23,538,327
Energy 772,649 4,558,618 3,032,640 -
Metals 1,466,026 8,489,672 1,911,070 4,170,523
---------------- ------------------------ ---------------------- ---------------------
$ 103,296,444 $ 122,695,651 $ 68,176,505 $ 37,524,794
================ ======================== ====================== =====================
</TABLE>
Substantially all of the Partnership's derivative financial instruments
outstanding at December 31, 1997 expire within one year.
The contract/notional values of the Partnership's open exchange-traded and
non-exchange-traded open derivative instrument positions as of December 31,
1997 and 1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
----------------------------------------------- -------------------------------------------------
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
----------------------- ------------------------ ----------------------- --------------------
<S> <C> <C> <C> <C>
Exchange- $ 89,274,821 $ 100,878,257 $ 52,198,423 $ 15,604,964
Traded
Non-Exchange- 14,021,623 21,817,394 15,978,082 21,919,830
Traded
---------------------- --------------------- ------------------------ --------------------
$ 103,296,444 $ 122,695,651 $ 68,176,505 $ 37,524,794
====================== ===================== ======================== ====================
</TABLE>
-11-
<PAGE>
The average fair values, based on contract/notional values, of the
Partnership's derivative instrument positions which were open as of the end
of each calendar month during the years ended December 31, 1997 and 1996 were
as follows:
<TABLE>
<CAPTION>
1997 1996
---------------------------------------------- --------------------------------------------
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
-------------------- --------------------- --------------------------------------------
<S> <C> <C> <C> <C>
Interest Rates
and Stock Indices $ 77,150,089 $ 37,849,496 $ 71,153,009 $ 40,875,010
Commodities 3,925,015 3,897,478 7,364,336 2,460,805
Currencies 18,669,147 28,646,929 43,682,609 47,984,354
Energy 3,139,779 2,312,458 2,998,134 1,830,883
Metals 5,072,385 7,398,721 4,032,918 8,151,036
----------------- ----------------- ---------------- -----------------
$ 107,956,415 $ 80,105,082 $ 129,231,006 $ 101,302,088
================= ================= ================ =================
</TABLE>
A portion of the amounts indicated as off-balance sheet risk reflects
offsetting commitments to purchase and to sell the same derivative instrument
on the same date in the future. These commitments are economically
offsetting but are not, as a technical matter, offset in the forward markets
until the settlement date.
Credit Risk
-----------
The risks associated with exchange-traded contracts are typically perceived
to be less than those associated with over-the-counter (non-exchange-traded)
transactions, because exchanges typically (but not universally) provide
clearinghouse arrangements in which the collective credit (in some cases
limited in amount, in some cases not) of the members of the exchange is
pledged to support the financial integrity of the exchange. In over-the-
counter transactions, on the other hand, traders must rely solely on the
credit of their respective individual counterparties. Margins, which may be
subject to loss in the event of a default, are generally required in exchange
trading, and counterparties may require margin in the over-the-counter
markets.
The fair value amounts in the above tables represent the extent of the
Partnership's market exposure in the particular class of derivative
instrument listed, but not the credit risk associated with counterparty
nonperformance. The credit risk associated with these instruments from
counterparty nonperformance is the net unrealized profit, if any, included on
the Statements of Financial Condition.
The Partnership also has credit risk because the sole counterparty or broker
with respect to most of the Partnership's assets is MLF.
-12-
<PAGE>
The gross unrealized profit and net unrealized profit (loss) on the
Partnership's open derivative instrument positions as of December 31, 1997
and 1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
--------------------------------- ---------------------------------
Gross Unrealized Net Unrealized Gross Unrealized Net Unrealized
Profit Profit (Loss) Profit Profit
-----------------------------------------------------------------------
<S> <C> <C> <C> <C>
Exchange-Traded $ 1,076,647 $ 709,701 $ 621,352 $ 481,708
Non-Exchange-Traded 362,223 (6,370) 361,146 116,450
-------------- -------------- -------------- --------------
$ 1,438,870 $ 703,331 $ 982,498 $ 598,158
============== ============== ============== ==============
</TABLE>
The Partnership controls credit risk by dealing almost exclusively with
Merrill Lynch entities as brokers and counterparties.
The Partnership, in its normal course of business, enters into various
contracts, with MLF acting as its commodity broker. Pursuant to the
brokerage arrangement with MLF, to the extent that such trading results in
receivables from and payables to MLF, these receivables and payables are
offset and reported as a net receivable or payable.
To the best of the knowledge and belief of the
undersigned, the information contained in this
report is accurate and complete.
/s/ Michael A. Karmelin
Michael A. Karmelin
Chief Financial Officer
Merrill Lynch Investment Partners Inc.
General Partner of
The S.E.C.T.O.R. Strategy Fund(SM) L.P.
-13-
<PAGE>
ML SJO PROSPECT L.L.C.
(A DELAWARE LIMITED LIABILITY COMPANY)
Financial Statements for the Period from
January 2, 1997 (Commencement of Operations)
to December 31, 1997 and Independent Auditors' Report
<PAGE>
ML Sjo Prospect L.L.C.
(A Delaware Limited Liability Company)
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
Page
INDEPENDENT AUDITORS' REPORT 1
FINANCIAL STATEMENTS FOR THE PERIOD FROM
January 2, 1997 (COMMENCEMENT OF OPERATIONS)
TO DECEMBER 31, 1997:
Statement of Financial Condition 2
Statement of Income 3
Statement of Changes in Members' Capital 4
Notes to Financial Statements 5-10
<PAGE>
INDEPENDENT AUDITORS' REPORT
- ----------------------------
To the Members of
ML Sjo Prospect L.L.C.:
We have audited the accompanying statement of financial condition of ML Sjo
Prospect L.L.C. (a Delaware limited liability company; the "Company") as of
December 31, 1997, and the related statements of income and changes in
members' capital for the period from January 2, 1997 (commencement of
operations) to December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit 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. 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 audit provides a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of ML Sjo Prospect L.L.C. as of December 31,
1997, and the results of its operations for the period from January 2, 1997
(commencement of operations) to December 31, 1997 in conformity with generally
accepted accounting principles.
DELOITTE & TOUCHE LLP
February 6, 1998
New York, New York
<PAGE>
ML SJO PROSPECT L.L.C.
(A Delaware Limited Liability Company)
STATEMENT OF FINANCIAL CONDITION
DECEMBER 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Accrued interest (Note 2) $ 93,192
Equity in commodity futures trading accounts:
Cash and option premiums 20,891,450
Net unrealized profit on open contracts 255,565
------------------
TOTAL $ 21,240,207
==================
LIABILITIES AND VOTING MEMBERS' CAPITAL
LIABILITIES:
Withdrawals payable $ 1,716,855
Brokerage commissions payable (Note 2) 154,735
Profit Shares payable (Note 3) 182,607
Administrative fees payable (Note 2) 4,420
-------------------
Total liabilities 2,058,617
VOTING MEMBERS' CAPITAL 19,181,590
Total Voting Members' capital 19,181,590
--------------------
TOTAL $ 21,240,207
====================
See notes to financial statements.
- 2 -
<PAGE>
ML SJO PROSPECT L.L.C.
(A Delaware Limited Liability Company)
STATEMENT OF INCOME
FOR THE PERIOD FROM JANUARY 2, 1997
(COMMENCEMENT OF OPERATIONS)
TO DECEMBER 31, 1997
- --------------------------------------------------------------------------------
REVENUES:
Trading profit:
Realized $ 2,563,871
Unrealized 255,565
----------------
Total trading results 2,819,436
Interest income (Note 2) 1,083,832
----------------
Total revenues 3,903,268
----------------
EXPENSES:
Brokerage commissions (Note 2) 1,874,826
Profit Shares (Note 3) 216,149
Administrative fees (Note 2) 53,103
----------------
Total expenses 2,144,078
----------------
NET INCOME $ 1,759,190
=================
See notes to financial statements.
- 3 -
<PAGE>
ML SJO PROSPECT L.L.C.
(A Delaware Limited Liability Company)
STATEMENT OF CHANGES IN MEMBERS' CAPITAL
FOR THE PERIOD FROM JANUARY 2, 1997
(COMMENCEMENT OF OPERATIONS)
TO DECEMBER 31, 1997
- --------------------------------------------------------------------------------
Non-Voting
Voting Members Members Total
-------------- ----------- ------------
Initial Contributions $ 19,005,590 $ 2,036,797 $ 21,042,387
Contributions 4,053,526 - 4,053,526
Withdrawals (5,495,743) (2,177,770) (7,673,513)
Net Income 1,618,217 140,973 1,759,190
------------- ----------- ------------
MEMBERS' CAPITAL,
DECEMBER 31, 199 19,181,590 - 19,181,590
============= =========== =============
See notes to financial statements.
- 4 -
<PAGE>
ML SJO PROSPECT L.L.C.
(A Delaware Limited Liability Company)
NOTES TO FINANCIAL STATEMENTS
FOR THE PERIOD FROM JANUARY 2, 1997
(COMMENCEMENT OF OPERATIONS)
TO DECEMBER 31, 1997
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
------------
ML Sjo Prospect L.L.C. (the "Company") was organized under the Delaware
Limited Liability Company Act on December 19, 1996 and commenced trading
activities on January 2, 1997. The Company engages in the speculative
trading of futures, options on futures and forward contracts on a wide
range of commodities. Merrill Lynch Investment Partners Inc. (formerly, ML
Futures Investment Partners Inc.) ("MLIP"), a wholly-owned subsidiary of
Merrill Lynch Group, Inc., which in turn is a wholly-owned subsidiary of
Merrill Lynch & Co., Inc. ("Merrill Lynch"), has been delegated
administrative authority over the Company, and Merrill Lynch Futures Inc.
("MLF"), also an affiliate of MLIP, is its commodity broker. The Company
has authorized two classes of Membership Interests: Non-Voting Membership
Interests and Voting Membership Interests ("Interests"). These two classes
of Interests have common economic interests in the Company, but the Non-
Voting Interests, which are held by non-United States companies, do not
participate in any respect in the management of the Company, or engage,
directly or indirectly, in the participation in or control of all or any
portion of the business activities or affairs of the Company, such
management being vested solely in the Voting Interests, which are held by
United States limited partnerships. The Voting Members, acting as Members
without any "manager," mutually control all business activities and affairs
of the Company by agreement of the majority in interest of such Members,
subject to the trading authority vested in and delegated to Sjo, Inc. (the
"Advisor" or "Sjo") and the administrative authority vested in and
delegated to MLIP. The Members of the Company, each of which is a
"commodity pool" sponsored by MLIP, share in the trading profit (loss) and
interest income of the Company in proportion to their respective capital
accounts.
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 as well as the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
Revenue Recognition
-------------------
Commodity futures, options on futures, and forward contract transactions
are recorded on the trade date and open contracts are reflected in net
unrealized profit on open contracts in the Statement of Financial Condition
at the difference between the original contract value and the fair value.
The change in net unrealized profit on open contracts from one period to
the next is reflected in change in unrealized in the Statement of Income.
Fair value is based on quoted market prices on the exchange or market on
which the contract is traded.
- 5 -
<PAGE>
Organizational Costs
--------------------
MLIP paid all organizational costs relating to the Company without direct
reimbursement from the Company or any Member.
Income Taxes
------------
No provision for income taxes has been made in the accompanying financial
statements as each Member is individually responsible for reporting income
or loss based on such Member's respective share of the Company's income and
expenses as reported for income tax purposes. Non-Voting Members are not
subject to U.S. tax.
Distributions
-------------
No distribution (except upon withdrawals) had been made by the Company to
any Member as of December 31, 1997.
Withdrawals
-----------
A Member may withdraw some or all of such Member's Capital at Net Asset
Value as of the close of business on any business day. There are no
withdrawal fees or charges.
Dissolution of the Company
--------------------------
The Company will terminate on December 30, 2046 or at an earlier date if
certain conditions occur, as well as under certain other circumstances as
set forth in the Organization Agreement. Were the Advisor to cease to
manage the Company's account, the Company would dissolve.
2. RELATED PARTY TRANSACTIONS
The Company's U.S. dollar assets are held at MLF in cash. On the cash held
at MLF, the Company receives interest from Merrill Lynch at the prevailing
91-day U.S. Treasury bill rate. Merrill Lynch may derive certain economic
benefits, in excess of the interest which Merrill Lynch pays to the
Partnership, from possession of such cash.
Merrill Lynch credits the Company with interest on the Company's non-U.S.
dollar-denominated assets based on local short-term rates. Merrill Lynch
charges the Company Merrill Lynch's cost of financing realized and
unrealized losses on the Company's non-U.S. dollar-denominated positions.
Following the allocation of the Company's trading profit (loss) and
interest income among the Members' respective capital accounts, MLIP
calculates the brokerage commissions, profit shares, administrative fees
and other expenses due from the Company to third parties, in respect of the
Company's trading on behalf of the respective Members (the Company being
subject to different commissions, fees and expenses in respect of its
trading as allocable to the various different Members). Such commissions,
fees and expenses are specifically allocated as of the end of each
accounting period (not pro rata based on the Members' respective capital
accounts) to, and deducted from, the appropriate Members' capital accounts
and paid out by the Company. The Company pays brokerage commissions to MLF,
at flat monthly rates reflecting the fee arrangement between each Member
and MLF. During the period from January 2, 1997 to December 31, 1997, such
rates ranged from .729 of 1% (an 8.75% annual rate) to .831 of 1% (a 9.75%
annual rate) of each Member's month-end assets invested in the Company. As
of December 31, 1997, the rate is .729 of 1% ( an 8.75% annual rate) of the
Member's month-end assets invested in the Company. As of
- 6 -
<PAGE>
December 31, 1997, the rate is .729 of 1% (an 8.75% annual rate) of the
Member's month-end assets invested in the Company.
The Company pays MLIP a monthly administrative fee of .021 of 1% (a .25%
annual rate) of the Member's month-end assets invested in the Company.
Month-end assets are not reduced for purposes of
calculating brokerage commissions and administrative fees by any accrued
brokerage commissions, administrative fees, profit shares or other fees or
charges.
MLF pays the Advisor an annual consulting fee of 1% of the Company's
average month-end assets, after reduction for a portion of the brokerage
commissions.
The Company trades forward contracts through a foreign exchange service
desk (the "F/X Desk") established by MLIP. The F/X Desk gives the Company
access to counterparties in addition to (but also including) Merrill Lynch
International Bank ("MLIB"). MLIP or another Merrill Lynch entity charges a
service fee equal to, at current exchange rates, approximately $5.00 to
$12.50 on each purchase or sale (not round-turn) of a futures contract-
equivalent face amount of a given currency traded in the forward markets.
No service fees are charged on trades awarded to MLIB (which receives bid-
ask spreads on such trades).
In its exchange of futures for physical ("EFP") trading with Merrill Lynch,
the Company acquires spot or forward (collectively, "cash") currency
positions through the F/X Desk in the same manner and on the same terms as
in the case of the Company's other F/X Desk trading. When the Company
exchanges these positions for futures, there is a differential between the
prices of the two positions. This differential reflects, in part, the
different settlement dates of the cash and the futures contracts and
prevailing interest rates, but also includes a pricing spread in favor of
MLIB or another Merrill Lynch entity. The Advisor, to date, has made little
use of EFPs.
The Company's F/X Desk service fee and EFP differential costs have, to date
totaled no more than .25 of 1% per annum of the Company's average month-end
assets.
3. ADVISORY AGREEMENT
The Company and the Advisor have entered into an Advisory Agreement. This
Advisory Agreement terminated one year after it is entered into, and has
been renewed until 12/31/98 subject to certain additional renewal rights
exercisable by the Company. The Advisor determines the commodity futures
and forward contract trades to be made on behalf of the Company, subject to
certain Company trading policies and to certain rights reserved by MLIP.
The Company pays to Sjo an annual Profit Share equal to 15% of any New
Trading Profit, as defined, attributable to each Member's capital account
in the Company. Profit Shares, which are calculated separately in respect
of each Member's capital account, are determined as of the end of each
calendar year and are also be paid to Sjo upon the withdrawal of capital
from the Company by a Member for whatever purpose, other than to pay
expenses.
- 7 -
<PAGE>
4. FAIR VALUE AND OFF-BALANCE SHEET RISK
The Company trades futures, options on futures and forward contracts on
interest rates, stock indices, commodities, currencies, energy and metals.
The Company's trading results by reporting category were as follows:
Total Trading Results
---------------------
Interest Rates $ 1,608,016
Stock Indices (111,089)
Commodities 1,258,342
Currencies 450,478
Energy (516,170)
Metals 129,859
--------------------
$ 2,819,436
====================
Market Risk
Derivative instruments involve varying degrees of off-balance sheet market
risk, and changes in the level or volatility of interest rates, foreign
currency exchange rates or the market values of the underlying financial
instruments or commodities underlying such derivative instruments
frequently result in changes in the Company's unrealized profit (loss) on
such derivative instruments as reflected in the Statement of Financial
Condition. The Company's exposure to market risk is influenced by a number
of factors, including the relationships among the derivative instruments
held by the Company as well as the volatility and liquidity in the markets
in which such derivative instruments are traded.
MLIP, which monitors the trading of the Company in MLIP's capacity as the
General Partner of the Voting Members and Sponsor of the Non-Voting
Members, has procedures in place intended to control market risk, although
there can be no assurance that they will, in fact, succeed in doing so. The
procedures focus primarily on monitoring the trading of the Advisor,
calculating the Net Asset Value of the Company and of the Members'
respective Capital Accounts as of the close of business on each day and
reviewing outstanding positions for over-concentrations. While MLIP does
not itself intervene in the markets to hedge or diversify the Company's
market exposure, MLIP may consult with the Advisor concerning the
possibility of the Advisor reducing trading leverage or market
concentrations. However, such interventions are unusual. Except in cases in
which it appears that Sjo has begun to deviate from past practice and
trading policies or to be trading erratically, MLIP's basic risk control
procedures consist simply of the ongoing process of monitoring Sjo with the
market risk controls being applied by Sjo.
Fair Value
The derivative instruments used in the Company's trading activities are
marked to market daily with the resulting unrealized profit recorded in the
Statement of Financial Condition and the related profit reflected in
trading revenues in the Statement of Income.
- 8 -
<PAGE>
The contract/notional values of open contracts, all of which were exchange
traded, as of December 31, 1997 were as follows:
------------------ ------------------
Commitment to Commitment to
Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards)
------------------- -------------------
Interest Rates $ 259,399,745 $ 30,326,212
=================== ===================
Substantially all of the Company's derivative instruments outstanding as of
December 31, 1997, expire within one year.
The average fair values, based on contract/notional values, of the
Company's derivative instrument positions which were open as of the end of
each calendar month during the period January 2, 1997 through December 31,
1997 were as follows:
----------------------------------------
Commitment to Commitment to
Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards)
------------------- -------------------
Interest Rates $ 194,525,907 $ 93,881,198
Stock Indices 10,338,576 16,608,547
Commodities 7,268,084 5,885,636
Currencies 16,122,843 19,305,449
Energy 1,618,935 2,010,335
Metals 5,914,036 5,393,765
------------- -------------
$ 235,788,381 $ 143,014,930
============= =============
A portion of the amounts indicated as off-balance sheet risk reflects
offsetting commitments to purchase and sell the same derivative instrument
on the same date in the future. These commitments are economically
offsetting but are not, as a technical matter, offset in the forward
markets until the settlement date.
Credit Risk
The risks associated with exchange-traded contracts are typically perceived
to be less than those associated with over-the-counter (non-exchange-
traded) transactions, because exchanges typically (but not universally)
provide clearinghouse arrangements in which the collective credit (in some
cases limited in amount, in some cases not) of the members of the exchange
is pledged to support the financial integrity of the exchange. In over-the-
counter transactions, on the other hand, traders must rely solely on the
credit of their respective individual counterparties. Margins, which may be
subject to loss in the event of a default, are generally required in
exchange trading, and counterparties may require margin in the over-the-
counter markets.
The fair value amounts in the above tables represent the extent of the
Company's market exposure in the particular class of derivative instrument
listed, but not the credit risk associated with counterparty
nonperformance. The credit risk associated with these instruments from
counterparty nonperformance is the net unrealized profit, if any, included
on the Statement of Financial Condition.
- 9 -
<PAGE>
The Company also has credit risk because the sole counterparty or broker
with respect to most of the Company's assets is MLF.
The gross unrealized profit and net unrealized profit on the Company's open
derivative instrument positions as of December 31, 1997 were as follows:
------------------------------
Gross
Unrealized Net Unrealized
Profit Profit
---------- -------------
Exchange-Traded $ 311,890 $ 255,565
========== ===========
The Company controls credit risk by dealing almost exclusively with Merrill
Lynch entities as brokers and counterparties.
The Company, in its normal course of business, enters into various
contracts, with MLF acting as its commodity broker. Pursuant to the
brokerage arrangement with MLF, these receivables and payables are offset
and reported as a net receivable or payable.
To the best of the knowledge and belief of the
undersigned, the information contained in this
report is accurate and complete.
/s/ Michael A. Karmelin
Michael A. Karmelin
Chief Financial Officer
Merrill Lynch Investment Partners Inc.
Commodity Pool Operator of
ML Sjo Prospect L.L.C.
<PAGE>
ML CHESAPEAKE DIVERSIFIED L.L.C.
(A DELAWARE LIMITED LIABILITY COMPANY)
Financial Statements for the year ended
December 31, 1997 and for the period
from November 1, 1996 (Commencement of Operations)
to December 31, 1996 and Independent Auditors' Report
<PAGE>
ML CHESAPEAKE DIVERSIFIED L.L.C.
(A Delaware limited Liability Company)
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
Page
----
INDEPENDENT AUDITORS' REPORT 1
FINANCIAL STATEMENTS FOR THE YEAR END
DECEMBER 31, 1997 AND FOR THE PERIOD FROM
NOVEMBER 1, 1996 (COMMENCEMENT OF OPERATIONS)
TO DECEMBER 31, 1996:
Statements of Financial Condition 2
Statements of Income 3
Statements of Changes in Members' Capital 4
Notes to Financial Statements 5-11
<PAGE>
INDEPENDENT AUDITORS' REPORT
- ----------------------------
To the Members of ML Chesapeake Diversified L.L.C.:
We have audited the accompanying statements of financial condition of ML
Chesapeake Diversified L.L.C. (a Delaware limited liability company; the
"Company") as of December 31, 1997 and 1996, and the related statements of
income and changes in members' capital for the year ended December 31, 1997 and
for the period from November 1, 1996 (commencement of operations) to December
31, 1996. These financial statements are the responsibility of the Company'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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of ML Chesapeake Diversified L.L.C. as of
December 31, 1997 and 1996, and the results of its operations for the year ended
December 31, 1997 and for the period from November 1, 1996 (commencement of
operations) to December 31, 1996 in conformity with generally accepted
accounting principles.
DELOITTE & TOUCHE LLP
February 6, 1998
New York, New York
<PAGE>
ML CHESAPEAKE DIVERSIFIED L.L.C.
(A Delaware Limited Liability Company)
STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1997 AND 1996
- --------------------------------------------------------------------------------
ASSETS 1997 1996
----------- -----------
Accrued interest (Note 2) $ 71,406 $ 85,553
Equity in commodity futures trading accounts:
Cash and option premiums 15,538,921 20,820,370
Net unrealized profit on open contracts 1,584,855 367,645
----------- -----------
TOTAL $17,195,182 $21,273,568
=========== ===========
LIABILITIES AND MEMBERS' CAPITAL
LIABILITIES:
Withdrawals payable $ 265,782 $ 309,446
Brokerage commissions payable (Note 2) 126,690 172,379
Profit Shares payable (Note 3) 308,627 93,034
Administrative fees payable (Note 2) 3,582 4,430
----------- -----------
Total liabilities 704,681 579,289
----------- -----------
MEMBERS' CAPITAL:
Voting Members 15,913,598 17,307,782
Non-Voting Members 576,903 3,386,497
----------- -----------
Total Members' capital 16,490,501 20,694,279
----------- -----------
TOTAL $17,195,182 $21,273,568
=========== ===========
See notes to financial statements.
- 2 -
<PAGE>
ML CHESAPEAKE DIVERSIFIED L.L.C.
(A Delaware Limited Liability Company)
STATEMENTS OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1997 AND
THE PERIOD FROM NOVEMBER 1, 1996
(COMMENCEMENT OF OPERATIONS)
TO DECEMBER 31, 1996
- --------------------------------------------------------------------------------
REVENUES: 1997 1996
---------- ----------
Trading profit:
Realized $1,335,899 $ 70,795
Change in unrealized 1,217,210 367,645
---------- ----------
Total trading results 2,553,109 438,440
Interest income (Note 2) 927,382 170,154
---------- ----------
Total revenues 3,480,491 608,594
---------- ----------
EXPENSES:
Brokerage commissions (Note 2) 1,646,907 359,828
Profit Shares (Note 3) 361,608 13,873
Administrative fees (Note 2) 46,611 9,248
---------- ----------
Total expenses 2,055,126 382,949
---------- ----------
NET INCOME $1,425,365 $ 225,645
========== ==========
See notes to financial statements.
- 3 -
<PAGE>
ML CHESAPEAKE DIVERSIFIED L.L.C.
(A Delaware Limited Liability Company)
STATEMENT OF CHANGES IN MEMBERS' CAPITAL
FOR THE YEAR ENDED DECEMBER 31, 1997 AND
THE PERIOD FROM NOVEMBER 1, 1996
(COMMENCEMENT OF OPERATIONS)
TO DECEMBER 31, 1996
- --------------------------------------------------------------------------------
Non-Voting
Voting Members Members Total
-------------- ------------ -----------
Initial Contributions $ 17,859,707 $ 3,403,696 $ 21,263,403
Withdrawals (743,910) (50,859) (794,769)
Net Income 191,985 33,660 225,645
------------ ------------ ------------
MEMBERS' CAPITAL,
DECEMBER 31, 1996 17,307,782 3,386,497 20,694,279
Withdrawals (4,049,775) (3,153,590) (7,203,365)
Contributions 1,386,748 187,474 1,574,222
Net Income 1,268,843 156,522 1,425,365
------------ ------------ ------------
MEMBERS' CAPITAL,
DECEMBER 31, 1997 $ 15,913,598 $ 576,903 $ 16,490,501
============ ============ ============
- 4 -
<PAGE>
ML CHESAPEAKE DIVERSIFIED L.L.C.
(A Delaware Limited Liability Company)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEAR ENDED DECEMBER 31, 1997 AND
THE PERIOD FROM NOVEMBER 1, 1996
(COMMENCEMENT OF OPERATIONS)
TO DECEMBER 31, 1996
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
------------
ML Chesapeake Diversified L.L.C. (the "Company") was organized under the
Delaware Limited Liability Company Act on October 23, 1996 and commenced
trading activities on November 1, 1996. The Company engages in the
speculative trading of futures, options on futures and forward contracts
on a wide range of commodities. Merrill Lynch Investment Partners Inc.
(formerly, ML Futures Investment Partners Inc.) ("MLIP"), a wholly-owned
subsidiary of Merrill Lynch Group, Inc., which in turn is a wholly-owned
subsidiary of Merrill Lynch & Co., Inc. ("Merrill Lynch"), has been
delegated administrative authority over the Company, and Merrill Lynch
Futures Inc. ("MLF"), also an affiliate of MLIP, is its commodity broker.
The Company has authorized two classes of Membership Interests:
Non-Voting Interests and Voting Interests ("Interests"). These two
classes of Interests have common economic interests in the Company, but
the Non-Voting Interests, which are held by non-United States companies,
do not participate in any respect in the management of the Company, or
engage, directly or indirectly, in the participation in or control of all
or any portion of the business activities or affairs of the Company, such
management being vested solely in the Voting Interests, which are held by
United States limited partnerships. The Voting Members, acting as Members
without any "manager," control all business activities and affairs of the
Company by agreement of the majority in interest of such Members, subject
to the trading authority vested in and delegated to Chesapeake Capital
Corporation (the "Advisor" or "Chesapeake") and the administrative
authority vested in and delegated to MLIP. The Members of the Company,
each of which is a "commodity pool" sponsored by MLIP, share in the
trading profit and interest income of the Company in proportion to their
respective capital accounts.
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 as well as the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
Revenue Recognition
-------------------
Commodity futures, options on futures, and forward contract transactions
are recorded on the trade date and open contracts are reflected in net
unrealized profit on open contracts in the Statements of Financial
Condition at the difference between the original contract value and the
fair value. The change in net unrealized profit on open contracts from
one period to the next is reflected in change in unrealized in the
Statements of Income. Fair value is based on quoted market prices on the
exchange or market on which the contract is traded.
- 5 -
<PAGE>
Organizational Costs
--------------------
MLIP paid all organizational costs relating to the Company without direct
reimbursement from the Company or any Member.
Income Taxes
------------
No provision for income taxes has been made in the accompanying financial
statements as each Member is individually responsible for reporting
income or loss based on such Member's respective share of the Company's
income and expenses as reported for income tax purposes. Non-Voting
Members are not subject to U.S. tax.
Distributions
-------------
No distribution (except upon withdrawals) had been made by the Company to
any Member as of December 31, 1997.
Withdrawals
-----------
A Member may withdraw some or all of such Member's Capital at Net Asset
Value as of the close of business on any business day. There are no
withdrawal fees or charges.
Dissolution of the Company
--------------------------
The Company will terminate on November 30, 2046 or at an earlier date if
certain conditions occur, as well as under certain other circumstances as
set forth in the Organization Agreement. Were the Advisor to cease to
manage the Company's account, the Company would dissolve.
2. RELATED PARTY TRANSACTIONS
The Company's U.S. dollar assets are held at MLF in cash. On the cash
held at MLF, the Company receives interest from Merrill Lynch at the
prevailing 91-day Treasury bill rate. Merrill Lynch may derive certain
economic benefits, in excess of the interest which Merrill Lynch pays to
the Company, from possession of such cash.
Merrill Lynch credits the Company with interest on the Company's non-U.S.
dollar-denominated assets based on local short-term rates. Merrill Lynch
charges the Company Merrill Lynch's cost of financing realized and
unrealized losses on the Company's non-U.S. dollar-denominated positions.
Following the allocation of the Company's trading profit (loss) and
interest income among the Members' respective capital accounts, MLIP
calculates the brokerage commissions, profit shares, administrative fees
and other expenses due from the Company to third parties, in respect of
the Company's trading on behalf of the respective Members (the Company
being subject to different commissions, fees and expenses in respect of
its trading as allocable to the various different Members). Such
commissions, fees and expenses are specifically allocated as of the end
of each accounting period (not pro rata based on the Members' respective
capital accounts) to, and deducted from, the appropriate Members' capital
accounts and paid out by the Company. The Company pays brokerage
commissions to MLF, at flat monthly rates reflecting the fee arrangement
between each Member and MLF. During the year ended December 31, 1997 and
the period ended December 31, 1996, such rates ranged from .729 of 1% (an
8.75% annual rate) to .831 of 1% (a 9.75% annual rate) of the Members'
month-end assets invested in
- 6 -
<PAGE>
the Company. As of December 31, 1997, the rate is .729 of 1% (an 8.75
annual rate) of each Members' month-end assets invested in the Company.
The Company pays MLIP a monthly administrative fee of .021 of 1% (a .25%
annual rate) of the Member's month-end assets invested in the Company.
Month-end assets are not reduced for purposes of calculating brokerage
commissions and administrative fees by any accrued brokerage commissions,
administrative fees, profit shares or other fees or charges.
MLF pays the Advisor an annual consulting fee of 2% of the Company's
average month-end assets, after reduction for a portion of the brokerage
commissions. Beginning January 1, 1997 the consulting fees paid by MLF to
the Advisor will be reduced to 1% per annum.
The Company trades forward contracts through a foreign exchange service
desk (the "F/X Desk") established by MLIP. The F/X Desk gives the Company
access to counterparties in addition to (but also including) Merrill
Lynch International Bank ("MLIB"). MLIP or another Merrill Lynch entity
charges a service fee equal to, at current exchange rates, approximately
$5.00 to $12.50 on each purchase or sale (not round-turn) of a futures
contract-equivalent face amount of a given currency traded in the forward
markets. No service fees are charged on trades awarded to MLIB (which
receives bid-ask spreads on such trades).
In its exchange of futures for physical ("EFP") trading with Merrill
Lynch, the Company acquires spot or forward (collectively, "cash")
currency positions through the F/X Desk in the same manner and on the
same terms as in the case of the Company's other F/X Desk trading. When
the Company exchanges these positions for futures, there is a
differential between the prices of the two positions. This differential
reflects, in part, the different settlement dates of the cash and the
futures contracts and prevailing interest rates, but also includes a
pricing spread in favor of MLIB or another Merrill Lynch entity. The
Advisor, to date, has made little use of EFPs.
The Company's F/X Desk service fee and EFP differential costs have, to
date totaled no more than .25 of 1% per annum of the Company's average
month-end assets.
3. ADVISORY AGREEMENT
The Company and the Advisor have entered into an Advisory Agreement. This
Advisory Agreement terminated 12/31/97 and has been renewed until
12/31/98, subject to certain additionalrenewal rights exercisable by the
Company. The Advisor determines the commodity futures and forward contact
trades to be made on behalf of the Company, subject to certain Company
trading policies and to certain rights reserved by MLIP.
The Company pays to Chesapeake a quarterly Profit Share equal to 20% of
any New Trading Profit, as defined, attributable to each Members' Capital
Account in the Company. Profit Shares, which are calculated separately in
respect of each Members' Capital Account, are determined as of the end of
each calendar quarter and are also paid to Chesapeake upon the withdrawal
of capital from the Company by a Member for whatever purpose, other than
to pay expenses. Beginning January 1, 1997, Profit Shares are determined
as of the end of each calendar year.
- 7 -
<PAGE>
4. FAIR VALUE AND OFF-BALANCE SHEET RISK
The Company trades futures, options on futures and forward contracts on
interest rates, stock indices, commodities, currencies, energy and
metals. The Company's trading results by reporting category were as
follows:
Total Trading Results
--------------------------------------------
1997 1996
------------------- -----------------
Interest Rates $ 763,346 $ 503,034
Stock Indices 666,880 (91,628)
Commodities 542,777 (388,130)
Currencies 671,508 422,927
Energy (1,082,330) (49,487)
Metals 990,928 41,724
------------------- -----------------
$ 2,553,109 $ 438,440
=================== =================
Market Risk
Derivative instruments involve varying degrees of off-balance sheet
market risk, and changes in the level or volatility of interest rates,
foreign currency exchange rates or market values of the underlying
financial instruments or commodities underlying such derivative
instruments frequently result in changes in the Company's unrealized
profit on such derivative instruments as reflected in the Statements of
Financial Condition. The Company's exposure to market risk is influenced
by a number of factors, including the relationships among the derivative
instruments held by the Company as well as the volatility and liquidity
of the markets in which such derivative instruments are traded.
MLIP, which monitors the trading of the Company in its capacity as the
General Partner of the Voting Members and Sponsor of the Non-Voting
Members, has procedures in place intended to control market risk,
although there can be no assurance that they will, in fact, succeed in
doing so. The procedures focus primarily on monitoring the trading of the
Advisor, calculating the Net Asset Value of the Company and of the
Members' respective capital accounts as of the close of business on each
day and reviewing outstanding positions for over-concentrations. While
MLIP does not itself intervene in the markets to hedge or diversify the
Company's market exposure, MLIP may consult with the Advisor concerning
the possibility of the Advisor reducing trading leverage or market
concentrations. However, such interventions are unusual. Except in cases
in which it appears that Chesapeake has begun to deviate from past
practice and trading policies or to be trading erratically, MLIP's basic
risk control procedures consist simply of the ongoing process of
monitoring Chesapeake with the market risk controls being applied by
Chesapeake.
Fair Value
The derivative instruments traded by the Company's trading activities are
marked to market daily with the resulting unrealized profit recorded in
the Statements of Financial Condition and the related profit reflected in
trading revenues in the Statements of Income.
- 8 -
<PAGE>
The contract/notional values of open contracts as of December 31, 1997
and 1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
------------------------------------------------ ------------------------------------------
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
------------------------ ----------------------- --------------------- ---------------------
<S> <C> <C> <C> <C>
Interest Rates $58,695,056 $18,009,766 $52,091,155 $ 3,639,167
Stock Indices 1,272,700 1,184,672 1,116,750 --
Commodities 4,584,639 7,520,083 2,140,808 1,671,435
Currencies 12,424,390 58,556,714 14,774,503 18,879,380
Energy -- 1,978,682 2,837,910 --
Metals 4,971,476 10,357,200 3,124,044 8,869,414
----------- ----------- ----------- -----------
$81,948,261 $97,607,117 $76,085,170 $33,059,396
=========== =========== =========== ===========
</TABLE>
Substantially all of the Company's derivative instruments outstanding as
of December 31, 1997, expire within one year.
The contract/notional values of the Company's exchange-traded and non-
exchange-traded open derivative instrument positions as of December 31,
1997 and 1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
---------------------------------------- -----------------------------------------
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
------------------- ------------------- ------------------- -------------------
<S> <C> <C> <C> <C>
Exchange Traded $73,789,832 $71,082,507 $72,969,376 $29,943,602
Non-Exchange-Traded 8,158,429 26,524,610 3,115,794 3,115,794
----------- ----------- ----------- -----------
$81,948,261 $97,607,117 $76,085,170 $33,059,396
=========== =========== =========== ===========
</TABLE>
- 9 -
<PAGE>
The average fair values, based on contract/notional values, of the
Company's derivative instruments positions which were open as of the end
of each calendar month during the year ended December 31, 1997 and for
the period November 1, 1996 through December 31, 1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
---------------------------------------------- ---------------------------------------------
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
----------------------- --------------------- ---------------------- ---------------------
<S> <C> <C> <C> <C>
Interest Rates $ 66,490,915 $ 33,591,146 $ 81,895,426 $ 17,084,098
Stock Indices 6,987,284 1,450,982 5,451,762 -
Commodities 7,427,509 3,331,339 1,496,098 2,820,670
Currencies 13,883,403 42,553,986 23,055,460 15,515,002
Energy 1,655,737 1,203,131 2,742,238 -
Metals 6,500,099 7,542,869 2,796,187 7,747,807
-------------- ------------- -------------- -------------
$ 102,944,947 $ 89,673,453 $ 117,437,171 $ 43,167,577
============== ============= ============== =============
</TABLE>
A portion of the amounts indicated as off-balance sheet risk reflects
offsetting commitments to purchase and sell the same derivative
instrument on the same date in the future. These commitments are
economically offsetting but are not, as a technical matter, offset in the
forward markets until the settlement date.
Credit Risk
The risks associated with exchange-traded contracts are typically
perceived to be less than those associated with over-the-counter (non-
exchange-traded) transactions, because exchanges typically (but not
universally) provide clearinghouse arrangements in which the collective
credit (in some cases limited in amount, in some cases not) of the
members of the exchange is pledged to support the financial integrity of
the exchange. In over-the-counter transactions, on the other hand,
traders must rely solely on the credit of their respective individual
counterparties. Margins, which may be subject to loss in the event of a
default, are generally required in exchange trading, and counterparties
may require margin in the over-the-counter markets.
The fair value amounts in the above tables represent the extent of the
Company's market exposure in the particular class of derivative
instrument listed, but not the credit risk associated with counterparty
nonperformance. The credit risk associated with these instruments from
counterparty nonperformance is the net unrealized profit, if any,
included on the Statements of Financial Condition.
The Company also has credit risk because the sole counterparty or broker
with respect to most of the Company's assets is MLF.
- 10 -
<PAGE>
The gross unrealized profit and net unrealized profit on the Company's
open derivative instrument positions as of December 31, 1997 and 1996
were as follows:
1997 1996
----------------------- --------------------------
Gross Net Gross Net
Unrealized Unrealized Unrealized Unrealized
Profit Profit Profit Profit (Loss)
---------- ---------- ---------- -------------
Exchange Traded $1,275,702 $1,079,882 $ 816,841 $ 385,170
Non-Exchange-Traded 669,503 504,973 89,849 (17,525)
---------- ---------- ---------- ----------
$1,945,205 $1,584,855 $ 906,690 $ 367,645
========== ========== ========== ==========
The Company controls credit risk by dealing almost exclusively with
Merrill Lynch entities as brokers and counterparties.
The Company, in its normal course of business, enters into various
contracts, with MLF acting as its commodity broker. Pursuant to the
brokerage arrangement with MLF, to the extent that such trading results
in receivables from and payables to MLF, these receivables and payables
are offset and reported as a net receivable or payable.
To the best of the knowledge and belief of the
undersigned, the information contained in this
report is accurate and complete.
/s/ Michael A. Karmelin
Michael A Karmelin
Chief Financial Officer
Merrill Lynch Investment Partners Inc.
Commodity Pool Operator of
ML Chesapeake Diversified L.L.C.
- 11 -
<PAGE>
ML MILLBURN GLOBAL L.L.C.
(A DELAWARE LIMITED LIABILITY COMPANY)
Financial Statements for the year ended
December 31, 1997 and for the period from
December 2, 1996 (Commencement of Operations)
to December 31, 1996 and Independent Auditors' Report
<PAGE>
ML MILLBURN GLOBAL L.L.C.
(A Delaware Limited Liability Company)
TABLE OF CONTENTS
- -------------------------------------------------------
Page
----
INDEPENDENT AUDITORS' REPORT 1
FINANCIAL STATEMENTS FOR THE YEAR ENDED
DECEMBER 31, 1997 AND FOR THE PERIOD FROM
DECEMBER 2, 1996 (COMMENCEMENT OF OPERATIONS)
TO DECEMBER 31, 1996:
Statements of Financial Condition 2
Statements of Income 3
Statements of Changes in Members' Capital 4
Notes to Financial Statements 5-11
<PAGE>
INDEPENDENT AUDITORS' REPORT
- ----------------------------
To the Members of
ML Millburn Global L.L.C.:
We have audited the accompanying statements of financial condition of ML
Millburn Global L.L.C. (a Delaware limited liability company; the "Company") as
of December 31, 1997 and 1996, and the related statements of income and changes
in members' capital for the year ended December 31, 1997 and for the period from
December 2, 1996 (commencement of operations) to December 31, 1996. These
financial statements are the responsibility of the Company'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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of ML Millburn Global L.L.C. as of December 31,
1997 and 1996, and the results of its operations for the year ended December 31,
1997 and for the period from December 2, 1996 (commencement of operations) to
December 31, 1996 in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
February 6, 1998
New York, New York
<PAGE>
ML MILLBURN GLOBAL L.L.C.
(A Delaware Limited Liability Company)
STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1997 and 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASSETS 1997 1996
------------------ ------------------
<S> <C> <C>
Accrued interest (Note 2) $ 154,701 $ 82,673
Equity in commodity futures trading accounts:
Cash and option premiums 34,556,738 27,521,635
Net unrealized profit on open contracts 873,497 916,519
------------------ ------------------
TOTAL $ 35,584,936 $ 28,520,827
================== ==================
LIABILITIES AND MEMBERS' CAPITAL
LIABILITIES:
Brokerage commissions payable (Note 2) $ 279,691 $ 270,878
Administrative fees payable (Note 2) 7,413 5,940
Profit Shares payable (Note 3) 902,022 135,593
Withdrawals payable 265,533 383,590
------------------ ------------------
Total liabilities 1,454,659 796,001
------------------ ------------------
MEMBERS' CAPITAL:
Voting Members 34,130,277 33,592,186
Receivable from Members - (5,867,360)
------------------ ------------------
Total Members' capital 34,130,277 27,724,826
------------------ ------------------
TOTAL $ 35,584,936 $ 28,520,827
================== ==================
</TABLE>
See notes to financial statements.
-2-
<PAGE>
ML MILLBURN GLOBAL L.L.C.
(A Delaware Limited Liability Company)
STATEMENTS OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1997 AND
FOR THE PERIOD FROM DECEMBER 2, 1996
(COMMENCEMENT OF OPERATIONS)
TO DECEMBER 31, 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996
---------------- ---------------
<S> <C> <C>
REVENUES:
Trading profit (loss):
Realized $ 6,777,967 $ (548,574)
Change in unrealized (43,022) 916,519
---------------- ---------------
Total trading results 6,734,945 367,945
Interest income (Note 2) 1,568,485 82,674
---------------- ---------------
Total revenues 8,303,430 450,619
---------------- ---------------
EXPENSES:
Administrative fees (Note 2) 91,883 5,940
Brokerage commissions (Note 2) 3,530,493 270,878
Profit Shares (Note 3) 978,330 14,552
---------------- ---------------
Total expenses 4,600,706 291,370
---------------- ---------------
NET INCOME $ 3,702,724 $ 159,249
================ ===============
</TABLE>
See notes to financial statements
-3-
<PAGE>
ML MILLBURN GLOBAL L.L.C.
(A Delaware Limited Liability Company)
STATEMENTS OF CHANGES IN MEMBER'S CAPITAL
FOR THE YEAR ENDED DECEMBER 31, 1997 AND
FOR THE PERIOD FROM DECEMBER 2, 1996
(COMMENCEMENT OF OPERATIONS)
TO DECEMBER 31, 1996
- --------------------------------------------------------------------------------
Initial Contributions $ 27,949,167
Contributions 5,867,360
Receivable from Member (5,867,360)
Withdrawals (383,590)
Net income 159,249
------------------
MEMBERS' CAPITAL,
DECEMBER 31, 1996 27,724,826
Collection of receivable 5,867,360
Withdrawals (3,164,632)
Net income 3,702,723
------------------
MEMBERS' CAPITAL,
DECEMBER 31, 1997 $ 34,130,277
==================
See notes to financial statements.
-4-
<PAGE>
ML MILLBURN GLOBAL L.L.C.
(A Delaware Limited Liability Company)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEAR ENDED DECEMBER 31, 1997 AND
THE PERIOD FROM DECEMBER 2, 1996
(COMMENCEMENT OF OPERATIONS)
TO DECEMBER 31, 1996
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
------------
ML Millburn Global L.L.C. (the "Company") was organized under the Delaware
Limited Liability Company Act on November 22, 1996 and commenced trading
activities on December 2, 1996. The Company engages in the speculative trading
of futures, options on futures and forward contracts on a wide range of
commodities. Merrill Lynch Investment Partners ("MLIP"), a wholly-owned
subsidiary of Merrill Lynch Group, Inc., which in turn is a wholly-owned
subsidiary of Merrill Lynch & Co., Inc. (one or more of Merrill Lynch & Co.,
Inc. and its affiliates being hereinafter referred to as "Merrill Lynch"), has
been delegated administrative authority over the Company, and Merrill Lynch
Futures Inc. ("MLF"), also an affiliate of MLIP, is its commodity broker. The
Company has authorized two classes of Membership Interests: Non-Voting
Interests and Voting Interests ("Interests"). These two classes of Interests
have common economic interests in the Company, but the Non-Voting Interests,
which will be held by non-United States companies, shall not participate in any
respect in the management of the Company, or engage, directly or indirectly, in
the participation in or control of all or any portion of the business activities
or affairs of the Company, such management being vested solely in the Voting
Interests, which are held by United States limited partnerships. The Voting
Members, acting as Members without any "manager," mutually control all business
activities and affairs of the Company by agreement of the majority in interest
of such Members, subject to the trading authority vested in and delegated to
Millburn Ridgefield Corp. (the "Advisor" or "Millburn") and the administrative
authority vested in and delegated to MLIP. The Members of the Company, each of
which is a "commodity pool" sponsored by MLIP, share in the trading profit
(loss) and interest income of the Company in proportion to their respective
capital accounts.
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 as
well as the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Revenue Recognition
-------------------
Commodity futures, options on futures and forward contract transactions are
recorded on the trade date and open contracts are reflected in net unrealized
profit on open contracts in the Statements of Financial Condition at the
difference between the original contract value and the fair value. The change
in net unrealized profit on open contracts from one period to the next is
reflected in change in unrealized in the Statements of Income. Fair value is
based on quoted market prices on the exchange or market on which the contract is
traded.
-5-
<PAGE>
Organizational Costs
--------------------
MLIP paid all organizational costs relating to the Company without direct
reimbursement from the Company or any Member.
Income Taxes
------------
No provision for income taxes has been made in the accompanying financial
statements as each Member is individually responsible for reporting income or
loss based on such Member's respective share of the Company's income and
expenses as reported for income tax purposes.
Distributions
-------------
No Distribution (except upon withdrawals) had been made by the Company to
any Member as of December 31, 1997.
Withdrawals
-----------
A Member may withdraw some or all of such Members' capital at Net Asset
Value as of the close of business on any business day. There are no withdrawal
fees or charges.
Dissolution of the Company
--------------------------
The Company will terminate on December 31, 2046 or at an earlier date if
certain conditions occur, as well as under certain other circumstances as set
forth in the Organization Agreement. Were the Advisor to cease to manage the
Company's account, the Company would dissolve.
2. RELATED PARTY TRANSACTIONS
The Company's U.S. dollar assets are held at MLF in cash. On the cash held
at MLF, the Company receives interest from Merrill Lynch at the prevailing 91-
day U.S. Treasury bill rate. Merrill Lynch may derive certain economic
benefits, in excess of the interest which Merrill Lynch pays to the Company,
from possession of such cash.
Merrill Lynch credits the Company with interest on the Company's non-U.S.
dollar-denominated assets based on local short-term rates. Merrill Lynch
charges the Company Merrill Lynch's cost of financing realized and unrealized
losses on the Company's non-U.S. dollar-denominated positions.
Following the allocation of the Company's trading profit (loss) and
interest income among the Members' respective capital accounts, MLIP calculates
the brokerage commissions, profit shares, administrative fees and other expenses
due from the Company to third parties, in respect of the Company's trading on
behalf of the respective Members (the Company being subject to different
commissions, fees and expenses in respect of its trading as allocable to the
various different Members). Such commissions, fees and expenses are
specifically allocated as of the end of each accounting period (not pro rata
based on the Members' respective capital accounts) to, and deducted from, the
appropriate Members' capital accounts and paid out by the Company. The Company
pays brokerage commissions to MLF, at flat monthly rates reflecting the fee
arrangement between each Member and MLF. During the year ended December 31,
1997 and the period from December 2, 1996 to December 31, 1996, such rates
ranged from .729 of 1% (an 8.75% annual rate) to .979 of 1% (an 11.75% annual
rate) of each Member's month-end assets invested in the Company. As of December
31, 1997, the rates ranged from .729 of 1%
-6-
<PAGE>
(an 8.75% annual rate) to .792 of 1% (a 9.50% annual rate) of the Members'
month-end assets invested in the Company.
The Company pays MLIP a monthly administrative fee of .021 of 1% (a .25%
annual rate) of the Member's month-end assets. Month-end assets are not
reduced for purposes of calculating brokerage commissions and administrative
fees by any accrued brokerage commissions, administrative fees, profit share or
other fees or charges.
MLF paid the Advisor an annual consulting fee of 4% of the Company's
average month-end assets, after reduction for a portion of brokerage
commissions. Beginning January 1, 1997 the consulting fee paid by MLF to the
Advisor was reduced to 2% per annum.
The Company trades forward contracts through a Foreign Exchange Service
Desk (the "F/X Desk") established by MLIP. The F/X Desk gives the Company
access to counterparties in addition to (but also including) Merrill Lynch
International Bank ("MLIB"). MLIP or another Merrill Lynch entity charges a
service fee equal to, at current exchange rates, approximately $5.00 to $12.50
on each purchase or sale (not round-turn) of a futures contract-equivalent face
amount of a given currency traded in the forward markets. No service fees are
charged on trades awarded to MLIB (which receives bid-ask spreads on such
trades).
In its exchange of futures for physical ("EFP") trading with Merrill Lynch,
the Company acquires spot or forward (collectively, "cash") currency positions
through the F/X Desk in the same manner and on the same terms as in the case of
the Company's other F/X Desk trading. When the Company exchanges these
positions for futures, there is a differential between the prices of the two
positions. This differential reflects, in part, the different settlement dates
of the cash and the futures contracts and prevailing interest rates, but also
includes a pricing spread in favor of MLIB or another Merrill Lynch entity. The
Advisor, to date, has made little use of EFPs.
The Company's F/X Desk service fee and EFP differential costs have, to date
totaled no more than .25 of 1% per annum of the Company's average month-end
assets.
3. ADVISORY AGREEMENT
The Company and the Advisor have entered into an Advisory Agreement. This
Advisory Agreement terminated one year after it was entered into and has been
renewed until 12/31/98, subject to certain additional renewal rights exercisable
by the Company. The Advisor determines the commodity futures and forward
contract trades to be made on behalf of the Company, subject to certain Company
trading policies and to certain rights reserved by MLIP.
The Company pays to Millburn a quarterly Profit Share equal to 20% of any
New Trading Profit, as defined, attributable to each Members' Capital Account in
the Company. Profit Shares, are calculated separately in respect of each
Members' Capital Account. During 1996, Profit Shares were determined as of the
end of each calendar quarter. Beginning January 1, 1997, Profit Shares are also
determined as of the end of each calendar year. Profit shares are also paid to
Millburn upon the withdrawal of capital from the Company by a Member for
whatever purpose, other than to pay expenses.
-7-
<PAGE>
4. FAIR VALUE AND OFF-BALANCE SHEET RISK
The Company trades futures, options on futures and forward contracts on interest
rates, stock indices, currencies and metals. The Company's trading results by
reporting category were as follows:
Trading Results
------------------------------------------------
1997 1996
------------------ -------------------
Interest rates $ 591,963 $ (968,118)
Stock indices 1,181,885 265,546
Currencies 5,610,941 1,028,590
Metals (649,844) 41,927
------------------ -------------------
$ 6,734,945 $ 367,945
================== ===================
Market Risk
Derivative instruments involve varying degrees of off-balance sheet market risk,
and changes in the level or volatility of interest rates, foreign currency
exchange rates or the market values of the underlying financial instruments or
commodities underlying such derivative instruments frequently result in changes
in the Company's unrealized profit (loss) on such derivative instruments as
reflected in the Statements of Financial Condition. The Company's exposure to
market risk is influenced by a number of factors, including the relationships
among the derivative instruments held by the Company as well as the volatility
and liquidity in the markets in which such derivative instruments are traded.
MLIP, which monitors the trading of the Company in MLIP's capacity as the
General Partner of the Voting Members, has procedures in place intended to
control market risk, although there can be no assurance that they will, in fact,
succeed in doing so. The procedures focus primarily on monitoring the trading
of the Advisor, calculating the Net Asset Value of the Company and of the
Members' respective capital accounts as of the close of business on each day and
reviewing outstanding positions for over-concentrations. While MLIP does not
itself intervene in the markets to hedge or diversify the Company's market
exposure, MLIP may consult with the Advisor concerning the possibility of the
Advisor reducing trading leverage or market concentrations. However, such
interventions are unusual. Except in cases in which it appears that the Advisor
has begun to deviate from past practice and trading policies or to be trading
erratically, MLIP's basic risk control procedures consist simply of the ongoing
process of monitoring Millburn with the market risk controls being applied by
Millburn.
Fair Value
The derivative instruments traded by the Company are marked to market daily with
the resulting unrealized profit recorded in the Statements of Financial
Condition and the related profit (loss) reflected in trading revenues in the
Statements of Income.
-8-
<PAGE>
The contract/notional values of open contracts as of December 31, 1997 and 1996
were as follows:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------------------------- -------------------------------------------------------
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
----------------------- ----------------------- ------------------------ -----------------------
<S> <C> <C> <C> <C>
Interest rates $ 113,325,505 $ 45,345,280 $ 104,423,803 $ 26,267,954
Stock indices 729,875 7,900,952 2,233,500 -
Currencies 61,598,754 91,949,255 140,452,466 244,633,536
Metals 2,768,365 11,251,745 6,379,654 12,694,954
----------------------- ----------------------- ------------------------ -----------------------
$ 178,422,499 $ 156,447,232 $ 253,489,423 $ 283,596,444
======================= ======================= ======================== =======================
</TABLE>
Substantially all of the Company's derivative instruments outstanding as of
December 31, 1997, expire within one year.
The contract/notional values of the Company's exchange-traded and non-exchange
traded open derivative instrument positions as of December 31, 1997 and 1996
were as follows:
<TABLE>
<CAPTION>
1997 1996
----------------------------------------------------- ---------------------------------------------------
<S> <C> <C> <C> <C>
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
--------------------- ----------------------- ----------------------- --------------------
Exchange-
Traded $ 117,094,640 $ 55,066,167 $ 111,666,188 $32,583,254
Non-Exchange-
Traded 61,327,859 101,381,065 141,823,235 251,013,190
--------------------- ----------------------- ----------------------- --------------------
$ 178,422,499 $ 156,447,232 $ 253,489,423 $ 283,596,444
===================== ======================= ======================= ====================
</TABLE>
-9-
<PAGE>
The average fair values, based on contract/notional values, of the Company's
derivative instrument positions which were open as of the end of each calendar
month during the year end December 31, 1997 and the period December 2, 1996
through December 31, 1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
------------------------------------------------------ --------------------------------------------------------
<S> <C> <C> <C> <C>
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
------------------------ ------------------------ ------------------------ -----------------------
Interest rates $ 109,239,425 $ 64,911,569 $ 104,423,803 $ 26,267,954
Stock indices 4,174,099 4,443,654 2,233,500 -
Currencies 181,132,627 197,159,660 140,452,466 244,633,536
Metals 10,647,435 11,798,908 6,379,654 12,694,954
------------------------ ------------------------ ------------------------ -----------------------
$ 305,193,586 $ 278,313,791 $ 253,489,423 $ 283,596,444
======================== ======================== ======================== =======================
</TABLE>
portion of the amounts indicated as off-balance sheet risk reflects offsetting
commitments to purchase and sell the same derivative instrument on the same date
in the future. These commitments are economically offsetting but are not, as a
technical matter, offset in the forward market until the settlement date.
Credit Risk
The risks associated with exchange-traded contracts are typically perceived to
be less than those associated with over-the-counter (non-exchange-traded)
transactions, because exchanges typically (but not universally) provide
clearinghouse arrangements in which the collective credit (in some cases limited
in amount, in some cases not) of the members of the exchange is pledged to
support the financial integrity of the exchange. In over-the-counter
transactions, on the other hand, traders must rely solely on the credit of their
respective individual counterparties. Margins, which may be subject to loss in
the event of a default, are generally required in exchange trading, and
counterparties may require margin in the over-the-counter markets.
The fair value amounts in the above tables represent the extent of the Company's
market exposure in the particular class of derivative instrument listed, but not
the credit risk associated with counterparty nonperformance. The credit risk
associated with these instruments from counterparty nonperformance is the net
unrealized profit, if any, included on the Statements of Financial Condition.
The Company also has credit risk because the sole counterparty or broker with
respect to most of the Company's assets is MLF.
The gross unrealized profit and net unrealized profit on the Company's open
derivative instrument positions as of December 31, 1997 and 1996 were as
follows:
<TABLE>
<CAPTION>
1997 1996
--------------------------------------------- -------------------------------------------
Gross Unrealized Net Unrealized Gross Unrealized Net Unrealized
Profit Profit Profit Profit
---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Exchange-
Traded $ 771,074 $ 600,833 $ 507,869 $ 196,239
Non-Exchange-
Traded 1,383,944 272,664 2,584,134 720,280
----------------- ----------------- ----------------- ---------------
$ 2,155,018 $ 873,497 $ 3,092,003 $ 916,519
================= ================= ================= ===============
</TABLE>
-10-
<PAGE>
The Company controls credit risk by dealing almost exclusively with Merrill
Lynch entities as brokers and counterparties.
The Company, in its normal course of business, enters into various contracts,
with MLF acting as its commodity broker. Pursuant to the brokerage a
To the best of the knowledge and belief of the
undersigned, the information contained in this
report is accurate and complete.
/s/ Michael A. Karmelin
Michael A. Karmelin
Chief Financial Officer
Merrill Lynch Investment Partners Inc.
Commodity Pool Operator of
ML Millburn Global L.L.C.
-11-
<PAGE>
ML JWH FINANCIAL AND METALS
PORTFOLIO L.L.C.
(A Delaware Limited Liability Company)
Financial Statements for the Year ended December 31, 1997 and for the
period from October 1, 1996 (Commencement of Operations)
to December 31, 1996 and Independent Auditors' Report
<PAGE>
ML JWH FINANCIAL AND METALS PORTFOLIO L.L.C.
(A Delaware Limited Liability Company)
TABLE OF CONTENTS
- ------------------------------------------------------
Page
----
INDEPENDENT AUDITORS' REPORT 1
FINANCIAL STATEMENTS FOR THE YEAR ENDED
DECEMBER 31, 1997 AND FOR THE PERIOD FROM
OCTOBER 1, 1996 (COMMENCEMENT OF OPERATIONS)
TO DECEMBER 31, 1996:
Statements of Financial Condition 2
Statements of Income 3
Statements of Changes in Members' Capital 4
Notes to Financial Statements 5-11
<PAGE>
INDEPENDENT AUDITORS' REPORT
- ----------------------------
To the Members of
ML JWH Financial and Metals Portfolio L.L.C.:
We have audited the accompanying statements of financial condition of ML JWH
Financial and Metals Portfolio L.L.C. (a Delaware limited liability company;
the "Company") as of December 31, 1997 and 1996, and the related statements of
income and changes in members' capital for the year ended December 31, 1997 and
for the period from October 1, 1996 (commencement of operations) to December 31,
1996. These financial statements are the responsibility of the Company'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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of ML JWH Financial and Metals Portfolio L.L.C.
as of December 31, 1997 and 1996, and the results of its operations for the year
ended December 31, 1997 and for the period from October 1, 1996 (commencement of
operations) to December 31, 1996 in conformity with generally accepted
accounting principles.
DELOITTE & TOUCHE LLP
February 6, 1998
New York, New York
<PAGE>
ML JWH FINANCIAL AND METALS PORTFOLIO L.L.C.
(A Delaware Limited Liability Company)
STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1997 AND 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996
--------------------- ---------------------
<S> <C> <C>
ASSETS
Accrued interest (Note 2) $ 278,160 $ 306,073
Equity in commodity futures trading accounts:
Cash and option premiums 62,041,417 79,820,720
Net unrealized gain on open contracts 2,728,987 698,571
--------------------- ---------------------
TOTAL $ 65,048,564 $ 80,825,364
===================== =====================
LIABILITIES AND MEMBERS' CAPITAL
LIABILITIES:
Profit Shares payable (Note 3) $ 614,420 $ 2,313,537
Brokerage commissions payable (Note 2) 494,568 697,868
Administrative fees payable (Note 2) 13,545 16,819
Withdrawals payable 2,567,125 16,819,986
--------------------- ---------------------
Total liabilities 3,689,658 19,848,210
--------------------- ---------------------
MEMBERS' CAPITAL:
Voting Members 59,766,977 53,977,573
Non-voting Members 1,591,929 6,999,581
--------------------- ---------------------
Total Members' capital 61,358,906 60,977,154
--------------------- ---------------------
TOTAL $ 65,048,564 $ 80,825,364
===================== =====================
</TABLE>
See notes to financial statements.
-2-
<PAGE>
ML JWH FINANCIAL AND METALS PORTFOLIO L.L.C.
(A Delaware Limited Liability Company)
STATEMENTS OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1997 AND
THE PERIOD FROM OCTOBER 1, 1996
(COMMENCEMENT OF OPERATIONS)
TO DECEMBER 31, 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION> 1997 1996
--------------------- ----------------------
REVENUES:
<S> <C> <C>
Trading profit:
Realized $ 10,175,257 $ 17,860,411
Change in unrealized 2,030,416 698,571
--------------------- ----------------------
Total trading results 12,205,673 18,558,982
Interest income (Note 2) 3,073,728 806,967
--------------------- ----------------------
Total revenues 15,279,401 19,365,949
--------------------- ----------------------
EXPENSES:
Profit Shares (Note 3) 1,024,612 2,313,537
Brokerage commissions (Note 2) 5,539,579 2,063,021
Administrative fees (Note 2) 149,850 49,703
--------------------- ----------------------
Total expenses 6,714,041 4,426,261
--------------------- ----------------------
NET INCOME $ 8,565,360 $ 14,939,688
===================== ======================
</TABLE>
See notes to financial statements.
-3-
<PAGE>
ML JWH FINANCIAL AND METALS PORTFOLIO L.L.C.
(A Delaware Limited Liability Company)
STATEMENTS OF CHANGES IN MEMBERS' CAPITAL
FOR THE YEAR ENDED DECEMBER 31, 1997 AND
THE PERIOD FROM OCTOBER 1, 1996
(COMMENCEMENT OF OPERATIONS)
TO DECEMBER 31, 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Voting Members Non-Voting Total
Members
----------------------- -------------------------------------------------
<S> <C> <C> <C>
Initial Contributions $ 56,790,791 $ 7,080,836 $ 63,871,627
Contributions 1,212,016 2,017 1,214,033
Withdrawals (17,295,297) (1,752,897) (19,048,194)
Net Income 13,270,063 1,669,625 14,939,688
----------------------- ------------------- ---------------------
MEMBERS' CAPITAL,
DECEMBER 31, 1996 53,977,573 6,999,581 60,977,154
Contributions 6,356,012 714,303 7,070,315
Withdrawals (8,626,795) (6,627,128) (15,253,923)
Net Income 8,060,187 505,173 8,565,360
----------------------- ------------------- ---------------------
MEMBERS' CAPITAL,
DECEMBER 31, 1997 $ 59,766,977 $ 1,591,929 $ 61,358,906
======================= =================== =====================
</TABLE>
See notes to financial statements.
-4-
<PAGE>
ML JWH FINANCIAL AND METALS PORTFOLIO L.L.C.
(A Delaware Limited Liability Company)
NOTES TO FINANCIAL STATEMENTS
FOR THE YEAR ENDED DECEMBER 31, 1997 AND
THE PERIOD FROM OCTOBER 1, 1996
(COMMENCEMENT OF OPERATIONS)
TO DECEMBER 31, 1996
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
------------
ML JWH Financial and Metals Portfolio L.L.C. (the "Company") was organized
under the Delaware Limited Liability Company Act on September 19, 1996 and
commenced trading activities on October 1, 1996. The Company engages in the
speculative trading of futures, options on futures and forward contracts on a
wide range of commodities. Merrill Lynch Investment Partners Inc. (formerly,
ML Futures Investment Partners Inc.) ("MLIP"), a wholly-owned subsidiary of
Merrill Lynch Group, Inc., which in turn is a wholly-owned subsidiary of
Merrill Lynch & Co., Inc. ("Merrill Lynch"), has been delegated
administrative authority over the Company, and Merrill Lynch Futures Inc.
("MLF"), also an affiliate of MLIP, is its commodity broker. The Company has
authorized two classes of Membership Interests: Non-Voting Interests and
Voting Interests ("Interests"). These two classes of Interests have common
economic interests in the Company, but the Non-Voting Interests, which are
held by non-United States companies, do not participate in any respect in the
management of the Company, or engage, directly or indirectly, in the
participation in or control of all or any portion of the business activities
or affairs of the Company, such management being vested solely in the Voting
Interests, which are held by United States limited partnerships. The Voting
Members, acting as Members without any "manager," mutually control all
business activities and affairs of the Company by agreement of the majority
in interest of such Members, subject to the trading authority vested in and
delegated to John W. Henry & Company, Inc. (the "Advisor" or "JWH") and the
administrative authority vested in and delegated to MLIP. The Members of the
Company, each of which is a "commodity pool" sponsored by MLIP, share in the
trading profit (loss) and interest income of the Company in proportion to
their respective capital accounts.
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 as
well as the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Revenue Recognition
--------------------
Commodity futures, options on futures, and forward contract transactions are
recorded on the trade date and open contracts are reflected in net unrealized
profit on open contracts in the Statements of Financial Condition at the
difference between the original contract value and the fair value. The
change in net unrealized profit on open contracts from one period to the next
is reflected in change in unrealized in the
-5-
<PAGE>
Statements of Income. Fair value is based on quoted market prices on the
exchange or market on which the contract is traded.
Organizational Costs
--------------------
MLIP paid all organizational costs relating to the Company without direct
reimbursement from the Company or any Member.
Income Taxes
-------------
No provision for income taxes has been made in the accompanying financial
statements as each Member is individually responsible for reporting income or
loss based on such Members' respective share of the Company's income and
expenses as reported for income tax purposes.
Distributions
-------------
No distribution (except upon withdrawals) had been made by the Company to any
Member as of December 31, 1997.
Withdrawals
-----------
A Member may withdraw some or all of such Member's capital at the Net Asset
Value as of the close of business on any business day. There are no
withdrawal fees or charges.
Dissolution of the Company
--------------------------
The Company will terminate on September 30, 2046 or at an earlier date if
certain conditions occur, as well as under certain other circumstances as set
forth in the Organization Agreement. Were the Advisor to cease to manage the
Company's account, the Company would dissolve.
2. RELATED PARTY TRANSACTIONS
The Company's U.S. dollar assets are held at MLF in cash. On the cash held
at MLF, the Company receives interest from Merrill Lynch at the prevailing
91-day U.S. Treasury bill rate. Merrill Lynch may derive certain economic
benefits, in excess of the interest which Merrill Lynch pays to the Company,
from possession of such cash.
Merrill Lynch credits the Company with interest on the Company's non-U.S.
dollar-denominated assets based on local short-term rates. Merrill Lynch
charges the Company Merrill Lynch's cost of financing realized and unrealized
losses on the Company's non-U.S. dollar-denominated positions.
Following the allocation of the Company's trading profit (loss) and interest
income among the Members' respective Capital Accounts, MLIP calculates the
brokerage commissions, profit shares, administrative fees and other expenses
due from the Company to third parties, in respect of the Company's trading on
behalf of the respective Members (the Company being subject to different
commissions, fees and expenses in respect of its trading as allocable to the
various different Members). Such commissions, fees and expenses are
specifically allocated as of the end of each accounting period (not pro rata
based on the Members' respective capital accounts) to, and deducted from, the
appropriate Members' capital accounts and paid out by the Company. The
Company pays brokerage commissions to MLF, at flat monthly rates reflecting
the fee arrangement between each Member and MLF. During the year ended
December 31, 1997 and the period from October 1, 1996 to December 31, 1996,
such rates ranged from
-6-
<PAGE>
.646 of 1% (a 7.75% annual rate) to .979 of 1% (an 11.75% annual rate) of the
Member's month-end assets invested in the Company.
The Company pays MLIP a monthly administrative fee of .021 of 1% (a .25%
annual rate) of the Member's month-end assets. Month-end assets are not
reduced for purposes of calculating brokerage commissions and administrative
fees by any accrued brokerage commissions, administrative fees, profit shares
or other fees of charges.
MLF pays the Advisor an annual consulting fee of 4% of the Company's average
month-end assets, after reduction for a portion of the brokerage commissions.
The Company trades forward contracts through a foreign exchange service desk
(the "F/X Desk") established by MLIP. The F/X Desk gives the Company access
to counterparties in addition to (but also including) Merrill Lynch
International Bank ("MLIB"). MLIP or another Merrill Lynch entity charges a
service fee equal to, at current exchange rates, approximately $5.00 to
$12.50 on each purchase or sale (not round-turn) of a futures contract-
equivalent face amount of a given foreign currency traded in the forward
markets. No service fees are charged on trades awarded to MLIB (which
receives bid-ask spreads on such trades).
In its exchange of futures for physical ("EFP") trading with Merrill Lynch,
the Company acquires a spot or forward (collectively, "cash") currency
positions through the F/X Desk in the same manner and on the same terms as in
the case of the Company's other F/X Desk trading. When the Company exchanges
these positions for futures, there is a differential between the prices of
the two positions. This differential reflects, in part, the different
settlement dates of the cash and the futures contracts and prevailing
interest rates, but also includes a pricing spread in favor of MLIB or
another Merrill Lynch entity. The Advisor, to date, has made little use of
EFPs.
The Company's F/X Desk service fee and EFP differential costs have, to date
totaled no more than .25 of 1% per annum of the Company's average month-end
assets.
3. ADVISORY AGREEMENT
The Company and the Advisor have entered into an Advisory Agreement. This
Advisory Agreement terminated one year after it was entered into and has been
renewed until 12/31/98, subject to certain additional renewal rights
exercisable by the Company. The Advisor determines the commodity futures,
options on futures and forward contract trades to be made on behalf of the
Company, subject to certain Company trading policies and to certain rights
reserved by MLIP.
The Company pays to JWH a quarterly Profit Share equal to 15% of any New
Trading Profit, as defined, attributable to each Member's Capital Account in
the Company. Profit Shares, which are calculated separately in respect of
each Member's Capital Account, are determined as of the end of each calendar
quarter and are also paid to JWH upon the withdrawal of capital from the
Company by a Member for whatever purpose, other than to pay expenses.
-7-
<PAGE>
4. FAIR VALUE AND OFF-BALANCE SHEET RISK
The Company trades futures, options on futures and forward contracts on
interest rates, stock indices, currencies, and metals. The Company's
trading results by reporting category were as follows:
Total Trading Results
------------------------------------------------
1997 1996
--------------------- ---------------------
Interest Rates $ 4,763,680 $ 10,439,465
Stock Indices 2,201,853 (371,033)
Currencies 1,794,830 5,889,115
Metals 3,445,310 2,601,435
--------------------- ---------------------
$ 12,205,673 $ 18,558,982
===================== =====================
Market Risk
Derivative instruments involve varying degrees of off-balance sheet market
risk, and changes in the level or volatility of interest rates, foreign
currency exchange rates or the market values of the underlying financial
instruments or commodities underlying such derivative instruments frequently
result in changes in the Company's unrealized profit on such derivative
instruments as reflected in the Statements of Financial Condition. The
Company's exposure to market risk is influenced by a number of factors,
including the relationships among the derivative instruments held by the
Company as well as the volatility and liquidity in the markets in which such
derivative instruments are traded.
MLIP, which monitors the trading of the Company in MLIP's capacity as the
General Partner of the Voting Members and Sponsor of the Non-Voting Members,
has procedures in place intended to control market risk, although there can
be no assurance that they will, in fact, succeed in doing so. The procedures
focus primarily on monitoring the trading of the Advisor, calculating the Net
Asset Value of the Company and of the Members' respective capital accounts as
of the close of business on each day and reviewing outstanding positions for
over-concentrations. While MLIP does not itself intervene in the markets to
hedge or diversify the Company's market exposure, MLIP may consult with the
Advisor concerning the possibility of the Advisor reducing trading leverage
or market concentrations. However, such interventions are unusual. Except
in cases in which it appears that JWH has begun to deviate from past practice
and trading policies or to be trading erratically, MLIP's basic risk control
procedures consist simply of the ongoing process of monitoring JWH with the
market risk controls being applied by JWH.
Fair Value
The derivative instruments traded by the Company are marked to market daily
with the resulting unrealized profit recorded in the Statements of Financial
Condition and the related profit reflected in trading revenues in the
Statements of Income.
-8-
<PAGE>
The contract/notional values of open contracts as of December 31, 1997 and
1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------------------------- ---------------------------------------------------------
<S> <C> <C> <C> <C>
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
---------------------- ---------------------- ----------------------- -----------------------
Interest Rates $ 200,852,720 $ 260,424,574 $ 171,304,600 $ 13,669,055
Stock Indicies - 4,996,821 - -
Currencies 69,236,628 134,487,777 119,088,247 96,734,685
Metals 8,173,620 23,636,110 - 33,126,830
---------------------- ---------------------- ----------------------- -----------------------
$ 278,262,968 $ 423,545,282 $ 290,392,847 $ 143,530,570
====================== ====================== ======================= =======================
</TABLE>
Substantially all of the Company's derivative instruments outstanding as of
December 31, 1997, expire within one year.
The contract/notional values of the Company's exchange-traded and non-
exchange traded open derivative instrument positions as of December 31, 1997
and 1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
--------------------------------------------------------- ------------------------------------------------------
<S> <C> <C> <C> <C>
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
----------------------- ----------------------- ----------------------- -----------------------
Exchange Traded $ 209,026,340 $ 305,091,785 $ 171,304,600 $ 46,795,885
Non-Exchange-Traded 69,236,628 118,453,497 119,088,247 96,734,685
----------------------- ----------------------- ----------------------- -----------------------
$ 278,262,968 $ 423,545,282 $ 290,392,847 $ 143,530,570
======================= ======================= ======================= =======================
</TABLE>
The average fair values, based on contract/notional values, of the Company's
derivative instruments positions which were open as of the end of each
calendar month during the year ended December 31, 1997 and for the period
October 1, 1996 through December 31, 1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
---------------------- --------------------------- ----------------- -----------------------
Interest Rates $ 364,504,683 $ 155,397,051 $ 591,299,377 $ 127,295,586
Stock Indicies 13,580,756 11,229,979 - -
Currencies 117,259,926 148,327,330 297,652,663 275,733,802
Metals 6,409,749 31,164,193 14,845,327 75,877,301
---------------------- --------------------------- ----------------- -----------------------
$ 501,755,114 $ 346,118,553 $ 903,797,367 $ 478,906,689
====================== =========================== ================= =======================
</TABLE>
A portion of the amounts indicated as off-balance sheet risk reflects
offsetting commitments to purchase and sell the same derivative instrument on
the same date in the future. These commitments are economically offsetting
but are not, as a technical matter, offset in the forward market until the
settlement date.
-9-
<PAGE>
Credit Risk
The risks associated with exchange-traded contracts are typically perceived
to be less than those associated with over-the-counter (non-exchange-traded)
transactions, because exchanges typically (but not universally) provide
clearinghouse arrangements in which the collective credit (in some cases
limited in amount, in some cases not) of the members of the exchange is
pledged to support the financial integrity of the exchange. In over-the-
counter transactions, on the other hand, traders must rely solely on the
credit of their respective individual counterparties. Margins, which may be
subject to loss in the event of a default, are generally required in exchange
trading, and counterparties may require margin in the over-the-counter
markets.
The fair value amounts in the above tables represent the extent of the
Company's market exposure in the particular class of derivative instrument
listed, but not the credit risk associated with counterparty nonperformance.
The credit risk associated with these instruments from counterparty
nonperformance is the net unrealized profit, if any, included on the
Statements of Financial Condition.
The Company also has credit risk because the sole counterparty or broker with
respect to most of the Company's assets is MLF.
The gross unrealized profit and net unrealized profit on the
Company's open derivative instrument positions as of December 31, 1997 and
1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------- ---------------------------------------
<S> <C> <C> <C> <C>
Gross Unrealized Net Unrealized Gross Unrealized Net Unrealized
Profit Profit (Loss) Profit Profit
----------------------------------------------------------------------------------
Exchange Traded $ 4,309,342 $ 3,661,949 $ 873,657 $ 39,049
Non-Exchange Traded 1,587,289 (932,962) 1,962,810 659,522
---------------- ---------------- ----------------- -----------------
$ 5,896,631 $ 2,728,987 $ 2,836,467 $ 698,571
================ ================ ================= =================
</TABLE>
The Company controls credit risk by dealing almost exclusively with
Merrill Lynch entities as brokers and counterparties.
The Company, through its normal course of business, enters into various
contracts, with MLF acting as its commodity broker. Pursuant to the
brokerage arrangement with MLF, to the extent that such trading results in
receivables from and payables to MLF, these receivables and payables are
offset and reported as a net receivable or payable.
-10-
<PAGE>
To the best of the knowledge and belief of the
undersigned, the information contained in this
report is accurate and complete.
/s/ Michael A. Karmelin
Michael A. Karmelin
Chief Financial Officer
Merrill Lynch Investment Partners Inc.
Commodity Pool Operator of
ML JWH Financial and Metals Portfolio L.L.C.
-11-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> BD
<S> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1996
<PERIOD-START> JAN-01-1997 JAN-01-1996
<PERIOD-END> DEC-31-1997 DEC-31-1996
<CASH> 0 0
<RECEIVABLES> 20,346,863 25,219,444
<SECURITIES-RESALE> 0 0
<SECURITIES-BORROWED> 0 0
<INSTRUMENTS-OWNED> 6,996,472 7,321,993
<PP&E> 0 0
<TOTAL-ASSETS> 27,343,335 32,541,437
<SHORT-TERM> 0 0
<PAYABLES> 767,052 592,405
<REPOS-SOLD> 0 0
<SECURITIES-LOANED> 0 0
<INSTRUMENTS-SOLD> 0 0
<LONG-TERM> 0 0
0 0
0 0
<COMMON> 0 0
<OTHER-SE> 26,576,283 31,949,032
<TOTAL-LIABILITY-AND-EQUITY> 27,343,335 32,541,437
<TRADING-REVENUE> 4,836 3,471,890
<INTEREST-DIVIDENDS> 1,118,910 1,364,326
<COMMISSIONS> 1,936,603 2,636,241
<INVESTMENT-BANKING-REVENUES> 0 0
<FEE-REVENUE> 0 0
<INTEREST-EXPENSE> 0 0
<COMPENSATION> 0 0
<INCOME-PRETAX> (58,822) 3,699,252
<INCOME-PRE-EXTRAORDINARY> (58,822) 3,699,252
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (58,822) 3,699,252
<EPS-PRIMARY> (0.39) 20.37
<EPS-DILUTED> (0.39) 20.37
</TABLE>
