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The
Baupost
Fund
Prospectus
February 28, 1999
The Baupost Fund (the "Fund") is a no-load, non-diversified, open-end management
investment company registered under the Investment Company Act of 1940, as
amended (the "1940 Act"). The Fund was established as a Massachusetts business
trust under an Agreement and Declaration of Trust dated June 29, 1990. The Fund
is managed by The Baupost Group, L.L.C. (the "Adviser").
The Securities and Exchange Commission has
not approved or disapproved these securities
or determined whether this prospectus is
truthful or complete. Any representation to
the contrary is a criminal offense.
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TABLE OF CONTENTS
Page
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THE FUND.......................................................................2
Investment Goal.............................................................2
Principal Investment Strategies.............................................2
Principal Risks.............................................................2
Performance Information.....................................................3
INVESTMENT OBJECTIVES, PRINCIPAL INVESTMENT STRATEGIES, AND RELATED RISKS......5
Investment Objectives.......................................................5
Principal Strategies And Their Related Risks................................5
Other Related Risks.........................................................7
Limiting Investment Risk....................................................8
MANAGEMENT, ORGANIZATION, AND CAPITAL STRUCTURE................................9
Management Of The Fund......................................................9
SHAREHOLDER INFORMATION.......................................................10
Pricing Of Fund Shares.....................................................10
Purchase Of Fund Shares....................................................10
Redemption Of Fund Shares..................................................11
Distribution Arrangements..................................................11
Tax Consequences...........................................................12
Shareholder Inquiries......................................................12
FINANCIAL HIGHLIGHTS..........................................................13
APPENDIX A --DESCRIPTION OF DEBT RATINGS......................................14
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THE FUND
INVESTMENT GOAL
The Fund seeks capital appreciation. Income is a secondary goal.
PRINCIPAL INVESTMENT STRATEGIES
The Fund invests in U.S. and foreign securities, including common
stocks, preferred stocks and debt securities. In selecting investments, the Fund
often invests in companies that appear to be available at less than their
intrinsic value. The Adviser generally focuses on the quality and price of
individual companies, not on industry or market-timing strategies. The Adviser
considers many factors, including the relationship of the market value of
investments to book value, estimated asset value, ongoing business value, cash
flow and earnings. However, the Adviser has no general criteria as to asset
size, earnings or industry which would make an investment unsuitable. The Fund
may from time to time invest a relatively large portion of its assets in cash or
money market instruments when, in the opinion of the Adviser, investment and
market conditions warrant such investments. It is impossible to predict when the
Fund will be fully invested or when it will hold large cash positions. The Fund
may be fully invested even during volatile market conditions.
PRINCIPAL RISKS
The main risks that could adversely affect the value of the Fund's
shares and the total return on your investment include:
- The risks of investing outside the United States, such as
currency fluctuations, economic or financial instability or
unfavorable political or legal developments in foreign markets.
These risks are increased when investing in emerging markets
(which the Fund may do without limitation).
- The risk that the market may continue indefinitely to undervalue
the investments in the Fund's portfolio or that the investments
may fail to appreciate as anticipated by the Adviser. Many
factors can adversely affect a stock's performance. This risk
may be greater for small and medium-sized companies, which could
be more vulnerable to adverse developments and are less liquid
to trade.
- The risk that movements in the securities markets will adversely
affect the price of the Fund's investments, regardless of how
well the companies in the Fund's portfolio perform.
- The risk that certain investment techniques designed to protect
the Fund's investments fail to do so or instead adversely impact
the Fund's performance.
- The risk that the Fund's investments in debt securities may be
adversely affected by changes in interest rates or the financial
condition of the issuers.
- The Fund frequently invests in securities, industries and asset
classes that are out of favor or ignored by other investors.
Investors in the Fund incur the risk that such a contrarian
strategy may not work; to the extent that adverse economic and
investment trends continue for a long time, the Fund could
experience a protracted period of underperformance.
- In addition, like other mutual funds, the Fund's performance
depends on the skill and judgement of its investment manager.
Investment in the Fund may result in a loss of capital. The Fund may
not achieve its goals, and is not intended as a complete investment program.
The Fund is a "non-diversified" fund, meaning that, when compared with
diversified funds, the Fund may invest a greater percentage of its assets in a
particular investment. Should the Fund concentrate in a smaller number of
securities, the Fund's risk would be potentially increased because the effect of
each investment on the Fund's
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performance would be magnified. This would help the Fund's performance when its
investments are successful but hurt the Fund's performance when its investments
are unsuccessful. If one of the securities in which the Fund has invested a
large portion of its assets goes down in value, it could have a significant
adverse effect on the Fund. Because of these and other risks, the Fund should
only be purchased by investors with long-term investment horizons who can bear
short-term fluctuations in their investment.
PERFORMANCE INFORMATION
The following information provides some indication of the Fund's risks.
The bar chart shows year-to-year changes in the performance of the Fund. The
table following the chart compares the Fund's performance to two broad measures
of market performance. The Fund's past performance is not an indication of
future performance.
CALENDAR YEAR TOTAL RETURNS
1991 22.60%
1992 13.86%
1993 18.84%
1994 8.03%
1995 11.22%
1996 23.37%
1997 24.68%
1998 (15.45)%
During the period covered by the bar chart, the highest return for a
quarter was 11.63% (quarter ending 6/28/96) and the lowest return for a quarter
was -18.47% (quarter ending 9/30/98).
AVERAGE TOTAL RETURNS
(FOR PERIODS ENDING 12/31/98)
<TABLE>
<CAPTION>
Since
Past 1 year Past 3 years Past 10 years Inception (12/14/90)
----------- ------------ ------------- --------------------
<S> <C> <C> <C> <C>
The Baupost Fund .......... (15.45)% 10.04% NA 13.07%
S&P 500 Index ............. 28.58% 24.06% NA 20.91%
Russell 2000 Index ........ (3.45)% 10.29% NA 15.75%
</TABLE>
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The Fund does not have a sales load or other charges paid by all
shareholders that affect its calculation of average annual total return. During
the periods reported above, a fee waiver arrangement was in place which had the
effect of lowering the Fund's management fee in some years and therefore
enhanced the total return of the Fund. The Fund's performance is compared to the
Standard & Poor's 500 Index, an unmanaged index of common stocks frequently used
as a general measure of U.S. stock market performance. The Fund's performance is
also compared to the Russell 2000 Index, which is composed of the 2,000 smallest
companies in the Russell 3000 Index, which, in turn, is composed of the 3,000
largest U.S. companies ranked by total market capitalization.
EXPENSE INFORMATION
The following table summarizes the Fund's expenses based on its most
recent fiscal year. The purpose of this table is to assist you in understanding
the various costs and expenses of the Fund that are borne by shareholders of the
Fund.
ANNUAL FUND OPERATING EXPENSES
(expenses that are deducted from fund assets, as a percentage of average
net assets)
<TABLE>
<S> <C> <C>
Management Fee 1.00%(1)
Other Expenses 1.19%
Investment-related expenses .62%
Administrative services fee .25%
All other expenses .32%
--- ----
Total Annual Fund Operating Expenses 2.19%(1)
Fee Waiver (.07%)(2)
----
Net Expenses 2.12%(2)
</TABLE>
(1) The Management Fee and Total Annual Fund Operating Expenses shown above do
not reflect the effects of a contractual fee waiver arrangement (the "Fee
Waiver") between the Fund and the Adviser. See "Management, Organization and
Capital Structure" below.
(2) The captions "Fee Waiver" and "Net Expenses" reflect the Fee Waiver.
EXAMPLE: THE EXAMPLE BELOW IS INTENDED TO HELP YOU COMPARE THE COST OF INVESTING
IN THE FUND WITH THE COST OF INVESTING IN OTHER MUTUAL FUNDS.
EXAMPLE 1 - BASIC EXPENSE TABLE
<TABLE>
<S> <C> <C> <C> <C>
You would pay the following 1 Year 3 Years 5 Years 10 Years
expenses on a $10,000 ------ ------- ------- --------
investment assuming (1) 5% $222 $685 $1,175 $2,524
annual return and (2) redemption
at the end of each time period:
</TABLE>
The Example does not represent past or future expenses; actual expenses
incurred during the periods covered by the Example may be more or less than
shown. Federal regulations require the Example to assume a 5% annual return, but
actual annual return will vary. See "Management, Organization and Capital
Structure" for more information about operating expenses.
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INVESTMENT OBJECTIVES, PRINCIPAL INVESTMENT STRATEGIES, AND RELATED RISKS
INVESTMENT OBJECTIVES
The principal investment objective of the Fund is capital appreciation.
Income is a secondary objective. These objectives are not fundamental and the
Trustees of the Fund may change them without shareholder approval. The Fund is
not intended to be a complete investment program, and there is no assurance the
Fund will achieve its objectives.
PRINCIPAL STRATEGIES AND THEIR RELATED RISKS
BASIC INVESTMENT STRATEGY. The Fund pursues its investment objectives
primarily through investments in common stocks, preferred stocks, debt
securities (such as bonds, debentures, notes, bank debt and claims) and
participations therein, derivative instruments (such as put or call options or
swaps) and other securities. These securities are analyzed and researched by The
Baupost Group, L.L.C. ("Baupost" or the "Adviser"), taking into account, among
other factors, the relationship of the market value of the securities to book
value, estimated asset value, ongoing business value, cash flow, and earnings to
determine if they are available at prices less than their intrinsic value. These
factors are not applied formulaically, as the Adviser examines each security
separately; the Adviser has no general criteria as to asset size, earnings or
industry type which would make a security unsuitable for purchase by the Fund.
The Fund may invest in common stocks, preferred stocks and debt
securities, whether domestic or foreign, and cash in such proportions as the
Adviser deems advisable. The preferred stocks and debt securities may be
convertible. The Fund may invest up to 25% of its total assets in any one
industry. The achievement of the Fund's investment objectives will depend upon
the Adviser's analytical and portfolio management skills. In light of the types
of securities in which the Fund may invest, the Fund is not an appropriate
investment for investors seeking short-term profits.
The Fund generally purchases securities for investment purposes and not
for the purpose of influencing or controlling management of the issuer. However,
the Fund may seek to influence or control management by investing in a potential
takeover, leveraged buyout or reorganization or by investing in other entities
that were organized in order to purchase securities for the purpose of
influencing or controlling management, if the Adviser believes that the possible
increase in the value of its investment will outweigh the risks and costs
associated with the action. The Fund may also discuss informally with management
different operating strategies, propose shareholder resolutions, engage in a
proxy contest or serve as part of a creditors' committee established in
connection with a company's insolvency. Neither the Fund nor the Adviser has any
experience in managing the types of companies in which the Fund will likely
invest.
The Fund may, from time to time, take temporary defensive positions that
are inconsistent with the Fund's principal investment strategies in attempting
to respond to adverse market, economic, political, or other conditions. The
effect of taking such a temporary defensive position may be that the Fund does
not achieve its investment objectives. Although the Adviser has the flexibility
to use these strategies, it may choose not to for a variety of reasons, even in
very volatile markets.
FREQUENT TRADING. The Fund may buy and sell investments relatively
often, which involves higher brokerage commissions and other expenses and may
increase the amount of taxes payable by shareholders. See "Tax Consequences."
DEBT SECURITIES. The Fund may invest without limit in debt securities,
including obligations of the U.S. Treasury. The values of debt securities
generally fluctuate inversely with changes in interest rates. The Fund has
established no rating criteria for debt securities in which it may invest,
although securities ratings will be a factor in the Adviser's decision to
purchase debt securities. Other factors that may influence the Adviser's
decision include the financial position and credit history of the issuer, the
yield, maturity and liquidity of the particular debt security, and the Adviser's
forecasts of interest rate and market movements. The debt securities purchased
by the Fund may have remaining maturities in excess of 20 years. Some debt
securities in which the Fund may invest may be secured by assets of the debtor.
In order to enforce its rights in the event of a default under such securities,
the Fund may be required to take possession of and manage such assets, which may
increase the Fund's operating expenses and
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adversely affect the Fund's net asset value. Neither the Fund nor the Adviser
has any experience in managing such assets. The Fund's intention to qualify as a
"regulated investment company" for federal income tax purposes may limit the
extent to which the Fund may exercise its rights by taking possession of such
assets. For a discussion of the risks associated with the Fund's investments in
lower-rated debt securities, see "Other Related Risks - Lower Rated Securities."
The Fund may purchase indebtedness and participations therein of
financially troubled companies, which include companies that are in default
under agreements representing indebtedness, companies that have experienced a
material adverse change in their business or operations, or companies that are
insolvent. The Fund may invest without limit in such indebtedness and may invest
in senior and subordinated indebtedness. Like the purchase of other debt
securities, the purchase of indebtedness of such companies always involves a
risk as to the creditworthiness of the issuer and the possibility that the
entire investment may be lost, although these risks are heightened when the Fund
invests in troubled companies. While there are established markets for some of
this indebtedness, certain indebtedness will be illiquid or less liquid than
more heavily traded securities. The Fund will not invest more than 15% of its
net assets in illiquid securities.
The Fund's ability to receive payments of principal and interest in
connection with participations held by it will depend primarily on the financial
condition of the borrowers, although the Fund may in some cases be required to
rely upon the lending institution from which it purchased the participation to
collect and pass on to the Fund such payments and to enforce the Fund's rights
under the loan. The Fund may have limited rights to enforce the terms of the
underlying loan and the liquidity of loan participations may be limited.
The Fund may also purchase claims against companies, including insolvent
companies. These claims are typically unsecured and generally represent money
due a supplier of goods or services to such company. Such claims are subject to
certain risks, such as the risk that the Fund may not be paid by the debtor on a
timely basis, if at all, or, if the Fund does receive payment, it may be in an
amount less than the value which the Adviser had placed on the claim.
REORGANIZATION TRANSACTIONS. The Fund may invest without limit in the
securities of companies involved in mergers, consolidations, liquidations and
reorganizations or as to which there exist tender or exchange offers
(collectively, "Reorganization Transactions"). Because the expected gain on an
individual investment in a company involved in a Reorganization Transaction is
normally smaller than the possible loss if the transaction is unexpectedly
terminated, Fund assets will not be invested unless the proposed transaction
appears to the Adviser to have a substantial probability of success. The
expected completion of each transaction is also extremely important since the
length of time that the Fund's assets may be invested in securities of a company
involved in a Reorganization Transaction will affect the rate of return realized
by the Fund. The Adviser may invest the Fund's assets in both negotiated, or
"friendly," reorganizations and non-negotiated, or "hostile," takeover attempts.
There can be no assurance that any Reorganization Transaction proposed at the
time the Fund makes its investment will be consummated or will be consummated on
the terms and within the time period contemplated.
FOREIGN INVESTMENTS. The Fund may invest without limit in foreign
securities, including securities issued by foreign governments. Securities of
foreign issuers, particularly non-governmental issuers, involve risks which are
not ordinarily associated with investing in domestic issuers. Since foreign
securities are normally denominated and traded in foreign currencies, the values
of the Fund's assets will be affected favorably or unfavorably by currency
exchange rates and exchange control regulations (which may include suspension of
the ability to transfer currency from a given country and repatriation of
investments) to the extent it invests in foreign securities. Exchange rates with
respect to certain currencies may be particularly volatile. In addition,
investments in foreign countries could be affected by other factors generally
not thought to be present in the United States, including the unavailability of
financial information or the difficulty of interpreting financial information
prepared under foreign accounting standards (which are generally not comparable
to U.S. standards), the possibility of expropriation, nationalization and
confiscatory or heavy taxation, the impact of political, social or diplomatic
developments, default in foreign government securities, limitations on the
removal of funds or other assets of the Fund, difficulties in invoking legal
process abroad and enforcing contractual obligations, and the difficulty of
assessing economic trends in foreign countries. Delays in settlement could
result in temporary periods when assets of the Fund are uninvested and no return
is being earned thereon. Inability to sell a portfolio security due to
settlement problems could result either in a loss to the Fund if the value of
the portfolio security subsequently declined or, if the Fund entered into a
contract to sell the security, could result in possible claims against the Fund.
Foreign securities markets may be less liquid and more volatile than U.S.
markets. Foreign brokerage commissions and other transaction costs and custodian
fees are generally higher than in the United States. The Adviser may engage in
foreign currency exchange transactions in connection with the purchase and sale
of foreign securities and to protect the value of specific portfolio positions,
although appropriate hedging transactions may not always be available or, even
if such transactions are available, the Adviser may choose not to hedge the
Fund's foreign currency exposure. See the Statement of Additional Information
for a more detailed description. Special tax considerations also apply to
investments in foreign securities. See "Tax Consequences."
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Some countries in which the Fund may invest may have fixed or managed
currencies that are not free-floating against the U.S. dollar. Further, certain
currencies may not be traded internationally. Certain of these currencies have
experienced a steady devaluation relative to the U.S. dollar. Any devaluations
in the currencies in which the Fund's portfolio securities are denominated may
have a detrimental impact on the Fund. Many countries in which the Fund may
invest have experienced substantial, and in some periods extremely high, rates
of inflation or deflation for many years. Inflation, deflation and rapid
fluctuations in such rates have had, and may continue to have, negative effects
on the economies and securities markets of certain countries.
There are substantial risks involved in investing in securities issued
by issuers located in underdeveloped or developing countries, which are
sometimes referred to as "emerging markets." These risks are in addition to the
usual risks inherent in foreign investments described above. Because of such
matters as greater risks of adverse political developments, the lack of
effective legal structures and difficulties effecting securities transfers and
settlements, the Fund risks the loss of its entire investment when investing in
securities issued by issuers located in certain foreign countries. The Fund may
invest without limit in emerging markets.
DERIVATIVES. The Fund may engage in a variety of transactions using
derivatives such as futures, options, warrants, forwards and swap contracts.
Derivatives are financial instruments whose value depends upon, or is derived
from, the value of something else, such as one or more underlying investments,
indexes or currencies. Derivatives may be traded on organized exchanges, or in
individually negotiated transactions with other parties (these are known as
"over the counter"). The Fund may use derivatives both for hedging and
non-hedging purposes.
Derivatives involve special risks and costs and may result in losses to
the Fund. The successful use of derivatives requires sophisticated management
and the Fund will depend on the Adviser's ability to analyze and manage
derivatives transactions. The prices of derivatives may move in unexpected ways,
especially in abnormal market conditions. Some derivatives are "leveraged" and
therefore may magnify or otherwise increase investment losses to the Fund. The
Fund's use of derivatives may also increase the amount of taxes payable by
shareholders.
Other risks arise from the potential inability to terminate or sell
derivatives positions. A liquid secondary market may not always exist for the
Fund's derivatives positions at any time. In fact, many over-the-counter
instruments also involve the risk that the other party will not meet its
obligations to the Fund.
OTHER RELATED RISKS
SMALLER COMPANIES. The Fund can invest in small and medium sized
companies, including companies with market capitalizations of less than $500
million. Some of these companies may be "micro cap" companies with market
capitalization of under $100 million. These companies are more likely than
larger companies to have limited product lines, markets or financial resources,
or to depend on a small, inexperienced management group. Stocks of these
companies may trade less frequently and in limited volume, and their prices may
fluctuate more than stocks of other companies. Stocks of these companies may
therefore be more vulnerable to adverse developments than those of larger
companies.
LOWER-RATED SECURITIES. Debt securities in which the Fund invests may or
may not be rated by rating agencies such as Moody's Investors Service, Inc.
("Moody's") or Standard & Poor's ("S&P"), and, if rated, such rating may range
from the very highest to the very lowest, currently C for Moody's and D for S&P.
Securities rated below investment grade (below Baa if rated by Moody's and below
BBB if rated by S&P) normally provide a yield or yield to maturity that is
significantly higher than that of investment grade issues, but are predominately
speculative with respect to capacity to pay interest and repay principal. The
lower-rated categories include debt securities that are in default and debt
securities of issuers who are insolvent. The rating assigned to a security by
Moody's or S&P does not reflect an assessment of the volatility of the
security's market value or the liquidity of an investment in the security.
The values of lower-rated securities (including unrated securities of
comparable quality) fluctuate more than those of higher-rated securities. In
addition, the lower rating reflects a greater possibility that the financial
condition of the issuer, or adverse changes in general economic conditions, or
both, or an unanticipated rise in interest rates, may impair the ability of the
issuer to make payments of principal and income. The inability (or perceived
inability) of issuers to make timely payment of interest and principal would
likely make the values of securities held by the Fund more volatile and could
limit the Fund's ability to sell its securities at prices approximating the
values the Fund had placed on such securities. In addition, the market price of
lower-rated securities is likely to be more volatile because: (i) an economic
downturn or increased interest rates may have a significant effect on the yield,
price and potential for default; (ii) the market may at times become less liquid
or respond to adverse publicity or investor perceptions, increasing the
difficulty in disposing of the securities or in valuing them for purposes of
determining the Fund's net asset value; and (iii) past legislation has limited
(and future legislation may further limit) investment by certain institutions in
lower-rated securities or the tax deductibility of the interest by the issuer,
which may
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adversely affect the value of such securities. The Fund will not necessarily
dispose of a security when its rating is reduced below its rating at the time of
purchase, although the Adviser will monitor the investment to determine whether
continued investment in the security will assist in meeting the Fund's
investment objectives. Because the Fund may invest without limit in such
lower-rated securities, the Fund's achievement of its investment objectives is
more heavily dependent on the Adviser's credit analysis. For a more complete
description of the ratings of debt securities, see "Appendix A -- Description of
Debt Ratings."
At times, a substantial portion of the Fund's assets may be invested in
securities as to which the Fund, by itself or together with other funds and
accounts managed by the Adviser and its affiliates, holds a major portion or all
of such securities. Although the Adviser generally considers such securities to
be liquid because of the availability of an institutional market for such
securities, it is possible that, under adverse market or economic conditions or
in the event of adverse changes in the financial condition of the issuer, the
Fund could find it more difficult to sell such securities when the Adviser
believes it advisable to do so or may be able to sell such securities only at
prices lower than if such securities were more widely held. Under such
circumstances, it may also be more difficult to determine the fair value of such
securities for purposes of computing the Fund's net asset value.
Certain securities held by the Fund may permit the issuer at its option
to "call," or redeem, its securities. If an issuer were to redeem securities
held by the Fund during a time of declining interest rates, the Fund may not be
able to reinvest the proceeds in securities providing the same investment return
as the securities redeemed.
The Fund may at times invest in so-called "zero-coupon" bonds and
"payment-in-kind" bonds. Zero-coupon bonds do not pay interest for their entire
lives and are issued at a discount from their principal amount in lieu of paying
interest periodically. Payment-in-kind bonds allow the issuer, at its option, to
make current interest payments on the bonds either in cash or in additional
bonds. Such investments may experience greater fluctuation in market value in
response to changes in market interest rates than bonds which pay interest in
cash currently. Both zero-coupon and payment-in-kind bonds allow an issuer to
avoid the need to generate cash to meet current interest payments, but may also
require a higher rate of return to attract investors who are willing to defer
receipt of such cash. Accordingly, such bonds involve greater credit risk than
bonds paying interest in cash currently. Even though such bonds may not pay
current interest in cash, the Fund is nonetheless required to accrue interest
income on such investments and to distribute such amounts at least annually to
shareholders. Thus, the Fund could be required at times to liquidate other
investments in order to satisfy its distribution requirements.
The amount of information about the financial condition of an issuer of
tax-exempt securities may not be as extensive as that which is made available by
corporations whose securities are publicly traded. Therefore, to the extent the
Fund invests in lower-rated tax-exempt securities, the achievement of the Fund's
goals is more dependent on the Adviser's investment analysis than would be the
case if the Fund were investing in higher-rated securities.
OTHER INVESTMENTS. In addition to the main investment strategies
described above, the Fund may also make other types of investments, such as
repurchase agreements, short sales and securities loans, and therefore may be
subject to other risks.
YEAR 2000 ISSUES. The Fund could be adversely affected if the computer
systems used by the Fund and the Fund's service providers do not properly
process and calculate date-related information relating to the end of this
century and the beginning of the next. While year 2000-related computer problems
could have a negative effect on the Fund's operations, the Fund is working to
avoid such problems and to obtain assurances from service providers that they
are taking similar steps. In addition, year 2000-related computer problems could
also adversely affect the Fund's investments. No assurances can be provided that
the Fund will not be adversely impacted by these matters.
LIMITING INVESTMENT RISK
Specific investment restrictions help the Fund attempt to limit
investment risks for its shareholders. See the Statement of Additional
Information. Except for investment restrictions designated as fundamental in the
Statement of Additional Information, the investment policies described in this
Prospectus and in the Statement of Additional Information are not fundamental
policies. The Trustees may change any non-fundamental investment policies
without shareholder approval.
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MANAGEMENT, ORGANIZATION, AND CAPITAL STRUCTURE
MANAGEMENT OF THE FUND
The Fund is advised and managed by Baupost, a Massachusetts limited
liability company. Seth A. Klarman, President of Baupost and of the Fund, owns
in excess of 50% of the ownership interest of Baupost. SAK Corporation, a
Massachusetts corporation with the principal function of managing and overseeing
Baupost, is wholly owned by Mr. Klarman. SAK Corporation is the sole manager of
Baupost, and as such, has sole decision-making authority over the management and
operation of Baupost. Mr. Klarman has had primary responsibility for the
day-to-day management of the Fund's portfolio since the Fund's inception in
January, 1991. Mr. Klarman has been with The Baupost Group, L.L.C. or The
Baupost Group, Inc. ("BGI"), its predecessor, since April, 1982. Prior to
January 2, 1998, the Fund was advised and managed by BGI. On that date, BGI
underwent a corporate restructuring that resulted, among other things, in the
transfer of all of its assets and liabilities of BGI to Baupost. Upon
consummation of that transaction, Baupost succeeded to the business operations
previously conducted by BGI.
Under the Management Contract with the Fund, Baupost, subject to such
policies as the Trustees may determine, selects and reviews the Fund's
investments and provides office space for the Fund and pays all salaries, fees
and expenses of officers and Trustees of the Fund who are affiliated with
Baupost. In the event that Baupost ceases to be the investment adviser to the
Fund, the right of the Fund to use the identifying name "Baupost" with respect
to the Fund may be withdrawn.
The Fund pays Baupost a quarterly management fee at the annual rate of
1.00% of the Fund's average net assets. Under the Management Contract, for the
purposes of determining the applicable management fee, "average net assets" is
determined at regular intervals throughout the year. Baupost has agreed with the
Fund to reduce its management fee by up to .75% to the extent that the Fund's
total annual expenses (including the management fee, the administrative fee
described below and certain other expenses, but excluding brokerage commissions,
transfer taxes, interest and expenses relating to preserving the value of the
Fund's investments) would otherwise exceed 1.50% of the Fund's average net
assets.
From time to time, the Fund may engage in certain investment practices
that the Adviser believes to be in the best interests of the Fund and its
shareholders which will cause the Fund to incur expenses not subject to the
expense limitation. For example, the Fund may invest in equity swap contracts
with interest components which will be recorded as swap interest expense, and as
such not subject to the expense limitation. Expenses incurred by the Fund which
are not subject to the expense limitation may at times be substantial. This was
the case during fiscal 1998 and 1999. In addition, the Fund will pay all
expenses incurred in connection with the organization and operation of the Fund.
ADMINISTRATOR
Baupost acts as the Fund's administrator under an Administrative
Services Agreement. Under the agreement with the Fund, Baupost provides, among
other things, bookkeeping and certain clerical services to the Fund and will
calculate the total net asset value, total net income, and net asset value per
share of the Fund. For these services, the Fund pays Baupost a quarterly fee at
the annual rate of .25% of the Fund's average net asset value.
-9-
<PAGE> 11
SHAREHOLDER INFORMATION
PRICING OF FUND SHARES
The net asset value of a share is determined for the Fund as of the
close of regular trading on the New York Stock Exchange (normally 4:00 p.m.
Eastern time) once on each day on which the Exchange is open (other than a day
on which no shares of the Fund were tendered for redemption and no order to
purchase shares was accepted by the Fund, but at least as frequently as the last
business day of each month). The net asset value per share for the Fund is
determined by dividing the total value of the Fund's portfolio investments and
other assets, less any liabilities, by the total outstanding shares of the Fund.
Portfolio securities (other than certain foreign securities, as described
below), options and futures contracts for which market quotations are available
and which are traded on an exchange or on NASDAQ are valued at the last quoted
sale price, or, if there is no such reported sale that day, at the closing bid
price. Securities, options and forward contracts traded in the over-the-counter
market (other than those traded on NASDAQ) and other unlisted securities are
valued at the most recent bid price as obtained from one or more dealers that
make markets in the securities. Portfolio securities which are traded both in
the over-the-counter market and on one or more stock exchanges are valued
according to the broadest and most representative market. To the extent the Fund
engages in "naked" short sales (i.e., it does not own the underlying security or
a security convertible into the underlying security without the payment of any
further consideration), the Fund will value such short positions as described
above, except that the valuation, where necessary, will be based on the asked
price instead of the bid price. Securities traded in foreign markets are valued
at their current market value, which, depending on local custom, may or may not
be the last quoted sale price (or the closing bid price). Other assets for which
no quotations are readily available are valued at fair value as determined in
good faith in accordance with procedures adopted by the Trustees of the Fund.
Determination of fair value will be based upon such factors as are deemed
relevant under the circumstances, including the financial condition and
operating results of the issuer, recent third party transactions (actual or
proposed) relating to such securities and, in extreme cases, the liquidation
value of the issuer.
Because of time zone differences, foreign exchanges and securities
markets will usually be closed prior to the time of the closing of the New York
Stock Exchange and values of foreign investments will be determined as of the
closing of such exchanges and securities markets. However, events affecting the
values of such foreign investments may occasionally occur between the closings
of such exchanges and securities markets and the time the Fund determines its
net asset value which will not be reflected in the computation of such net asset
value. If an event materially affecting the value of such foreign investments
occurs during such period, then such investments will be valued at fair value as
determined in good faith in accordance with procedures adopted by the Trustees.
The use of fair value pricing by the Fund may cause the net asset value of its
shares to differ significantly from the net asset value that would be calculated
using current market values.
Because foreign securities (including options and futures contracts with
respect to foreign securities and currencies) are quoted in foreign currencies,
fluctuations in the value of such currencies in relation to the U.S. dollar will
affect the net asset value of shares of the Fund even though there has not been
any change in the values of such securities measured in terms of the foreign
currencies in which they are denominated. The value of foreign securities is
converted into U.S. dollars at current currency exchange rates.
PURCHASE OF FUND SHARES
Shares of the Fund may be purchased in a continuous offering for cash
without a sales charge or underwriting commission directly from the Fund once
each month on the last day on which the New York Stock Exchange (the "Exchange")
is open for business (a "Purchase Date"). The purchase price of shares of the
Fund is the net asset value as of the close of the Exchange on the relevant
Purchase Date. The minimum initial purchase of Fund shares is $50,000. The
minimum purchase for any subsequent investment is $1,000. The Fund may waive
these minimums at its discretion. Investors should call the offices of the Fund
before attempting to place an order for Fund shares. The Fund reserves the right
at any time to reject an order.
Before investing in the Fund, shareholders will be required to execute
an agreement pursuant to which they will agree not to transfer their shares,
except as approved by the Fund. For these purposes, redemptions of Fund shares
are not considered transfers, but pledges of Fund shares are.
-10-
<PAGE> 12
Before an order to purchase shares will be accepted, all required forms
must be fully completed and received by the Fund no later than the business day
preceding the Purchase Date, although the Fund requests that orders be sent so
that they are received by the Fund no later than five business days before such
Purchase Date. Unless otherwise approved by the Fund, all payments for purchases
must be made by wire transfer to an account designated by State Street Bank and
Trust Company. The deadline for wire transfers is 10:00 a.m. Eastern time on the
Purchase Date. When the consideration is received by the Fund after the
deadline, the purchase order may be rejected and may have to be resubmitted to
the Fund on the next Purchase Date.
Purchases will be made in full and fractional shares of the Fund
calculated to three decimal places. Shareholders will be sent a statement of
shares owned subsequent to each transaction.
REDEMPTION OF FUND SHARES
Shares of the Fund may be redeemed on any day the New York Stock
Exchange is open for business. The redemption price is the net asset value per
share next determined after receipt by the Fund of the redemption request in
"good order." Shares of the Fund will generally be redeemed by a distribution in
cash; however, the Fund reserves the right to redeem shares by a distribution in
kind of securities held by the Fund.
Securities used to redeem Fund shares in kind will be valued in
accordance with the Fund's procedures for valuation described under "Pricing of
Fund Shares." Securities distributed by the Fund in kind will be selected by the
Adviser in light of the Fund's investment objectives and will not generally
represent a pro rata distribution of each security held in the Fund's portfolio.
Shareholders who receive a distribution in kind should expect to incur
transaction costs when converting such securities to cash.
Payment on redemption will be made as promptly as possible and in any
event within seven days after the requested date provided that the request is in
"good order." A redemption request is in "good order" if it includes the exact
name in which shares are registered and the number of shares or the dollar
amount of shares to be redeemed and if it is signed exactly in accordance with
the form of registration. Persons acting in a fiduciary capacity, or on behalf
of a corporation, partnership or trust, must specify, in full, the capacity in
which they are acting. When opening an account with the Fund, shareholders may
be required to designate the account(s) to which funds may be transferred upon
redemption.
The Fund may suspend the right of redemption and may postpone payment
for more than seven days when the New York Stock Exchange is closed for other
than weekends or holidays, or if permitted by the rules of the Securities and
Exchange Commission, during periods when trading on the New York Stock Exchange
is restricted or during an emergency which makes it impracticable for the Fund
to dispose of its securities or to fairly determine the value of its net assets,
or during any other period permitted by the Securities and Exchange Commission
for the protection of investors.
DISTRIBUTION ARRANGEMENTS
The Fund intends to pay out as dividends substantially all of its
ordinary income (which principally consists of any dividends and interest it
receives from its investments, less accrued expenses). The Fund also intends to
distribute substantially all of its capital gain net income, if any, after
giving effect to any available capital loss carryover. The Fund's policy is to
declare and pay distributions of its ordinary income annually, generally in
December, although it may do so more frequently as determined by the Trustees of
the Fund. The Fund's policy is to distribute capital gain net income annually,
generally in December, although it may do so more frequently as determined by
the Trustees of the Fund and to the extent permitted by applicable regulations.
All dividends and/or distributions will be paid in shares of the Fund at
net asset value unless the shareholder elects to receive cash. Shareholders may
make or change this election by indicating their choice on the Shareholder
Information Sheet provided when an account is opened or by writing to the
Transfer Agent.
-11-
<PAGE> 13
TAX CONSEQUENCES
All Fund distributions will be taxable to shareholders as ordinary
income, except that distributions of any long-term capital gains are currently
taxable as such (generally at a 20% rate for non-corporate shareholders)
regardless of how long a shareholder may have owned shares in the Fund.
Distributions will be taxed whether received in cash or in additional shares of
the Fund. Distributions are taxable to you even if they are paid from income or
gains earned by the Fund before your investment (and thus were included in the
price you paid for your shares). The Fund will provide federal tax information
annually, including information about dividends and other distributions paid
during the preceding year.
Under the "backup withholding" rules, the Fund may be required to
withhold for the payment of Federal income tax 31% of a non-corporate
shareholder's taxable distributions and redemption proceeds if such shareholder
fails to provide the Fund with a correct taxpayer identification number or to
make required certifications, or if a shareholder has been notified by the
Internal Revenue Service that he is otherwise subject to backup withholding. The
taxpayer identification number of an individual is his social security number.
Any gain resulting from the sale or exchange of your shares will
generally also be subject to tax.
The foregoing is a general summary of the Federal income tax
consequences for shareholders who are U.S. citizens or residents or U.S.
corporations. Shareholders should consult their own tax advisors about the
federal tax consequences of an investment in the Fund in light of each
shareholder's particular tax situation. Shareholders should also consult their
own tax advisors about consequences under foreign, state, local or other
applicable tax laws. See the Statement of Additional Information for more
information about taxes.
SHAREHOLDER INQUIRIES
Shareholders may direct inquiries to the Fund c/o The Baupost Group,
L.L.C., 44 Brattle Street, Post Office Box 381288, Cambridge, Massachusetts
02238.
-12-
<PAGE> 14
THE BAUPOST FUND FINANCIAL HIGHLIGHTS
The table below presents selected per share data, total returns, and ratios
for the Fund's last five fiscal years for each share of beneficial interest. The
information in the table has been audited and reported on by Ernst & Young LLP,
the Fund's independent auditors, whose report appears in the Statement of
Additional Information. The Fund's Annual Report, which contains additional
unaudited performance information, is available upon request.
<TABLE>
<CAPTION>
Year Ended
October 31
----------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
SELECTED PER SHARE DATA (a)
Net Asset Value, beginning of period $17.09 $15.38 13.47 14.33 14.77
Income from Investment Operations
Net investment income 0.55 0.30 0.41 0.25 0.22
Net realized and unrealized
gain (loss) (2.83) 3.47 2.43 0.71 1.23
------ ---- ---- ---- ----
Total from investment operations (2.28) 3.77 2.84 0.96 1.45
------ ---- ---- ---- ----
Less Distributions
From net investment income 0.58 0.40 0.28 0.25 0.46
In excess of net investment income -- -- -- 0.08 --
From net realized gain 2.05 1.66 0.65 1.49 1.43
---- ---- ---- ---- ----
Total distributions 2.63 2.06 0.93 1.82 1.89
---- ---- ---- ---- ----
Net Asset Value, end of period $12.18 $17.09 $15.38 $13.47 $14.33
====== ====== ====== ====== ======
TOTAL RETURN (16.30%) 27.04% 22.51% 7.91% 11.06%
RATIOS AND SUPPLEMENTAL DATA
Net Assets, end of period
(in thousands) $134,003 $152,958 $108,788 $89,439 $81,787
Ratio of expenses to
average net assets 2.12%(a) 2.14%(a) 1.50% 1.54% 1.53%
Total expenses to average
net assets 2.19%(a) 2.14%(a) 1.50% 1.54% 1.55%
Ratio of net investment income
to average net assets 2.98% 1.45% 2.27% 1.60% 1.32%
Ratio of net investment income
excluding waiver of management
fee to average net assets 2.91% 1.45% 2.27% 1.60% 1.30%
Portfolio Turnover rate 129% 140% 120% 106% 161%
</TABLE>
(a) The increase in expense ratios is due to equity swap contract interest
expense.
-13-
<PAGE> 15
APPENDIX A -- DESCRIPTION OF DEBT RATINGS
I. Moody's Investors Service, Inc.
Moody's Investors Service, Inc. describes classifications of bonds
as follows:
Aaa - Bonds which are rated Aaa are judged to be of the best
quality. They carry the smallest degree of investment risk and are
generally referred to as "gilt edge." Interest payments are protected by
a large or by an exceptionally stable margin and principal is secure.
While the various protective elements are likely to change, such changes
as can be visualized are most unlikely to impair the fundamentally strong
position of such issues.
Aa - Bonds which are rated Aa are judged to be of high quality by
all standards. Together with the Aaa group they comprise what are
generally known as high grade bonds. They are rated lower than the best
bonds because margins of protection may not be as large as in Aaa
securities or fluctuation of protective elements may be of greater
amplitude or there may be other elements present which make the long term
risks appear somewhat larger than in Aaa securities.
A - Bonds which are rated A possess many favorable investment
attributes and are to be considered as upper medium grade obligations.
Factors giving security to principal and interest are considered
adequate, but elements may be present which suggest a susceptibility to
impairment sometime in the future.
Baa - Bonds which are rated Baa are considered as medium grade
obligations, (i.e., they are neither highly protected nor poorly
secured). Interest payments and principal security appear adequate for
the present but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such bonds
lack outstanding investment characteristics and in fact have speculative
characteristics as well.
Ba - Bonds which are rated Ba are judged to have speculative
elements; their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and
thereby not well safeguarded during both good and bad times over the
future. Uncertainty of position characterizes bonds in this class.
B - Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interests and principal payments or of
maintenance of other terms of the contract over any long period of time
may be small.
Caa - Bonds which are rated Caa are of poor standing. Such issues
may be in default or there may be present elements of danger with respect
to principal or interest.
Ca - Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or have
other marked shortcomings.
C - Bonds which are rated C are the lowest rated class of bonds and
issues so rated can be regarded as having extremely poor prospects of
ever attaining any real investment standing.
Moody's applies numerical modifiers 1, 2 and 3 in each generic
rating classification from Aa through B in its corporate bond ratings
system. The modifier 1 indicates that the security ranks in the higher
end of its generic rating category; the modifier 2 indicates a mid-range
ranking; and the modifier 3 indicates that the issue ranks in the lower
end of its generic rating category.
II. Standard & Poor's
Standard & Poor's describes classifications of corporate bonds as
follows:
AAA - Debt rated 'AAA' has the highest rating assigned by Standard
& Poor's. Capacity to pay interest and repay principal is extremely
strong.
-14-
<PAGE> 16
AA - Debt rated 'AA' has a very strong capacity to pay interest and
repay principal and differs from the higher rated issues only in small
degree.
A - Debt rated 'A' has a strong capacity to pay interest and repay
principal, although it is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than debt in
higher rated categories.
BBB - Debt rated 'BBB' is regarded as having an adequate capacity
to pay interest and repay principal. Whereas it normally exhibits
adequate protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than in
higher-rated categories.
SPECULATIVE GRADE
Debt rated 'BB', 'B', 'CCC', 'CC', and 'C' is regarded as having
predominantly speculative characteristics with respect to capacity to pay
interest and repay principal in accordance with the terms of the
obligation. 'BB' indicates the least degree of speculation and 'C' the
highest. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major
exposures to adverse conditions.
BB - Debt rated 'BB' has less near-term vulnerability to default
than other speculative issues. However, it faces major ongoing
uncertainties or exposure to adverse business, financial, or economic
conditions which could lead to inadequate capacity to meet timely
interest and principal payments. The 'BB' rating category is also used
for debt subordinated to senior debt that is assigned an actual or
implied 'BBB-' rating.
B - Debt rated 'B' has a greater vulnerability to default but
currently has the capacity to meet interest payments and principal
repayments. Adverse business, financial, or economic conditions will
likely impair capacity or willingness to pay interest and repay
principal. The 'B' rating category is also used for debt subordinated to
senior debt that is assigned an actual or implied 'BB' or 'BB-' rating.
CCC - Debt rated 'CCC' has a currently identifiable vulnerability
to default, and is dependent upon favorable business, financial, and
economic conditions to meet timely payment of interest and repayment of
principal. In the event of adverse business, financial, or economic
conditions, it is not likely to have the capacity to pay interest and
repay principal. The 'CCC' rating category is also used for debt
subordinated to senior debt that is assigned an actual or implied 'B' or
'B-' rating.
CC - The rating 'CC' typically is applied to debt subordinated to
senior debt that is assigned an actual or implied 'CCC' rating.
C - The rating 'C' typically is applied to debt subordinated to
senior debt that is assigned an actual or implied 'CCC-' rating. The 'C'
rating may be used to cover a situation where a bankruptcy petition has
been filed, but debt service payments are continued.
CI - The rating 'CI' is reserved for income bonds on which no
interest is being paid.
D - Debt rated 'D' is in payment default. The 'D' rating category
is used when interest payments or principal payments are not made on the
date due, even if the applicable grace period has not expired, unless
Standard & Poor's believes that such payments will be made during such
grace period. The 'D' rating also will be used upon the filing of a
bankruptcy petition if debt service payments are jeopardized.
Plus (+) Or Minus (-) Ratings from 'AA' to 'CCC' may be modified by
the addition of a plus or minus sign to show relative standing within the
major rating categories.
-15-
<PAGE> 17
For more information about
The Baupost Fund
For investors who want more information about the Fund, the following
documents are available free upon request:
ANNUAL/SEMI-ANNUAL REPORTS
Additional information about the Fund's investments is available in
the Fund's annual and semi-annual reports to shareholders. The Fund's
annual report discusses the market conditions and investment strategies
that significantly affected the Fund's performance during its last fiscal
year.
STATEMENT OF ADDITIONAL INFORMATION (SAI)
The SAI provides more detailed information about the Fund.
The SAI is incorporated by reference into this prospectus, which
means it is part of this prospectus for legal purposes. You may get free
copies of the annual/semi-annual reports, the SAI, request other
information about the Fund, or make shareholder inquiries by contacting
the Fund at:
THE BAUPOST FUND
44 BRATTLE STREET, 5TH FLOOR
P.O. BOX 381288
CAMBRIDGE, MA 02238
1-800-241-6680
You may review and copy information about the Fund, including its
SAI, at the Securities and Exchange Commission's public reference room in
Washington, D.C. You may call the Commission at 1-800-SEC 0330 for
information about the operation of the public reference room. You may
also access reports and other information about the Fund on the
Commission's Internet site at http://www.sec.gov. You may get copies of
this information, with payment of a duplication fee, by writing the
Public Reference Section of the Commission, Washington, D.C. 20549-6009.
You may need to refer to the Fund's file number.
INVESTMENT COMPANY ACT FILE NO. 811-6138
<PAGE> 18
The
Baupost
Fund
Statement of Additional Information
February 28, 1999
This Statement of Additional Information (the "Statement") of The
Baupost Fund (the "Fund") contains information which may be useful to investors
but which is not included in the Prospectus of The Baupost Fund (the
"Prospectus"). This Statement is not a prospectus and is only authorized for
distribution when accompanied or preceded by the Prospectus dated February 28,
1999. The Statement should be read together with the Prospectus and the Fund's
Annual Report from 1998 (the "Annual Report"). The Statement contains
information incorporated by reference from the Annual Report which was
previously distributed in a shareholder distribution. Copies of the Prospectus
and the Annual Report can be obtained without charge by calling the Fund at
1-800-241-6680 or by writing to the Fund, 44 Brattle Street, Post Office Box
381288, Cambridge, Massachusetts 02238.
TABLE OF CONTENTS
PAGE
----
FUND DESCRIPTION AND HISTORY.................................................B-2
FUND POLICIES AND INVESTMENT RESTRICTIONS....................................B-2
THE FUND'S INVESTMENTS AND RISKS.............................................B-4
MANAGEMENT OF THE FUND......................................................B-18
INVESTMENT ADVISORY AND OTHER SERVICES......................................B-21
BROKERAGE ALLOCATION AND OTHER PRACTICES....................................B-23
PURCHASE, REDEMPTION AND PRICING OF SHARES..................................B-24
TAXATION OF FUND............................................................B-26
PERFORMANCE DATA............................................................B-27
EXPERTS.....................................................................B-28
REPORT OF INDEPENDENT AUDITORS..............................................B-29
FINANCIAL STATEMENTS........................................................B-30
<PAGE> 19
FUND DESCRIPTION AND HISTORY
The Baupost Fund (the "Fund") was established as a Massachusetts
business trust under an Agreement and Declaration of Trust dated June 29, 1990.
The Fund is a no-load, non-diversified, open-end management investment company
registered under the Investment Company Act of 1940, as amended (the "1940
Act").
The Declaration of Trust permits the Trustees to issue an unlimited
number of full and fractional shares of beneficial interest which presently
constitute a single series, the Fund. Each share of the Fund represents an equal
proportionate interest with each other share. The Declaration of Trust also
permits the Trustees, without shareholder approval, to subdivide any series of
shares into two or more classes of shares, with such preferences and other
rights and privileges as the Trustees may designate. The Fund's shares are not
currently divided into classes. The Trustees may also, without shareholder
approval, establish one or more additional separate portfolios for investments
in the Fund or merge two or more existing portfolios. Shareholders' investments
in such a portfolio would be evidenced by a separate series of shares.
Fund shares are entitled to dividends as declared by the Trustees and,
in liquidation of the Fund, are entitled to receive the net assets of the Fund.
Fund shares are entitled to vote at any meetings of shareholders. Although the
Fund is not required to hold annual meetings of shareholders, shareholders have
the right to call a meeting to remove Trustees.
The Declaration of Trust provides for the perpetual existence of the
Fund. The Fund may, however, be terminated at any time by vote of at least
two-thirds of the outstanding shares of the Fund. The Declaration of Trust
further provides that the Trustees may also terminate the Fund upon written
notice to the shareholders.
FUND POLICIES AND INVESTMENT RESTRICTIONS
The Fund is guided by the following policies and fundamental investment
restrictions, which may not be changed without a vote of a majority of its
outstanding voting securities. The Investment Company Act of 1940 (the "1940
Act") provides that a "vote of a majority of the outstanding voting securities"
means the affirmative vote of the lesser of (1) more than 50% of the outstanding
shares of the Fund or (2) 67% or more of the shares present at a meeting if more
than 50% of the outstanding shares are represented at the meeting in person or
by proxy. Fundamental investment restrictions (1) - (4) below describe
investment policies in which the Fund may, to the extent permitted, currently
engage; fundamental investment restrictions (5) - (7) describe investment
policies in which the Fund may not engage. The Fund may:
(1) Borrow money to the extent permitted by the 1940 Act, the
rules or regulations thereunder or applicable orders of the
Securities and Exchange Commission, as such statute, rules,
regulations or orders may be amended from time to time.
(2) Purchase or sell real estate to the extent permitted by the
1940 Act, the rules or regulations thereunder or applicable
orders or the Securities and Exchange Commission, as such
statute, rules, regulations or orders may be amended from time
to time.
(3) Purchase or sell commodities, commodities contracts, futures
contracts or options to the extent permitted by the 1940 Act,
the rules or regulations thereunder or applicable orders of
the Securities and Exchange Commission, as such statute,
rules, regulations or orders may be amended from time to time.
B-2
<PAGE> 20
(4) Make loans to the extent permitted by the 1940 Act, the rules
or regulations thereunder or applicable orders of the
Securities and Exchange Commission, as such statute, rules,
regulations or orders may be amended from time to time.
The Fund may not and will not:
(5) Underwrite securities issued by other persons except to the
extent that, in connection with the disposition of its
portfolio investments, it may be deemed to be an underwriter
under certain federal securities laws.
(6) Invest 25% or more of the value of its total assets in any one
industry. (U.S. Government Securities, including securities
issued by agencies or instrumentalities of the U.S.
Government, and securities backed by the credit of a U.S.
governmental entity will not be considered to represent an
industry.)
(7) Issue senior securities, except as appropriate to evidence
indebtedness that the Fund is permitted to incur consistent
with restriction 1 above.
It is contrary to the Fund's present policy, which may be changed by the
Trustees without shareholder approval, to:
(1) Invest more than 15% of its net assets in illiquid securities.
(2) Purchase securities on margin, except that the Fund may obtain
short-term credits as may be necessary for the clearance of
purchases and sales of securities, and except that it may make
margin payments in connection with financial futures contracts
or options.
(3) Invest more than 5% (taken at the lower of cost or market
value) of its net assets in warrants (provided that of this
5%, no more than 2% may be warrants not listed on the New York
Stock Exchange or the American Stock Exchange). For purposes
of this restriction, warrants acquired by the Fund as part of
a unit or attached to securities at the time of purchase are
deemed to be without value.
(4) Borrow money in excess of 10% of the value (taken at the lower
of cost or current value) of its total assets (not including
the amount borrowed) at the time the borrowing is made, and
then only from banks as a temporary measure to facilitate the
meeting of redemption requests which might otherwise require
the untimely disposition of portfolio investments or for
extraordinary or emergency purposes.
(5) Pledge, hypothecate, mortgage or otherwise encumber its assets
in excess of 15% of its total assets (taken at current value)
in connection with borrowings permitted by the Fund's
investment restrictions.
With respect to fundamental investment restriction 1 concerning
borrowing, a registered investment company like the Fund may borrow up to 33
1/3% of its total assets under the 1940 Act. With respect to fundamental
investment restrictions 2 and 3, the 1940 Act provides no limits on the
applicable investment activities. With respect to fundamental investment
restriction 4 concerning making loans, the 1940 Act permits a fund to make loans
if expressly permitted by a fund's investment policies, but never to persons who
control or are under common control with that fund. Thus, the 1940 Act
effectively prohibits the Fund from making loans to certain persons when
conflicts of interest or undue influence are most likely present.
For the purposes of fundamental investment restriction 6 concerning
investments in any one industry, the Fund will consider all relevant factors in
determining who is the issuer of a loan participation. These factors will
include the credit quality of the borrower, the amount and quality of the
collateral, the terms of the loan agreement and other relevant agreements
(including inter-creditor agreements), the degree to which the credit of any
person interpositioned between the Fund and the borrower was deemed material to
the decision to purchase
B-3
<PAGE> 21
the participation interest, the interest rate environment, and general economic
conditions applicable to the borrower and such interpositioned person.
For the purposes of certain diversification criteria imposed by federal
tax laws, the Fund will consider the borrower to be the issuer of a loan
participation. In addition, with respect to loan participations under which the
Fund does not have privity of contract with the borrower or would not have a
direct cause of action against the borrower in the event of its failure to pay
scheduled principal or interest, the Fund will also consider each person
interpositioned between the Fund and the borrower to be an issuer of a loan
participation.
Except as otherwise noted, all percentage limitations on investments
will apply at the time of the making of an investment and shall not be
considered violated unless an excess or deficiency occurs or exists immediately
after and as a result of such investment.
THE FUND'S INVESTMENTS AND RISKS
OTHER INVESTMENT PRACTICES AND RISK CONSIDERATIONS
The Fund may from time to time engage in the investment practices
described below. In addition, the Fund may buy and sell (i.e., write) call and
put options on individual securities or on securities indices, buy and sell
futures contracts and related options, engage in spread and straddle
transactions, and engage in foreign currency exchange transactions (including
buying and selling options on foreign currencies and engaging in foreign
currency futures transactions and options thereon). Some of the options which
the Fund may purchase or sell may be traded over-the-counter. Each of these
practices involves certain special risks. For information on options and futures
transactions and foreign currency exchange transactions, including limitations
designed to reduce the risks associated with these practices, see "Options,
Future, Foreign Currency and Exchange Transactions". Because of the investment
leverage involved in options and futures transactions, the Fund's obligations
under its options and futures transactions could require the Fund to deliver or
take delivery of investments with a value equal to or greater than the entire
amount of its assets.
SHORT SALES. The Fund may make short sales of securities. A short sale
is a transaction in which the Fund sells a security it does not own in
anticipation that the market price of that security will decline. When the Fund
makes a short sale, it must borrow the security sold short and deliver it to the
other party to the transaction. Short sales involve certain expenses and entail
risks. The Fund may have to pay a fee to borrow particular securities and is
often obligated to pay over any payments received on such borrowed securities.
The net proceeds of the short sale will be retained by the broker to the extent
necessary to meet margin requirements, until the short position is closed out.
If the price of the security sold short increases between the time of the short
sale and the time the Fund replaces the borrowed security, the Fund will incur a
loss; conversely, if the price declines, the Fund will realize a gain. Any gain
will be decreased, and any loss increased, by the transaction costs described
above. ALTHOUGH THE FUND'S GAIN IS LIMITED TO THE PRICE AT WHICH IT SOLD THE
SECURITY SHORT, ITS POTENTIAL LOSS IS UNLIMITED IF THE FUND DOES NOT OWN THE
SECURITY.
The staff of the Securities and Exchange Commission is of the opinion
that a short sale involves the creation of a senior security and is, therefore,
subject to the limitations of Section 18 of the 1940 Act. The staff has taken
the position that in order to comply with the provisions of Section 18, the Fund
must put in a segregated account (not with the broker) an amount of cash or
securities equal to the difference between: (a) the market value of the
securities sold short at the time they were sold short, and (b) any cash or
securities required to be deposited as collateral with the broker in connection
with the short sale (not including the proceeds from the short sale). In
addition, until the Fund replaces the borrowed security, it must daily maintain
the segregated account at such a level that the amount deposited in it plus the
amount deposited with the broker as collateral will equal the current market
value of the securities sold short. It is currently expected that no more than
25% of the Fund's net assets will be used as collateral or deposited in a
segregated account in connection with short sales.
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REPURCHASE AGREEMENTS. The Fund may enter into repurchase agreements on
up to 25% of its total assets with banks or securities dealers in order to earn
income. A repurchase agreement is a contract pursuant to which the Fund agrees
to purchase a security and simultaneously agrees to resell it to such bank or
dealer at an agreed-upon time and price, thereby determining the yield during
the Fund's holding period. The Fund will normally limit its investments in
repurchase agreements to those agreements maturing in seven days or less.
Repurchase agreements maturing in more than seven days, together with any other
illiquid assets of the Fund, will not at the time of making such investment
exceed 15% of the value of the Fund's total net assets. The securities
underlying repurchase agreements will be limited to securities in which the Fund
could invest directly pursuant to the Fund's investment policies. Repurchase
agreements are considered by the staff of the Securities and Exchange Commission
to be loans by the Fund to the bank or dealer involved, with the underlying
securities constituting collateral for the loans. The Adviser will monitor such
transactions to ensure that the value of the underlying securities will be at
least equal at all times to the total amount of the repurchase obligation,
including the interest factor. If the seller defaults, the Fund could realize a
loss on the sale of the underlying security to the extent the proceeds of the
sale, including accrued interest, are less than the resale price provided in the
agreement, including interest. In addition, if the seller should be involved in
bankruptcy or insolvency proceedings, the Fund may incur delay and costs in
selling the underlying security or may suffer a loss of principal and interest
if the Fund is treated as an unsecured creditor and is required to return the
underlying collateral to the seller's estate. The Fund's investments in
repurchase agreements will be limited to transactions with financial
institutions which are determined by the Adviser to present minimal credit
risks. The Adviser will monitor the creditworthiness of such financial
institutions.
LOANS OF SECURITIES. The Fund may lend its portfolio securities,
provided that cash or other collateral equal to at least 100% of the market
value of the securities loaned is continuously maintained by the borrower with
the Fund. During the time securities are on loan, the borrower will pay the Fund
an amount equivalent to any dividends or interest paid on such securities, and
the Fund may invest the cash collateral and earn additional income, or it may
receive an agreed-upon amount of interest income from the borrower who has
delivered equivalent collateral. These loans are subject to termination at the
option of the Fund or the borrower. The Fund may pay reasonable administrative
and custodial fees in connection with a loan and may pay a negotiated portion of
the interest earned on the cash or equivalent collateral to the borrower or
placing broker. It is not currently anticipated that the Fund will have on loan
at any given time securities totaling more than one-third of its net assets. The
Fund runs the risk that the counterparty to a loan transaction will default on
its obligation and that the value of the collateral received may be insufficient
to cover the securities loaned as a result of an increase in the value of the
securities or decline in the value of the collateral.
FORWARD COMMITMENTS. The Fund may enter into contracts to purchase
securities for a fixed price at a specified future date beyond customary
settlement time ("forward commitments"). If the Fund does so, it will maintain
cash or securities in a segregated account having a value at all times
sufficient to meet the purchase price or will enter into offsetting contracts
for the forward sale of other securities it owns. Forward commitments involve a
risk of loss if the value of the security to be purchased declines prior to the
settlement date, which risk is in addition to the risk of decline in value of
the Fund's other assets. Although the Fund will generally enter into forward
commitments with the intention of acquiring securities for its portfolio, it may
dispose of a commitment prior to settlement if the Adviser deems it appropriate
to do so. The Fund may realize gains or losses upon the sale of forward
commitments. The Adviser will monitor the creditworthiness of the parties to
such forward commitments. The Fund will not invest more than 25% of its total
assets in forward commitments.
WARRANTS. The Fund may from time to time purchase warrants. Warrants
represent the right to purchase securities of an issuer at a specific price for
a specific period of time. They do not represent ownership of such securities,
but only the right to buy them. Warrants have no voting rights, pay no dividends
and have no rights with respect to the assets of the corporation issuing them.
The prices of warrants do not necessarily correlate with the prices of the
underlying securities.
REAL ESTATE AND RELATED SECURITIES. The Fund may invest in real estate
and real estate-related securities. Real estate-related securities include
securities that are backed by, represent interests in or are secured by real
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<PAGE> 23
estate, as well as securities issued by companies or limited partnerships that
invest in real estate or interests in real estate. Investments in these
securities entail certain risks due to a variety of factors, including
uncertainties surrounding the underlying real estate ventures. Factors affecting
the performance of real estate ventures may include satisfactory completion of
construction, excess supply of real estate in certain markets, prudent
management of insurance risks, sufficient level of occupancy, adequacy of
financing available in capital markets, competent management, adequate rent to
cover operating expenses, local and regional markets for competing assets,
changes in applicable laws and governmental regulations (including taxes), and
social and economic trends.
The Fund may purchase and sell real estate in order to protect its
investment in such securities. Certain real estate-related securities in which
the Fund may invest may not be readily marketable; real estate is not readily
marketable. Investments in real estate and in real estate-related securities
that are not readily marketable entail additional risks, such as difficulty in
pricing the real estate or security for purposes of determining the Fund's net
asset value and the possibility that the Fund would be unable to sell the real
estate or security at a price approximating its market value when it decides to
sell the real estate or security. If the Fund has rental income or income from
the direct disposition of real property, the receipt of such income may
adversely affect its ability to retain its status as a regulated investment
company. See "Tax Consequences."
NEW INVESTMENT PRODUCTS. New types of hedging instruments and
derivative instruments (including instruments used for nonhedging purposes) are
developed and marketed from time to time. Consistent with its investment
limitations, the Fund expects to invest in those new types of securities and
instruments that Baupost believes may assist the Fund in achieving its
investment objectives. Such investments may involve risks which exceed those
involved in the activities described above.
SWAPS, CAPS, FLOORS AND COLLARS. The Fund may enter into swaps, caps,
floors and collars on various securities, securities indexes, interest rates,
prepayment rates, foreign currencies or other financial instruments or indexes,
for both hedging and non-hedging purposes.
Swaps typically involve an exchange of obligations by two parties. For
example, interest rate swaps involve the exchange of respective rights to
receive interest, such as an exchange of fixed rate payments for floating rate
payments. Currency swaps involve the exchange of respective rights to make or
receive payments in specified currencies. In an equity swap, the counterpart
generally agrees to pay the Fund the amount, if any, by which the notional
amount of the equity swap contract would have increased in value had it been
invested in the underlying stock or stocks plus the dividends that would have
been received on those stocks. The Fund agrees to pay to the counterpart a
floating rate of interest (typically based on the London Inter Bank Offered
Rate) on the notional amount of the equity swap contract plus the amount, if
any, by which that notional amount would have decreased in value had it been
invested in such stock or stocks. Therefore, the return to the Fund on any
equity swap contract should be the gain or loss on the notional amount plus
dividends on the underlying stocks less the interest paid by the Fund on the
notional amount less premium paid, if any. The Fund may also from time to time
enter into the opposite side of equity swap contacts, which are known as
"reverse equity swaps."
Caps, floors and collars are variations on swaps. The purchase of a cap
entitles the purchaser to receive payments from the party selling the cap to the
extent that a specified index exceeds a predetermined interest rate or amount.
The purchase of an interest rate floor entitles the purchaser to receive
payments from the party selling the floor to the extent that a specified index
falls below a predetermined interest rate or amount. A collar is a combination
of a cap and a floor that preserves a certain return within a predetermined
range of interest rates or values. Caps, floors and collars are similar in many
respects to over-the-counter options transactions, and may involve investment
risks that are similar to those associated with options transactions and options
on futures contracts.
Payments under a swap contract may be made at the conclusion of the
contract or periodically during its term. If there is a default by the
counterpart to a swap contract, the Fund will be limited to contractual remedies
pursuant to the agreements related to the transaction. There is no assurance
that swap contract counter parties will be able to meet their obligations
pursuant to swap contracts or that, in the event of default, the Fund will
succeed in pursuing contractual remedies. The Fund thus assumes the risk that it
may be delayed in or prevented from
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<PAGE> 24
obtaining payments owed to it pursuant to swap contracts. To address this risk,
the Fund will usually enter into swap contracts on a net basis, which means that
the two payment streams (one from the Fund to the counterpart, one to the Fund
from the counterpart) are netted out, with the Fund receiving or paying, as the
case may be, only the net amount of the two payments. Interest rate swaps do not
involve the delivery of securities, other underlying assets, or principal.
Accordingly, the risk of loss with respect to interest rate swaps entered into
on a net basis would be limited to the net amount of the interest payments that
the Fund is contractually obligated to make. If the other party to an interest
rate swap defaults, the Fund's risk of loss consists of the net amount of
interest payments that the Fund is contractually entitled to receive. In
contrast, currency swaps and other types of swaps may involve the delivery of
the entire principal value of one designated currency or financial instrument in
exchange for the other designated currency or financial instrument. Therefore,
the entire principal value of such swaps may be subject to the risk that the
other party will default on its contractual delivery obligations.
In addition, because swap contracts are individually negotiated and
ordinarily non-transferable, there also may be circumstances in which it would
be impossible for the Fund to close out its obligations under the swap contract.
Under such circumstances, the Fund might be able to negotiate another swap
contract with a different counterpart to offset the risk associated with the
first swap contract. Unless the Fund is able to negotiate such an offsetting
swap contact, however, the Fund could be subject to continued adverse
developments, even after the Adviser has determined that it would be prudent to
close out or offset the first swap contract.
The use of swaps involves investment techniques and risks different
from and potentially greater than those associated with ordinary portfolio
securities transactions. If the Adviser is incorrect in its expectations of
market values, interest rates, or currency exchange rates, the investment
performance of the Fund would be less favorable than it would have been if this
investment technique were not used. Because certain foreign markets may be
closed for all practical purposes to U.S. investors such as the Fund, the Fund
may invest indirectly in such markets through swap transactions and would
therefore be subject to the risks described above with respect to investments in
foreign securities as well as being subject to the risk of relying upon the
counterpart of the swap contract to fulfill its obligations.
INDEXED SECURITIES. The Fund may invest in indexed securities whose
value is linked to currencies, foreign or domestic securities, interest rates,
commodities, indices, or other financial indicators. Most indexed securities are
short to intermediate term fixed-income securities whose values at maturity or
interest rates rise or fall according to the change in one or more specified
underlying instruments. Indexed securities may be positively or negatively
indexed (i.e., their value may increase or decrease if the underlying instrument
appreciates). The increase or decrease in the value of the indexed security may
be a multiple of the percentage change (positive or negative) in the value of
the underlying reference instrument(s). Indexed Securities may have return
characteristics similar to direct investments in the underlying instrument or to
one or more options on the underlying instrument. Indexed securities may, for
the reasons described above, be more volatile than the underlying instrument
itself. Because certain foreign markets may be closed for all practical purposes
to U.S. investors such as the Fund, the Fund may invest indirectly in such
markets through the purchase of indexed securities and would therefore be
subject to the risks described above with respect to investments in foreign
securities as well as being subject to the risk of relying upon the issuer of
the indexed security to fulfill its obligations under the terms of the security.
CASH AND SHORT-TERM OBLIGATIONS. Depending upon market conditions, part
or all of the Fund's assets may be invested in cash (including foreign
currencies) or high quality cash equivalent short-term obligations and unrated
cash equivalent short-term obligations that the Adviser determines as comparable
in quality to that of such rated obligations including, but not limited to,
commercial paper, notes, certificates of deposit, bankers' acceptances and other
obligations of banks, repurchase agreements and short-term obligations issued or
guaranteed by the U.S. or foreign governments, their agencies and
instrumentalities. It is impossible to predict when, for how long, or to what
extent the Fund will invest its assets in cash and cash equivalent short-term
obligations.
OTHER INVESTMENT COMPANIES. From time to time and subject to applicable
law, certain of the Fund's investments may include investments in other
investment companies, including investment companies not registered under the
Investment Company Act of 1940. When the Fund invests in other investment
companies,
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<PAGE> 25
shareholders may in effect pay multiple levels of fees (i.e., the Fund's fees
and the fees of the other investment companies).
OPTIONS, FUTURES, FOREIGN CURRENCY AND EXCHANGE TRANSACTIONS
Subject to applicable law, and unless otherwise specified in the
prospectus or this Statement of Additional Information, the Fund may engage
without limit in options and futures transactions and certain foreign currency
exchange transactions for hedging and non-hedging purposes. These investment
practices may be used to attempt to reduce fluctuations in the Fund's net asset
value or for other purposes permitted by applicable law. There can be no
assurance that such practices will be successful. Expenses and losses resulting
from these activities will reduce the Fund's current income and net asset value.
In connection with transactions in futures contracts and related
options written by the Fund, the Fund will be required to deposit with its
custodian or broker as "initial margin" an amount of cash and/or securities.
Thereafter, subsequent payments (referred to as "variation margin") are made to
and from the broker to reflect changes in the values of the futures contracts or
options. Because of the investment leverage involved in these transactions, the
Fund's obligations under its futures contracts or options could require the Fund
to deliver or take delivery of investments with a value equal to or greater than
the entire amount of its assets.
WRITING COVERED OPTIONS. The Fund may write covered call options and
covered put options on securities when, in the opinion of the Adviser, such
transactions are consistent with the Fund's investment objectives and policies.
Call options written by the Fund give the purchaser the right to buy the
underlying securities from the Fund at a stated exercise price; put options give
the purchaser the right to sell the underlying securities to the Fund at a
stated price. The aggregate value of the securities underlying put options
written by the Fund may not exceed 50% of the Fund's total assets.
The Fund may write only covered options, which means that, so long as
the Fund is obligated as the writer of a call option, it will own the underlying
securities subject to the option (or comparable securities satisfying the cover
requirements of securities exchanges) or will segregate cash or securities equal
to the value of the securities to be delivered if the option were exercised. In
the case of put options, the Fund will segregate cash or securities equal to the
price to be paid if the option is exercised. In addition, the Fund will be
considered to have covered a put or call option if and to the extent that it
holds an option that offsets some or all of the risk of the option it has
written. For more information about cover and segregation requirements, see
"Regulatory Requirements" below. The Fund may write combinations of covered puts
and calls on the same underlying security. See "Spread and Straddle
Transactions" below.
The Fund will receive a premium from writing a put or call option,
which increases the Fund's return in the event the option expires unexercised or
is closed out at a profit. The amount of the premium reflects, among other
things, the relationship between the exercise price and the current market value
of the underlying security, the volatility of the underlying security, the
amount of time remaining until expiration, current interest rates, and the
effect of supply and demand in the options market and in the market for the
underlying security. By writing a call option, the Fund, to the extent it owns
the underlying security, limits its opportunity to profit from any increase in
the market value of the underlying security above the exercise price of the
option but continues to bear the risk of a decline in the value of the
underlying security. By writing a put option, the Fund assumes the risk that it
may be required to purchase the underlying security for an exercise price higher
than its then-current market value, resulting in a potential capital loss unless
the security subsequently appreciates in value.
The Fund may terminate an option that it has written prior to the
expiration by entering into a closing purchase transaction in which it purchases
an offsetting option. The Fund realizes a profit or loss from a closing
transaction if the cost of the transaction (option premium plus transaction
costs) is less or more than the premium received from writing the option.
Because increases in the market price of a call option generally reflect
increases in the market price of the security underlying the option, any loss
resulting from a closing purchase transaction may be offset in whole or in part
by unrealized appreciation of the underlying security owned by the Fund.
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In connection with certain options that the Fund may write, the Fund
may be required to deposit cash or securities as "margin," or collateral for its
obligation to buy or sell the underlying security. As the value of the
underlying security varies, the Fund may have to deposit additional margin.
Margin requirements are complex and are fixed by individual brokers, subject to
minimum requirements currently imposed by the Federal Reserve Board and by stock
exchanges and other self-regulatory organizations.
PURCHASING PUT OPTIONS. The Fund may purchase put options for any
purpose, including to protect its portfolio holdings in an underlying security
against a decline in market value. Such protection is provided during the life
of the put option since the Fund, as holder of the option, is able to sell the
underlying security at the put exercise price regardless of any decline in the
underlying security's market price. In order for a put option to be profitable,
the market price of the underlying security must decline sufficiently below the
exercise price to cover the premium and transaction costs. By using put options
in this manner, the Fund will reduce any profit it might otherwise have realized
from appreciation of the underlying security by the premium paid for the put
option and by transaction costs. There is no limit on the amount of the Fund's
assets that can be used to purchase put options.
PURCHASING CALL OPTIONS. The Fund may purchase call options for any
purpose, including to hedge against an increase in the price of securities that
the Fund wants ultimately to buy. Such hedge protection is provided during the
life of the call option since the Fund, as holder of the call option, is able to
buy the underlying security at the exercise price regardless of any increase in
the underlying security's market price. In order for a call option to be
profitable, the market price of the underlying security must rise sufficiently
above the exercise price to cover the premium and transaction costs. There is no
limit on the amount of the Fund's assets that can be used to purchase call
options.
SPREAD AND STRADDLE TRANSACTIONS. In addition to the strategies
described above, the Fund may engage in "spread" transactions in which it
purchases and writes a put or call option on the same underlying security, with
the options having different exercise prices and/or expiration dates. The Fund
may also engage in so-called "straddles," in which it purchases or sells
combinations of put and call options on the same security. When it engages in
spread and straddle transactions, the Fund seeks to profit from differentials in
the option premiums paid and received by it and in the market prices of the
related options positions when they are closed out or sold. Spread and straddle
transactions require the Fund to purchase and/or write more than one option
simultaneously. Accordingly, the Fund's ability to enter into such transactions
and to liquidate its positions when necessary or deemed advisable may be more
limited than if the Fund were to purchase or sell a single option. Similarly,
costs incurred by the Fund in connection with these transactions will in many
cases be greater than if the Fund were to purchase or sell a single option.
RISK FACTORS IN OPTIONS TRANSACTIONS
The successful use of the Fund's options strategies depends on the
ability of the Adviser to forecast interest rate and market movements correctly.
For example, if the Fund were to write a call option based on the Adviser's
expectation that the price of the underlying security would fall, but the price
were to rise instead, the Fund could be required to sell the security upon
exercise at a price below the current market price. Similarly, if the Fund were
to write a put option based on the Adviser's expectation that the price of the
underlying security would rise, but the price were to fall instead, the Fund
could be required to purchase the security upon exercise at a price higher than
the current market price.
When it purchases an option, the Fund runs the risk that it will lose
its entire investment in the option in a relatively short period of time, unless
the Fund exercises the option or enters into a closing transaction with respect
to the option during the life of the option. If the price of the underlying
security does not rise (in the case of a call) or fall (in the case of a put) to
an extent sufficient to cover the option premium and transaction costs, the Fund
will lose part or all of its investment in the option. This contrasts with an
investment by the Fund in the underlying security, since the Fund will not lose
any of its investment in such security if the price does not change.
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The effective use of options also depends on the Fund's ability to
terminate option positions at times when the Adviser deems it desirable to do
so. There is no assurance that the Fund will be able to effect closing
transactions at any particular time or at an acceptable price.
If a secondary trading market in options were to become unavailable,
the Fund could no longer engage in closing transactions. Lack of investor
interest might adversely affect the liquidity of the market for particular
options or series of options. A market may discontinue trading of a particular
option or options generally. In addition, a market could become temporarily
unavailable if unusual events -- such as volume in excess of trading or clearing
capability -- were to interrupt its normal operations.
A market may at times find it necessary to impose restrictions on
particular types of options transactions, such as opening transactions. For
example, if an underlying security ceases to meet qualifications imposed by the
market or the Options Clearing Corporation, new series of options on that
security will no longer be opened to replace expiring series, and opening
transactions in existing series may be prohibited. If an options market were to
become unavailable, the Fund as a holder of an option would be able to realize
profits or limit losses only by exercising the option, and the Fund, as option
writer, would remain obligated under the option until expiration or exercise.
Disruptions in the markets for the securities underlying options
purchased or sold by the Fund could result in losses on the options. If trading
is interrupted in an underlying security, the trading of options on that
security is normally halted as well. As a result, the Fund as purchaser or
writer of an option will be unable to close out its positions until options
trading resumes, and it may be faced with considerable losses if trading in the
security reopens at a substantially different price. In addition, the Options
Clearing Corporation or other options markets may impose exercise restrictions.
If a prohibition on exercise is imposed at the time when trading in the option
has also been halted, the Fund as purchaser or writer of an option will be
locked into its position until one of the two restrictions has been lifted. If
the Options Clearing Corporation were to determine that the available supply of
an underlying security appears insufficient to permit delivery by the writers of
all outstanding calls in the event of exercise, it may prohibit indefinitely the
exercise of put options. The Fund, as holder of such a put option, could, under
certain circumstances, lose its entire investment.
Special risks are presented by internationally traded options. Because
of time differences between the United States and the various foreign countries,
and because different holidays are observed in different countries, foreign
options markets may be open for trading during hours or on days when U.S.
markets are closed. As a result, option premiums may not reflect the current
prices of the underlying interest in the United States.
FUTURES CONTRACTS AND RELATED OPTIONS
A financial futures contract sale creates an obligation by the seller
to deliver the type of financial instrument called for in the contract in a
specified delivery month for a stated price. A futures contract purchase creates
an obligation by the purchaser to take delivery of the type of financial
instrument called for in the contract in a specified delivery month at a stated
price. The specific instruments delivered or taken, respectively, at settlement
date are not determined until on or near that date. The determination is made in
accordance with the rules of the exchange on which the futures contract sale or
purchase was made. Futures contracts are traded in the United States only on
commodity exchanges or boards of trade -- known as "contract markets" --
approved for such trading by the Commodity Futures Trading Commission (the
"CFTC"), and must be executed through a futures commission merchant or brokerage
firm which is a member of the relevant contract market. Futures contracts
purchased by the Fund may also be traded outside of the United States.
Although futures contracts by their terms call for actual delivery or
acceptance of commodities or securities, in most cases the contracts are closed
out before the settlement date without the making or taking of delivery. Closing
out a futures contract sale is effected by purchasing a futures contract for the
same aggregate amount of the specific type of financial instrument or commodity
with the same delivery date. If the price of the initial sale of the futures
contract exceeds the price of the offsetting purchase, the seller is paid the
difference and realizes a gain. Conversely, if the price of the offsetting
purchase exceeds the price of the initial sale, the seller
B-10
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realizes a loss. Similarly, the closing out of a futures contract purchase is
effected by the purchaser's entering into a futures contract sale. If the
offsetting sale price exceeds the purchase price, the purchaser realizes a gain,
and if the purchase price exceeds the offsetting sale price, he realizes a loss.
Unlike when the Fund purchases or sells a security, no price is paid or
received by the Fund upon the purchase or sale of a futures contract. Upon
entering into a contract, the Fund is required to deposit with its custodian in
a segregated account in the name of the futures broker or directly with a
futures commission merchant an amount of cash or securities. This amount is
known as "initial margin." The nature of initial margin in futures transactions
is different from that of margin in security transactions in that futures
contract margin does not involve the borrowing of funds to finance the
transactions. Rather, initial margin is similar to a performance bond or good
faith deposit which is returned to the Fund upon termination of the futures
contract, assuming all contractual obligations have been satisfied. Futures
contracts also involve brokerage costs.
Subsequent payments, called "variation margin," to and from the broker
(or the custodian) are made on a daily basis as the price of the underlying
security or commodity fluctuates, making the long and short positions in the
futures contract more or less valuable, a process know as "marking to the
market." For example, when the Fund has purchased a futures contract on a
security and the price of the underlying security has risen, that position will
have increased in value and the Fund will receive from the broker a variation
margin payment based on that increase in value. Conversely, when the Fund has
purchased a futures contract on a security and the price of the underlying
security has declined, the position would be less valuable and the Fund would be
required to make a variation margin payment to the broker.
The Fund may elect to close some or all of its futures positions at any
time prior to their expiration in order to reduce or eliminate a position then
currently held by the Fund. The Fund may close its position by taking opposite
positions which will operate to terminate the Fund's position in the futures
contracts. Final determinations of variation margin are then made, additional
cash is required to be paid by or released to the Fund, and the Fund realizes a
loss or a gain. Such closing transactions involve additional commission costs.
OPTIONS ON FUTURES CONTRACTS. The Fund may purchase and write call and
put options on futures contracts it may buy or sell and enter into closing
transactions with respect to such options to terminate existing positions. A put
option on a futures contract gives the Fund the right to assume a short position
in the futures contract until expiration of the option. A call option on a
futures contract gives the Fund the right to assume a long position in the
futures contract until the expiration of the option. The Fund may use options on
futures contracts in lieu of writing or buying options directly on the
underlying securities or purchasing and selling the underlying futures
contracts. For example, to hedge against a possible decrease in the value of its
portfolio securities, the Fund may purchase put options or write call options on
futures contracts rather than selling futures contracts. Similarly, the Fund may
purchase call options or write put options on futures contracts as a substitute
for the purchase of futures contracts to hedge against a possible increase in
the price of securities which the Fund expects to purchase. Such options
generally operate in the same manner as options purchased or written directly on
the underlying investments.
As with options on securities, the holder or writer of an option may
terminate his position by selling or purchasing an offsetting option. There is
no guarantee that such closing transactions can be effected.
The Fund will be required to deposit initial margin and maintenance
margin with respect to put and call options on futures contracts written by it
pursuant to brokers' requirements similar to those described above.
RISKS OF TRANSACTIONS IN FUTURES CONTRACTS AND RELATED OPTIONS
Certain risks arise because of the possibility of imperfect correlation
between movements in the prices of futures contracts and options and movements
in the prices of the underlying stock index, currency or security or of the
securities or currencies that are the subject of the hedge. Successful use of
futures contracts by the Fund is subject to the Adviser's ability to predict
movements in the direction of interest rates and other factors affecting
securities and currency markets. For example, if the Fund has hedged against the
possibility of decline in the
B-11
<PAGE> 29
values of its investments and the values of its investments increase instead,
the Fund will lose part or all of the benefit of the increase through payments
of daily maintenance margin. The Fund may have to sell investments at a time
when it may be disadvantageous to do so in order to meet margin requirements.
Compared to the purchase or sale of futures contracts, the purchase of
call or put options on futures contracts involves less potential risk to the
Fund because the maximum amount at risk is the premium paid for the options
(plus transaction costs). However, there may be circumstances when the purchase
of a call or put option on a futures contract would result in a loss to the Fund
when the purchase or sale of a futures contract would not, such as when there is
no movement in the prices of the hedged investments. The writing of an option on
a futures contract involves risks similar to those risks relating to the sale of
futures contracts.
There is no assurance that higher than anticipated trading activity or
other unforeseen events might not, at times, render certain market clearing
facilities inadequate, and thereby result in the institution by exchanges of
special procedures which may interfere with the timely execution of customer
orders.
To reduce or eliminate a position held by the Fund, the Fund may seek
to close out a position. The ability to establish and close out positions will
be subject to the development and maintenance of a liquid secondary market. It
is not certain that this market will develop or continue to exist for a
particular futures contract or option. Reasons for the absence of a liquid
secondary market on an exchange include the following: (i) there may be
insufficient trading interest in certain contracts or options; (ii) restrictions
may be imposed by an exchange on opening transactions or closing transactions,
or both; (iii) trading halts, suspensions or other restrictions may be imposed
with respect to particular classes or series of contracts or options, or
underlying securities; (iv) unusual or unforeseen circumstances may interrupt
normal operations on an exchange; (v) the facilities of an exchange or a
clearing corporation may not at all times be adequate to handle current trading
volume; or (vi) one or more exchanges could, for economic or other reasons,
decide or be compelled at some future date to discontinue the trading of
contracts or options (or a particular class or series of contracts or options),
in which event the secondary market on that exchange for such contracts or
options (or in the class or series of contracts or options) would cease to
exist, although outstanding contracts or options on the exchange that had been
issued by a clearing corporation as a result of trades on that exchange would
continue to be exercisable in accordance with their terms.
U.S. TREASURY SECURITY FUTURES CONTRACTS AND OPTIONS. The Fund may
purchase and sell futures contracts and related options on U.S. Treasury
securities when, in the opinion of the Adviser, price movements in Treasury
security futures and related options will correlate closely with price movements
in the securities which are the subject of the hedge. U.S. Treasury security
futures contracts require the seller to deliver, or the purchaser to take
delivery of, the type of U.S. Treasury security called for in the contract at a
specified date and price. Options on U.S. Treasury security futures contracts
give the purchaser the right in return for the premium paid to assume a position
in a U.S. Treasury security futures contract at the specified option exercise
price at any time during the period of the option.
Successful use of U.S. Treasury security futures contracts by the Fund
is subject to the Adviser's ability to predict movements in the direction of
interest rates and other factors affecting markets for debt securities. For
example, if the Fund has sold U.S. Treasury security futures contracts in order
to hedge against the possibility of an increase in interest rates which would
adversely affect securities held in its portfolio, and the prices of the Fund's
securities increase instead as a result of a decline in interest rates, the Fund
will lose part or all of the benefit of the increased value of its securities
which it has hedged because it will have offsetting losses in its futures
positions. In addition, in such situations, if the Fund has insufficient cash,
it may have to sell securities to meet daily maintenance margin requirements at
a time when it may be disadvantageous to do so.
There is also a risk that price movements in U.S. Treasury security
futures contracts and related options will not correlate closely with price
movements in markets for the securities that are the subject of the hedge. For
example, if the Fund has hedged against a decline in the values of securities
held by it by selling Treasury security futures and the values of Treasury
securities subsequently increase while the values of its securities decrease,
the
B-12
<PAGE> 30
Fund would incur losses on both the Treasury security futures contracts
written by it and the securities held in its portfolio.
INDEX FUTURES CONTRACTS. An index futures contract is a contract to buy
or sell units of an index at a specified future date at a price agreed upon when
the contract is made. Entering into a contract to buy units of an index is
commonly referred to as buying or purchasing a contract or holding a long
position in the index. Entering into a contract to sell units of an index is
commonly referred to as selling a contract or holding a short position. A unit
is the current value of the index. The Fund may enter into stock index futures
contracts, debt index futures contracts, or other index futures contracts
appropriate to its objectives. The Fund may also purchase and sell options on
index futures contracts.
For example, the Standard & Poor's Composite 500 Stock Price Index
("S&P 500") is composed of 500 selected common stocks, most of which are listed
on the New York Stock Exchange. The S&P 500 assigns relative weightings to the
common stocks included in the Index, and the value fluctuates with changes in
the market values of those common stocks. In the case of the S&P 500, contracts
are to buy or sell 250 units. Thus, if the value of the S&P 500 were $150, one
contract would be worth $37,500 (250 units x $150). The stock index futures
contract specifies that no delivery of the actual stocks making up the index
will take place. Instead, settlement in cash must occur upon the termination of
the contract, with the settlement being the difference between the contract
price and the actual level of the stock index at the expiration of the contract.
For example, if the Fund enters into a futures contract to buy 250 units of the
S&P 500 at a specified future date at a contract price of $150 and the S&P 500
is at $154 on that future date, the Fund will gain $1,000 (250 units x gain of
$4). If the Fund enters into a futures contract to sell 250 units of the stock
index at a specified future date at a contract price of $150 and the S&P 500 is
at $152 on that future date, the Fund will lose $500 (250 units x loss of $2).
There are several risks in connection with the use by the Fund of index
futures. One risk arises because of the imperfect correlation between movements
in the prices of the index futures and movements in the prices of securities
which are the subject of the hedge.
Successful use of index futures by the Fund is also subject to the
Adviser's ability to predict movements in the direction of the market. For
example, it is possible that, where the Fund has sold futures to hedge its
portfolio against a decline in the market, the index on which the futures are
written may advance and the value of securities held in the Fund's portfolio may
decline. If this occurred, the Fund would lose money on the futures and also
experience a decline in value in its portfolio securities. It is also possible
that, if the Fund has hedged against the possibility of a decline in the market
adversely affecting securities held in its portfolio and securities prices
increase instead, the Fund will lose part or all of the benefit of the increased
value of those securities it has hedged because it will have offsetting losses
in its futures positions. In addition, in such situations, if the Fund has
insufficient cash, it may have to sell securities to meet daily variation margin
requirements at a time when it is disadvantageous to do so.
In addition to the possibility that there may be an imperfect
correlation, or no correlation at all, between movements in the index futures
and the portion of the portfolio being hedged, the prices of index futures may
not correlate perfectly with movements in the underlying index due to certain
market distortions. Due to the possibility of imperfect correlation between
movements in the index and movements in the prices of index futures, even a
correct forecast of general market trends by the Adviser may still not result in
a successful hedging transaction.
OPTIONS ON STOCK INDEX FUTURES. Options on index futures are similar to
options on securities except that options on index futures give the purchaser
the right, in return for the premium paid, to assume a position in an index
futures contract (a long position if the option is a call and a short position
if the option is a put), at a specified exercise price at any time during the
period of the option. Upon exercise of the option, the delivery of the futures
position by the writer of the option to the holder of the option will be
accompanied by delivery of the accumulated balance in the writer's futures
margin account which represents the amount by which the market price of the
index futures contract, at exercise, exceeds (in the case of a call) or is less
than (in the case of a put) the exercise price of the option on the index
future. If an option is exercised on the last trading day prior to its
B-13
<PAGE> 31
expiration date, the settlement will be made entirely in cash equal to the
difference between the exercise price of the option and the closing level of the
index on which the future is based on the expiration date. Purchasers of options
who fail to exercise their options prior to the exercise date suffer a loss of
the premium paid.
OPTIONS ON INDICES
As an alternative to purchasing and selling call and put options on
index futures, the Fund may purchase and sell call and put options on the
underlying indices themselves. Such options would be used in a manner identical
to the use of options on index futures.
FOREIGN CURRENCY TRANSACTIONS
The Fund may engage in currency exchange transactions to protect
against uncertainty in the level of future currency exchange rates. In addition,
the Fund may write covered call and put options on foreign currencies for the
purpose of increasing its current return.
Generally, the Fund may engage in both "transaction hedging" and
"position hedging." When it engages in transaction hedging, the Fund enters into
foreign currency transactions with respect to specific receivables or payables,
generally arising in connection with the purchase or sale of portfolio
securities. The Fund will engage in transaction hedging when it desires to "lock
in" the U.S. dollar price of a security it has agreed to purchase or sell, or
the U.S. dollar equivalent of a dividend or interest payment in a foreign
currency. By transaction hedging the Fund will attempt to protect itself against
a possible loss resulting from an adverse change in the relationship between the
U.S. dollar and the applicable foreign currency during the period between the
date on which the security is purchased or sold, or on which the dividend or
interest payment is declared, and the date on which such payments are made or
received.
The Fund may purchase or sell a foreign currency on a spot (or cash)
basis at the prevailing spot rate in connection with the settlement of
transactions in portfolio securities denominated in that foreign currency. The
Fund may also enter into contracts to purchase or sell foreign currencies at a
future date ("forward contracts") and purchase and sell foreign currency futures
contracts.
For transaction hedging purposes the Fund may also purchase
exchange-listed and over-the-counter call and put options on foreign currency
futures contracts and on foreign currencies. A put option on a futures contract
gives the Fund the right to assume a short position in the futures contract
until expiration of the option. A put option on currency gives the Fund the
right to sell a currency at an exercise price until the expiration of the
option. A call option on a futures contract gives the Fund the right to assume a
long position in the futures contract until the expiration of the option. A call
option on currency gives the Fund the right to purchase a currency at the
exercise price until the expiration of the option.
When it engages in position hedging, the Fund enters into foreign
currency exchange transactions to protect against a decline in the values of the
foreign currencies in which its portfolio securities are denominated (or an
increase in the value of currency for securities which the Fund expects to
purchase, when the Fund holds cash or short-term investments). In connection
with position hedging, the Fund may purchase put or call options on foreign
currency and foreign currency futures contracts and buy and sell forward
contracts and foreign currency futures contracts. The Fund may also purchase or
sell foreign currency on a spot basis.
It is impossible to forecast with precision the market value of
portfolio securities at the expiration or maturity of a forward or futures
contract. Accordingly, it may be necessary for the Fund to purchase additional
foreign currency on the spot market (and bear the expense of such purchase) if
the market value of the security or securities being hedged is less than the
amount of foreign currency the Fund is obligated to deliver and a decision is
made to sell the security or securities and make delivery of the foreign
currency. Conversely, it may be necessary to sell on the spot market some of the
foreign currency received upon the sale of the portfolio security or securities
if the market value of such security or securities exceeds the amount of foreign
currency the Fund is obligated to deliver.
B-14
<PAGE> 32
Transaction and position hedging do not eliminate fluctuations in the
underlying prices of the securities which the Fund owns or intends to purchase
or sell. They simply establish a rate of exchange which one can achieve at some
future point in time. Additionally, although these techniques tend to minimize
the risk of loss due to a decline in the value of the hedged currency, they tend
to limit any potential gain which might result from the increase in value of
such currency.
The Fund may seek to increase its current return or to offset some of
the costs of hedging against fluctuations in current exchange rates by writing
covered call options and covered put options on foreign currencies. The Fund
receives a premium from writing a call or put option, which increases the Fund's
current return if the option expires unexercised or is closed out at a net
profit. The Fund may terminate an option that it has written prior to its
expiration by entering into a closing purchase transaction in which it purchases
an option having the same terms as the option written.
The Fund's currency hedging transactions may call for the delivery of
one foreign currency in exchange for another foreign currency and may at times
not involve currencies in which its portfolio securities are then denominated.
In addition to the other risks described above, these cross hedging transactions
by the Fund involve the risk of imperfect correlation between changes in the
values of the currencies to which such transactions relate and changes in the
value of the currency or other asset or liability which is the subject of the
hedge.
CURRENCY FORWARD AND FUTURES CONTRACTS. A forward foreign currency
contract involves an obligation to purchase or sell a specific currency at a
future date, which may be any fixed number of days from the date of the contract
as agreed by the parties, at a price set at the time of the contract. In the
case of a cancelable forward contract, the holder has the unilateral right to
cancel the contract at maturity by paying a specified fee. The contracts are
traded in the interbank market conducted directly between currency traders
(usually large commercial banks) and their customers. A forward contract
generally has no deposit requirement, and no commissions are charged at any
stage for trades. A foreign currency futures contract is a standardized contract
for the future delivery of a specified amount of a foreign currency at a future
date at a price set at the time of the contract. Foreign currency futures
contracts traded in the United States are designed by and traded on exchanges
regulated by the CFTC, such as the New York Mercantile Exchange.
Forward foreign currency exchange contracts differ from foreign
currency futures contracts in certain respects. For example, the maturity date
of a forward contract may be any fixed number of days from the date of the
contract agreed upon by the parties, rather than a predetermined date in a given
month. Forward contracts may be in any amounts agreed upon by the parties rather
than predetermined amounts. Also, forward foreign exchange contracts are traded
directly between currency traders so that no intermediary is required. A forward
contract generally requires no margin or other deposit.
At the maturity of a forward or futures contract, the Fund may either
accept or make delivery of the currency specified in the contract, or at or
prior to maturity enter into a closing transaction involving the purchase or
sale of an offsetting contract. Closing transactions with respect to forward
contracts are usually effected with the currency trader who is a party to the
original forward contract. Closing transactions with respect to futures
contracts are effected on a commodities exchange; a clearing corporation
associated with the exchange assumes responsibility for closing out such
contracts.
Positions in the foreign currency futures contracts may be closed out
only on an exchange or board of trade which provides a secondary market in such
contracts. Although the Fund intends to purchase or sell foreign currency
futures contracts only on exchanges or boards of trade where there appears to be
an active secondary market, there is no assurance that a secondary market on an
exchange or board of trade will exist for any particular contract or at any
particular time. In such event, it may not be possible to close a futures
position and, in the event of adverse price movements, the Fund would continue
to be required to make daily cash payments of variation margin. Foreign currency
futures contracts share many of the same risks described above with respect to
other futures contracts.
B-15
<PAGE> 33
FOREIGN CURRENCY OPTIONS. In general, options on foreign currencies
operate similarly to options on securities and are subject to many similar
risks. Foreign currency options are traded primarily in the over-the-counter
market, although options on foreign currencies have recently been listed on
several exchanges. Options are traded not only on the currencies of individual
nations, but also on the European Currency Unit ("ECU"). The ECU is composed of
amounts of a number of currencies, and is the official medium of exchange of the
European Community's European Monetary System.
The Fund will only purchase or write foreign currency options when the
Adviser believes that a liquid secondary market exists for such options. There
can be no assurance that a liquid secondary market will exist for a particular
option at any specific time. Options on foreign currencies are affected by all
of those factors which influence foreign exchange rates and investments
generally.
The value of any currency, including U.S. dollars and foreign
currencies, may be affected by complex political and economic factors applicable
to the issuing country. In addition, the exchange rates of foreign currencies
(and therefore the values of foreign currency options) may be significantly
affected, fixed, or supported directly or indirectly by U.S. and foreign
governmental actions. Government intervention may increase risks involved in
purchasing or selling foreign currency options, since exchange rates may not be
free to fluctuate in response to other market forces.
The value of a foreign currency option reflects the value of an
exchange rate, which in turn reflects the relative values of the relevant
currencies. Because foreign currency transactions occurring in the interbank
market involve substantially larger amounts than those that may be involved in
the exercise of foreign currency options, investors may be disadvantaged by
having to deal in an odd-lot market for the underlying foreign currencies in
connection with options at prices that are less favorable than for round-lots.
Foreign governmental restrictions or taxes could result in adverse changes in
the cost of acquiring or disposing of foreign currencies.
There is no systematic reporting of last sale information for foreign
currencies and there is no regulatory requirement that quotations available
through dealers or other market sources be firm or revised on a timely basis.
Available quotation information is generally representative of very large
round-lot transactions in the interbank market and thus may not reflect exchange
rates for smaller odd-lot transactions (less than $1 million) where rates may be
less favorable. The interbank market in foreign currencies is a global,
around-the-clock market. To the extent that options markets are closed while the
markets for the underlying currencies remain open, significant price and rate
movements may take place in the underlying markets that cannot be reflected in
the options markets.
SETTLEMENT PROCEDURES. Settlement procedures relating to the Fund's
investments in foreign securities and to the Fund's foreign currency exchange
transactions may be more complex than settlements with respect to investments in
debt or equity securities of U.S. issuers, and may involve certain risks not
present in the Fund's domestic investments. For example, settlement of trades of
foreign securities or of foreign currency option exercises may occur within a
foreign country, and the Fund may be required to accept or make delivery of the
underlying securities or foreign currency in conformity with any applicable U.S.
or foreign restrictions or regulations, and may be required to pay any fees,
taxes or charges associated with such delivery. Such investments may also
involve the risk that an entity involved in the settlement may not meet its
obligations.
FOREIGN CURRENCY CONVERSION. Although foreign exchange dealers do not
charge a fee for currency conversion, they do realize a profit based on the
difference (the "spread") between prices at which they are buying and selling
various currencies. Thus, a dealer may offer to sell a foreign currency to the
Fund at one rate, while offering a lesser rate of exchange should the Fund
desire to resell that currency to the dealer.
OVER-THE-COUNTER OPTIONS
Certain options are traded "over-the-counter" ("OTC") rather than on an
exchange. This means that the Fund will enter into such option contracts with
particular securities dealers who make markets in these options. The Fund's
ability to terminate option positions in the OTC market will be more limited
than for exchange-traded
B-16
<PAGE> 34
options and may also involve the risk that securities dealers participating in
such transactions would fail to meet their obligations to the Fund. To the
extent required by applicable pronouncements by the Staff of the Division of
Investment Management of the Securities and Exchange Commission, the Fund may
treat OTC options purchased by the Fund and assets held to cover OTC options
written by the Fund as illiquid securities.
REGULATORY REQUIREMENTS
Current regulatory requirements impose limitations on how the Fund may
engage in options, futures and forward transactions. To the extent necessary,
the Fund will comply with these regulations when engaging in options, futures
and forward transactions (including options on securities, securities indices
and currencies). In general, these regulations require that the Fund either
"cover" its position or place cash or securities in a segregated account in an
amount equal to the Fund's obligation. The methods of cover and the types of
securities required to be segregated may vary depending on the type of financial
instrument and the particular transaction.
PORTFOLIO TURNOVER
While it is a policy of the Fund generally not to engage in trading for
short-term gains, portfolio changes will be made without regard to the length of
time a security has been held or whether a sale would result in a profit or
loss, if in the Adviser's judgment such transactions are advisable. A change in
the securities owned by the Fund is known as "portfolio turnover." For purposes
of calculating portfolio turnover, all securities whose maturity or expiration
date is one year or less at the time of acquisition are excluded from the
calculation. As a result of the Fund's investment policies, under certain market
conditions, the Fund's portfolio turnover rate may be higher than that of other
mutual funds. Portfolio turnover generally involves some expense, including
brokerage commissions or dealer markups and other transaction costs on the sale
of securities and reinvestment in other securities. These transactions may
result in realization of taxable capital gains or losses. Portfolio turnover
rates are shown in the section "The Baupost Fund Financial Highlights."
The purchase and sale of portfolio securities for the Fund and for the
other investment advisory clients of the Adviser are made by the Adviser with a
view to achieving their respective investment objectives. For example, a
particular security may be bought or sold only for certain clients of the
Adviser even though it could have been bought or sold for other clients at the
same time. Likewise, a particular security may be bought for one or more clients
when one or more other clients are selling the security. In some instances,
therefore, one client may sell indirectly a particular security to another
client. It also happens that two or more clients may simultaneously buy or sell
the same security, in which event purchases or sales are effected pro rata on
the basis of cash available or another equitable basis so as to avoid any one
account's being systematically preferred over any other account.
B-17
<PAGE> 35
MANAGEMENT OF THE FUND
The Trustees are responsible for generally overseeing the conduct of
the Fund's business. Subject to such policies as the Trustees may determine,
Baupost furnishes a continuing investment program for the Fund and makes
investment decisions on its behalf. Subject to the control of the Trustees,
Baupost also manages the Fund's other affairs and business.
<TABLE>
<CAPTION>
Name and Address* Positions Held with Fund Principal Occupation(s) During Past Five Years
- ---------------- ------------------------ ----------------------------------------------
<S> <C> <C>
Seth A. Klarman** Trustee and President The Baupost Group, L.L.C., President and Member of
Advisory Board; The Baupost Group, Inc., President
and Director (formerly, investment adviser to the
Fund); SAK Corporation, President (managing member of
The Baupost Group, L.L.C.).
William J. Poorvu** Trustee, Vice Chairman and The Baupost Group, L.L.C., Chairman of Advisory
Treasurer Board; The Baupost Group, Inc., Chairman and
Director; Massachusetts Financial Services Company
Group of Funds, Trustee/Director (mutual funds); CBL
Associates Properties, Inc., Director (a public Real
Estate Investment Trust); Harvard University, Graduate
School of Business Administration, Class of 1961
Adjunct Professor in Entrepreneurship; William J.
Poorvu, Proprietor (real estate investments).
</TABLE>
* Unless otherwise indicated, the address of each person listed in the
table is P.O. Box 381288, 44 Brattle Street, Cambridge, MA 02238.
** Persons who are "interested persons" (as defined in the 1940 Act) of
the Fund and The Baupost Group, L.L.C.
B-18
<PAGE> 36
<TABLE>
<CAPTION>
Name and Address* Positions Held with Fund Principal Occupation(s) During the Past Five Years
- ----------------- ------------------------ --------------------------------------------------
<S> <C> <C>
Howard H. Stevenson** Trustee and Chairman The Baupost Group, L.L.C., Vice Chairman of
Advisory Board; The Baupost Group, Inc., Vice
Chairman, Director and Treasurer; Harvard
University, Graduate School of Business
Administration, Professor; Camp, Dresser & McKee,
Director (engineering consultants); Landmark
Communications Inc., Director (communications);
Sheffield Steel Corp., Director (a steel
manufacturer); African Communications Group,
Director (a communications group); Terry Hinge &
Hardware, Director (a manufacturer); Gulf States
Steel, Director (an investment advisory marketing
firm); Bessemer Securities Corporation, Director
(investments); Westboro Holdings LP, Director and
Treasurer (investments). Formerly, Director of
Passamaquoddy Technologies (a technology firm) and
Preco Corporation (a paper manufacturer).
Samuel Plimpton** Trustee The Baupost Group, L.L.C., Managing Director; The
Brattle Advisors, L.P. Baupost Group, Inc., Vice President; Brattle
44 Brattle Street Advisors, L.P., General Partner (real estate
Cambridge, MA 02138 counselors). Formerly, Director, Perry Dean Rogers
and Partners (an architecture firm).
Robert W. Ackerman Trustee Sheffield Steel Corp., President and Chief Executive
Sheffield Steel Corp. Officer (a steel manufacturer); Gulf States Steel,
220 North Jefferson Director (a steel manufacturer); Steel
Sands Springs, OK 74063 Manufacturer's Association, Chairman. Formerly,
President and Chief Executive Officer, Lincoln Pulp
& Paper Co., Inc. (a paper manufacturer).
David Auerbach Trustee Dana-Farber Cancer Institute, Trustee; Dana-Farber
607 Boylston Street Cancer Institute, Member, Executive Committee;
Boston, MA 02116 Jimmy Fund Committee, Dana-Farber Cancer Institute,
Chairman; Beth Israel-Deaconess Medical Center,
Overseer; Boston Latin School Foundation, Director.
</TABLE>
* Unless otherwise indicated, the address of each person listed in the
table is P.O. Box 381288, 44 Brattle Street, Cambridge, MA 02238.
** Persons who are "interested persons" (as defined in the 1940 Act) of
the Fund and The Baupost Group, L.L.C.
B-19
<PAGE> 37
<TABLE>
<CAPTION>
Name and Address* Positions Held with Fund Principal Occupation(s) During Past Five Years
- ----------------- ------------------------ ----------------------------------------------
<S> <C> <C>
Jay Light Trustee Harvard University Graduate School of Business
Harvard University Administration, Dwight P. Robinson, Jr. Professor
Graduate of Business Administration and Senior Associate
School of Business Dean; United Asset Management Corporation,
Administration Director (a holding company comprised of
Soldiers Field Road investment management firms); Harvard Management
Boston, MA 02163 Company, Director (an investment adviser to
President and Fellows of Harvard College);
The Jeffrey Company, Director (investments);
College Retirement Equity Fund, Trustee; The
Brigham and Women's Hospital, Trustee and,
formerly, Chairman of the Investment
Committee; Partners Healthcare System,
Chairman of the Investment Committee; GMO
Funds, Trustee (a series of institutional
mutual funds).
Paul C. Gannon Vice President The Baupost Group, L.L.C., Chief Financial and
Administrative Officer and Managing Director; The
Baupost Group, Inc., Chief Financial and
Administrative Officer and Vice President.
Scott A. Stone Clerk The Baupost Group, L.L.C., Director of Compliance,
Vice President and Clerk; The Baupost Group, Inc.,
Director of Compliance and Assistant Vice President.
</TABLE>
* Unless otherwise indicated, the address of each person listed in the
table is P.O. Box 381288, 44 Brattle Street, Cambridge, MA 02238.
** Persons who are "interested persons" (as defined in the 1940 Act) of
the Fund and The Baupost Group, L.L.C.
Except as noted below, the principal occupations of the officers and
Trustees for the last five years have been with the employers as shown above,
although in some cases they have held different positions with such employers.
The Fund pays the Trustees, other than those who are interested persons
of The Baupost Group, L.L.C. ("Baupost" or the "Adviser"), an annual fee of
$8,000, in addition to a fee of $750 for each meeting attended. During fiscal
1998, the Fund paid Trustees' fees aggregating $33,250, of which $11,250 was
paid to Mr. Ackerman, $11,250 was paid to Mr. Auerbach and $10,750 was paid to
Mr. Light. The Fund is the only investment company advised by Baupost and has no
pension or retirement plan for its Trustees.
PRINCIPAL HOLDERS OF FUND SHARES
At January 31, 1999, the officers and Trustees of the Fund as a group
owned of record or beneficially 14.54% of the outstanding shares of the Fund,
and to the knowledge of the Fund, no person owned of record or beneficially 5.0%
or more of the shares of the Fund except William J. Poorvu, 975 Memorial Drive,
#710, Cambridge, MA 02138 owned of record and beneficially 0.64% of the shares
of the Fund, and as trustee for various trusts beneficially owned 7.06% of the
shares of the Fund.
B-20
<PAGE> 38
LIABILITY OF SHAREHOLDERS, TRUSTEES AND OFFICERS
Under Massachusetts law, shareholders could, under certain circumstances,
be held personally liable for the obligations of the Fund. However, the
Declaration of Trust disclaims shareholder liability for acts or obligations of
the Fund and requires that notice of such disclaimer be given in each agreement,
obligation, or instrument entered into or executed by the Fund or the Trustees.
The Declaration of Trust provides for indemnification out of the property of the
Fund for all loss and expense of any shareholder of the Fund held personally
liable for the obligations of the Fund. Thus, the risk of a shareholder
incurring financial loss on account of shareholder liability is considered
remote since it is limited to circumstances in which the disclaimer is
inoperative and the Fund would be unable to meet its obligations.
The Declaration of Trust further provides that the Trustees will not be
liable for errors of judgment or mistakes of fact or law. However, nothing in
the Declaration of Trust protects a Trustee against any liability to which the
Trustee would otherwise be subject by reason of willful misfeasance, bad faith,
gross negligence, or reckless disregard of the duties involved in the conduct of
his or her office. The Declaration of Trust also provides for indemnification by
the Fund of the Trustees and the officers of the Fund against liabilities and
expenses reasonably incurred in connection with litigation in which they may be
involved because of their offices with the Fund, except if it is determined in
the manner specified in the Declaration of Trust that such indemnification would
relieve any officer or Trustee of any liability to the Fund or its shareholders
by reason of willful misfeasance, bad faith, gross negligence or reckless
disregard of his or her duties.
INVESTMENT ADVISORY AND OTHER SERVICES
INVESTMENT ADVISER
The Fund is advised and managed by Baupost, a Massachusetts limited
liability company. Seth A. Klarman, President of Baupost and of the Fund, owns
in excess of 50% of the ownership interest of Baupost. SAK Corporation, a
Massachusetts corporation with the principal function of managing and overseeing
Baupost, is wholly owned by Mr. Klarman. SAK Corporation is the sole manager of
Baupost, and as such, has sole decision-making authority over the management and
operation of Baupost. Mr. Klarman has had primary responsibility for the
day-to-day management of the Fund's portfolio since the Fund's inception in
January, 1991. Mr. Klarman has been with The Baupost Group, L.L.C. or The
Baupost Group, Inc. ("BGI") since April, 1982. Prior to January 2, 1998, the
Fund was advised and managed by BGI. On that date, BGI underwent a corporate
restructuring that resulted, among other things, in the transfer of all of its
assets and liabilities of BGI to Baupost. Upon consummation of that transaction,
Baupost succeeded to the business operations previously conducted by BGI.
MANAGEMENT CONTRACT
As disclosed in the Prospectus under the heading "Management, Organization
and Capital Structure --Management of the Fund," under an investment advisory
contract (the "Management Contract") between the Fund and the Adviser, subject
to such policies as the Trustees of the Fund may determine, the Adviser will
furnish continuously an investment program for the Fund and will make investment
decisions on behalf of the Fund and place all orders for the purchase and sale
of portfolio securities. Subject to the control of the Trustees, the Adviser
also provides office space, and pays all salaries, fees and expenses of officers
and Trustees of the Fund who are affiliated with the Adviser. As indicated under
"Brokerage Allocation and Other Practices -- Brokerage Transactions" the Fund's
portfolio transactions may be placed with broker-dealers that furnish the
Adviser, at no cost, certain research, statistical and quotation services of
value to the Adviser in advising the Fund or its other clients.
B-21
<PAGE> 39
As disclosed in the Prospectus, the Fund pays the Adviser a quarterly
management fee at the annual rate of 1.00% of the Fund's average net assets. The
Adviser has agreed to an "expense limitation," whereby the Adviser will reduce
its management fee by up to .75% to the extent that the Fund's total annual
expenses (including the management fee and the administrative fee and certain
other expenses but excluding brokerage commissions, transfer taxes, interest and
expenses relating to preserving the value of the Fund's investments) would
otherwise exceed 1.50% of the Fund's average net assets. From time to time,
depending on its investments, expenses incurred by the Fund which are not
subject to the expense limitation may be substantial. This was the case during
fiscal 1998.
The Management Contract provides that the Adviser shall not be subject to
any liability to the Fund or to any shareholder of the Fund in connection with
the performance of its services thereunder in the absence of willful
misfeasance, bad faith, gross negligence or reckless disregard of its
obligations and duties.
The Management Contract will continue in effect for a period of more than
two years from the date of its execution only so long as its continuance is
approved at least annually by (i) vote, cast in person at a meeting called for
that purpose, of a majority (or one, if there is only one) of those Trustees who
are not "interested persons" of the Adviser or the Fund, and by (ii) the
majority vote of either the full Board of Trustees or the vote of a majority of
the outstanding shares of the Fund. The Management Contract automatically
terminates on assignment, and may be terminated by either the Fund or the
Adviser upon not more than 60 days' but not less than 30 days' notice to the
other party.
Prior to January 2, 1998, under a substantially identical management
contract (the "Old Management Contract") with The Baupost Group, Inc. ("BGI"),
BGI provided services identical to those described above. For these services,
the Fund paid BGI at rates identical to those described above. During its 1996,
1997 and 1998 fiscal years, the Fund paid management fees of $991,872,
$1,353,786 and $259,449 to BGI pursuant to the Old Management Contract, and
$1,422,180 to Baupost pursuant to the current Management Contract, respectively.
ADMINISTRATIVE ARRANGEMENTS
Baupost serves as the Fund's administrator under an Administrative
Services Agreement (the "Agreement") between the Fund and Baupost dated as of
October 31, 1998. Pursuant to the Agreement, Baupost is paid a quarterly fee at
the annual rate of .25% of the Fund's average net assets. Under the Agreement,
Baupost provides, among other things, bookkeeping and certain clerical services
to the Fund and will calculate the total net asset value, total net income, and
net asset value per share of the Fund. The Agreement provides that it shall
continue indefinitely, but that it may be terminated by either party upon 60
days' notice. The Agreement further provides that Baupost will only be liable to
the Fund for loss or damage incurred by the Fund resulting from Baupost's lack
of good faith, negligence or willful misconduct and also provides that the Fund
will indemnify Baupost against, among other things, loss or damage incurred by
Baupost on account of any claim, demand, action or suit arising out of, or in
connection with, its duties under the Agreement, provided that Baupost has acted
in good faith and without negligence or willful misconduct.
Prior to October 31, 1997, under a Transfer Agency and Administrative
Services Agreement with BGI then in effect, BGI provided, in addition to the
services described above, transfer and dividend disbursing agent services. For
services under the Transfer Agency and Administrative Services Agreement, BGI
was paid a quarterly fee at the annual rate of .25% of the Fund's average net
assets. During its 1997 fiscal year, the Fund paid $338,446 to BGI pursuant to
the Transfer Agency and Administrative Services Agreement.
B-22
<PAGE> 40
TRANSFER AGENCY AND DIVIDEND DISBURSING ARRANGEMENTS
State Street Bank and Trust Company ("State Street"), 225 Franklin Street,
Boston, Massachusetts 02110, serves as the Fund's Transfer Agent and Dividend
Disbursing Agent under a Transfer Agency and Service Agreement between the Fund
and State Street dated as of October 31, 1997. Pursuant to the Agreement, State
Street receives orders for the purchase and redemption of shares of the Fund,
issues such shares to the appropriate shareholder account or pays over such
money as is appropriate to the redeeming shareholder and delivers all pertinent
documentation relating to these transactions to the Custodian. Additionally, as
Dividend Disbursing Agent, State Street prepares and transmits payments for
dividends and distributions declared by the Fund. The Agreement provides by its
terms that it may be terminated by either party upon 60 days' notice.
CUSTODIAN
State Street serves as the Fund's custodian pursuant to a Custodian
Agreement between the Fund and State Street dated as of October 31, 1997. As
such, State Street holds in safekeeping certificated securities and cash
belonging to the Fund and, in such capacity, is the registered owner of
securities in book-entry form belonging to the Fund. Upon instruction, State
Street receives and delivers cash and securities of the Fund in connection with
Fund transactions and collects all dividends and other distributions made with
respect to Fund portfolio securities. State Street also maintains certain
accounts and records of the Fund. State Street has also contracted with certain
foreign banks and depositories to hold portfolio securities outside of the
United States on behalf of the Fund. The contract with State Street provides by
its terms that it shall continue indefinitely, but that it may be terminated by
either party upon 60 days' notice.
BROKERAGE ALLOCATION AND OTHER PRACTICES
BROKERAGE TRANSACTIONS
Transactions on stock exchanges and other agency transactions involve the
payment of negotiated brokerage commissions. Such commissions vary among
different brokers. There is generally no stated commission in the case of
securities traded in the over-the-counter markets, but the price paid for such
securities usually includes an undisclosed dealer commission or mark-up. In
placing orders for the portfolio transactions of the Fund, the Adviser will seek
the best price and execution available, except to the extent it may be permitted
to pay higher brokerage commissions for brokerage and research services as
described below. The determination of what may constitute best price and
execution by a broker-dealer in effecting a securities transaction involves a
number of considerations, including, without limitation, the overall net
economic result to the Fund (involving price paid or received and any
commissions and other costs paid), the efficiency with which the transaction is
effected, the ability to effect the transaction at all where a large block is
involved, availability of the broker to stand ready to execute possibly
difficult transactions in the future and the financial strength and stability of
the broker. Because of such factors, a broker-dealer effecting a transaction may
be paid a commission higher than that charged by another broker-dealer.
Over-the-counter transactions often involve dealers acting for their own
account. It is the Adviser's policy to place over-the-counter market orders for
the Fund with primary market makers unless better prices or executions are
available elsewhere.
Although the Adviser does not consider the receipt of research services as
a factor in selecting brokers to effect portfolio transactions for the Fund, the
Adviser may receive such services from brokers who handle the Fund's portfolio
transactions. Research services may include a wide variety of analyses, reviews
and reports on such matters as economic and political developments, industries,
companies, securities and portfolio strategy. The Adviser may use such research
in servicing other clients as well as the Fund.
B-23
<PAGE> 41
As permitted by Section 28(e) of the Securities Exchange Act of 1934, as
amended (the "1934 Act"), and subject to such policies as the Trustees of the
Fund may determine, the Adviser may pay an unaffiliated broker or dealer that
provides "brokerage and research services" (as defined in the 1934 Act) to the
Adviser an amount of commission for effecting a portfolio investment transaction
in excess of the amount of commission another broker or dealer would have
charged for effecting that transaction.
During its 1996, 1997 and 1998 fiscal years, the Fund paid brokerage
commissions aggregating $201,261, $462,346 and $748,261, respectively. The
aggregate dollar amount of brokerage commissions in fiscal 1997 differed
materially from the previous fiscal year due principally to increased assets
under management which has led to an increase in the total amount of brokerage
commissions paid.
PURCHASE, REDEMPTION AND PRICING OF SHARES
PURCHASE OF FUND SHARES
Shares of the Fund may be purchased in a continuous offering for cash
without a sales charge or underwriting commission directly from the Fund once a
month on the last day on which the New York Stock Exchange (the "Exchange") is
open for business (a "Purchase Date"). The purchase price of shares of the Fund
is the net asset value as of the close of the Exchange on the relevant Purchase
Date. The minimum initial purchase of Fund shares is $50,000. The minimum
purchase for any subsequent investment is $1,000. The Fund may waive these
minimums at its discretion. Investors should call the offices of the Fund before
attempting to place an order for Fund shares. The Fund reserves the right at any
time to reject an order.
Before investing in the Fund, shareholders will be required to execute an
agreement pursuant to which they will agree not to transfer their shares, except
as approved by the Fund. For these purposes, redemptions of Fund shares are not
considered transfers, but pledges of Fund shares are.
Before an order to purchase shares will be accepted, all required forms
must be fully completed and received by the Fund no later than the business day
preceding the Purchase Date, although the Fund requests that orders be sent so
that they are received by the Fund no later than five business days before such
Purchase Date. Unless otherwise approved by the Fund, all payments for purchases
must be made by wire transfer to an account designated by State Street Bank and
Trust Company. The deadline for wire transfers is 10:00 a.m. Eastern time on the
Purchase Date. When the consideration is received by the Fund after the
deadline, the purchase order will be rejected and will have to be resubmitted to
the Fund on the next Purchase Date.
Purchases will be made in full and fractional shares of the Fund
calculated to three decimal places. Shareholders will be sent a statement of
shares owned subsequent to each transaction.
REDEMPTION OF FUND SHARES
Shares of the Fund may be redeemed on any day the New York Stock Exchange
is open for business. The redemption price is the net asset value per share next
determined after receipt by the Fund of the redemption request in "good order."
Shares of the Fund will generally be redeemed by a distribution in cash;
however, the Fund reserves the right to redeem shares by a distribution in kind
of securities held by the Fund.
Securities used to redeem Fund shares in kind will be valued in accordance
with the Fund's procedures for valuation described under "Pricing of Fund
Shares." Securities distributed by the Fund in kind will be selected by the
Adviser in light of the Fund's investment objectives and will not generally
represent a pro rata distribution of each security held in the Fund's portfolio.
Shareholders who receive a distribution in kind should expect to incur
transaction costs when converting such securities to cash.
B-24
<PAGE> 42
Payment on redemption will be made as promptly as possible and in any
event within seven days after the requested date provided that the request is in
"good order." A redemption request is in "good order" if it includes the exact
name in which shares are registered and the number of shares or the dollar
amount of shares to be redeemed and if it is signed exactly in accordance with
the form of registration. Persons acting in a fiduciary capacity, or on behalf
of a corporation, partnership or trust, must specify, in full, the capacity in
which they are acting. When opening an account with the Fund, shareholders may
be required to designate the account(s) to which funds may be transferred upon
redemption.
The Fund may suspend the right of redemption and may postpone payment for
more than seven days when the New York Stock Exchange is closed for other than
weekends or holidays, or if permitted by the rules of the Securities and
Exchange Commission, during periods when trading on the New York Stock Exchange
is restricted or during an emergency which makes it impracticable for the Fund
to dispose of its securities or to fairly determine the value of its net assets,
or during any other period permitted by the Securities and Exchange Commission
for the protection of investors.
DETERMINATION OF NET ASSET VALUE
As indicated in the Prospectus, the net asset value of each Fund share is
determined as of the close of trading on the New York Stock Exchange (normally
4:00 p.m. Eastern time) once on each day which the Exchange is open (other than
a day on which no shares of the Fund were tendered for redemption and no order
to purchase shares was accepted by the Fund).
SHAREHOLDER VOTING RIGHTS
Shareholders are entitled to one vote for each full share held (with
fractional votes for fractional shares held) and will vote in the election of
Trustees and on other matters submitted to the vote of shareholders.
Shareholders will vote by individual series on all matters except (i) when
required by the 1940 Act, shares shall be voted in the aggregate and not by
individual series and (ii) when the Trustees have determined that the matter
affects only the interests of one or more series, then only shareholders of such
series shall be entitled to vote thereon. Shareholders of one series shall not
be entitled to vote on matters exclusively affecting another series, such
matters including, without limitation, the adoption of or change in the
investment objectives, policies or restrictions of the other series and the
approval of the investment advisory contracts of the other series.
There will normally be no meetings of shareholders for the purpose of
electing Trustees, except that in accordance with the 1940 Act (i) the Fund will
hold a shareholders' meeting for the election of Trustees at such time as less
than a majority of the Trustees holding office have been elected by shareholders
and (ii) if, as a result of a vacancy in the Board of Trustees, less than
two-thirds of the Trustees holding office have been elected by the shareholders,
that vacancy may only be filled by a vote of the shareholders. The Fund will
also be required by law to hold shareholder meetings for the adoption of any
contract for which shareholder approval is required by the 1940 Act. In
addition, Trustees may be removed from office by a written consent signed by the
holders of two-thirds of the outstanding shares and filed with State Street or
by a vote of the holders of two-thirds of the outstanding shares at a meeting
duly called for the purpose, which meeting shall be held upon the written
request of the holders of not less than 10% of the outstanding shares. Upon
written request by ten or more shareholders of record who have been such for at
least six months preceding the date of application, and who hold in the
aggregate either shares having a net asset value of at least $25,000 or at least
1% of the outstanding shares, whichever is less, stating that they wish to
communicate with the other shareholders for the purpose of obtaining the
signatures necessary to demand a meeting to consider removal of a Trustee, the
Fund will provide a list of shareholders or disseminate appropriate materials
(at the expense of the requesting shareholders). Except as set forth above, the
Trustees shall continue to hold office and may appoint successor Trustees.
Voting rights are not cumulative.
No amendment may be made to the Declaration of Trust without the
affirmative vote of a majority of the outstanding shares of the Fund except (i)
to change the Fund's name or to cure technical problems in the
B-25
<PAGE> 43
Declaration of Trust or (ii) to establish, designate or modify new and existing
series or classes of Fund shares or other provisions relating to Fund shares in
response to applicable laws or regulations.
TAXATION OF FUND
The taxation of Fund distributions is summarized in the Prospectus under
the heading "Tax Consequences." The Fund intends to qualify each year as a
"regulated investment company" under the Internal Revenue Code of 1986, as
amended (the "Code"). In order to so qualify and to qualify for the special tax
treatment accorded regulated investment companies and their shareholders, the
Fund must, among other things, (a) derive at least 90% of its gross income from
dividends, interest, payments with respect to certain securities loans, gains
from the sale or other disposition of stock, securities or foreign currencies,
or other income (including but not limited to gains from options, futures or
forward contracts) derived with respect to its business of investing in such
stock, securities or currencies; (b) diversify its holdings so that, at the
close of each quarter of its taxable year, (i) at least 50% of the value of its
total assets consists of cash, cash items, U.S. government securities,
securities of other regulated investment companies, and other securities limited
generally with respect to any one issuer to a value not greater than 5% of the
total assets of the Fund and to not more than 10% of the outstanding voting
securities of such issuer, and (ii) not more than 25% of the value of its assets
is invested in the securities of any one issuer (other than U.S. government
securities or securities of other regulated investment companies); and (c)
distribute in or with respect to each taxable year at least 90% of the sum of
its taxable net investment income, its net tax-exempt income, and the excess, if
any, of net short-term capital gains over net long-term capital losses for such
year. To the extent the Fund qualifies as a regulated investment company which
is eligible for special federal income tax treatment, the Fund will not be
subject to federal income tax on income paid to its shareholders in the form of
dividends or capital gain distributions.
In order to eliminate an excise tax liability imposed on certain
undistributed income, the Fund must distribute prior to each calendar year end
an amount equal to the sum of: (i) 98% of the Fund's capital gain net income, if
any, realized in the one-year period ending on October 31 of such year, (ii) 98%
of the Fund's ordinary income realized in such calendar year, and (iii) any
undistributed income from the prior year. The Fund will be treated as having
distributed on December 31 of a given year any dividend of ordinary income or
capital gain net income that is declared and payable to shareholders of record
on a date in October, November or December of such year and paid on or before
January 31 of the next year. The Fund intends to make distributions which are
necessary to eliminate such excise tax liability.
Foreign currency exchange gain and loss arising from the Fund's
transactions in foreign currencies, foreign currency-denominated debt
securities, certain foreign currency options, futures contracts and forward
contracts will generally be treated for federal income tax purposes as ordinary
income or loss.
The Fund's transactions, including hedging transactions, in options,
futures contracts, forward contracts, short sales, spreads, straddles and
foreign currencies will be subject to special tax rules (including constructive
sale, mark-to-market, straddle, wash sale and short sale rules), the effect of
which may be to accelerate income to the Fund, defer losses to the Fund, cause
adjustments in the holding periods of the Fund's securities and convert
short-term capital losses into long-term capital losses. These rules could
therefore affect the amount, timing and character of distributions to
shareholders.
Certain of the Fund's hedging activities, including its transactions in
foreign currencies or foreign currency-denominated instruments, are likely to
produce a difference between its book income and its taxable income. This
difference may require the Fund to make distributions exceeding book income in
order to qualify as a regulated investment company, or cause the Fund's
distributions to exceed the Fund's taxable income. Distributions in excess of
the Fund's earnings and profits will be treated as a non-taxable return of
capital to the extent of the shareholder's tax basis in his or her shares and
thereafter as capital gain.
B-26
<PAGE> 44
Fund investments in foreign securities may be subject to withholding taxes
at the source on dividend or interest payments. In that case, the Fund's yield
on those securities would be decreased. If at the end of the Fund's taxable year
more than 50% of the value of the Fund's total assets represents stock or
securities of foreign corporations, the Fund intends to make an election
permitted by the Code to treat any qualified foreign taxes it paid as paid by
its shareholders. In this case, shareholders who are U.S. citizens, U.S.
corporations and, in some cases, U.S. residents generally will be required to
include in U.S. taxable income their pro rata share of such taxes, but may then
generally be entitled to claim a foreign tax credit or deduction (but not both)
for their share of such taxes. A shareholder's ability to claim a foreign tax
credit or deduction in respect of foreign taxes paid by the Fund may be subject
to certain limitations imposed by the Code (including, with respect to a credit,
a holding period requirement), as a result of which a shareholder may not get a
full credit or deduction for the amount of such taxes. Shareholders who do not
itemize on their federal income tax returns may claim a credit (but no
deduction) for such foreign taxes.
Investment in an entity that qualifies as a "passive foreign investment
company" under the Code could subject the Fund to a U.S. federal income tax or
other charge on certain "excess distributions" with respect to the investment,
and on the gains from disposition of the investment. This tax, however, can be
avoided by making an election to mark such investments to market annually or to
treat the passive foreign investment company as a "qualified electing fund."
If a Fund failed to qualify as a regulated investment company accorded
special tax treatment in any taxable year, the Fund would be subject to tax on
its taxable income at corporate rates, and all distributions from earnings and
profits, including any distributions of net tax-exempt income and net long-term
capital gains, would be taxable to shareholders as ordinary income. In addition,
the Fund could be required to recognize unrealized gains, pay substantial taxes
and interest and make substantial distributions before requalifying as a
regulated investment company that is accorded special tax treatment.
Dividends and distributions on a Fund's shares are generally subject to
federal income tax as described herein and in the Prospectus under the heading
"Tax Consequences" to the extent they do not exceed the Fund's realized income
and gains, even though such dividends and distributions may economically
represent a return of a particular shareholder's investment. Such distributions
are likely to occur in respect of shares purchased at a time when a Fund's net
asset value reflects gains that are either unrealized, or realized but not
distributed. Such realized gains may be required to be distributed even when a
Fund's net asset value also reflects unrealized losses.
PERFORMANCE DATA
From time to time the Fund may include in its communications to current or
prospective shareholders figures reflecting total return over various time
periods. "Total return" is the rate on the amount invested in the Fund from the
beginning until the end of the stated period. "Average annual total return" is
the annual compounded percentage change in the value of the amount invested in
the Fund from the beginning until the end of the stated period. Both rates of
return assume the reinvestment of all dividends and distributions. The Fund does
not have a sales load or other charges paid by all shareholders that affect its
calculation of total or average annual total return. Any quotation of total
return for any period when an expense limitation was in effect will be greater
than if the limitation had not been in effect.
The Fund's average annual total return since the commencement of its
operations (December 14, 1990) through October 31, 1998 was 12.70%. The Fund's
average annual total return for the one-year and five-year periods ended October
31, 1998 was -16.30% and 9.32%, respectively.
B-27
<PAGE> 45
EXPERTS
The statement of assets and liabilities of The Baupost Fund as of October
31, 1998, including the schedule of investments, schedule of securities sold
short, and schedule of forward foreign currency contracts, the related statement
of operations for the year then ended and the related statement of changes in
net assets for each of the two years in the period then ended appearing in this
Statement of Additional Information, and the Financial Highlights for each of
the five years then ended appearing in the Prospectus and for the five years
then ended in this Statement of Additional Information, have been audited by
Ernst & Young LLP, independent auditors, as set forth in their report thereon
appearing elsewhere herein, and are included in reliance upon such report given
upon the authority of such firm as experts in accounting and auditing.
B-28
<PAGE> 46
REPORT OF INDEPENDENT AUDITORS
To the Trustees and Shareholders of
The Baupost Fund
We have audited the accompanying statement of assets and liabilities of The
Baupost Fund, including the schedule of investments, schedule of securities sold
short and schedule of forward foreign currency contracts, as of October 31,
1998, and the related statement of operations for the year then ended, the
statement of changes in net assets for each of the two years in the period then
ended and the financial highlights for each of the five years in the period then
ended. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements and financial highlights. Our procedures included confirmation of
securities owned as of October 31, 1998, by correspondence with the custodian
and brokers. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of The
Baupost Fund at October 31, 1998, the results of its operations for the year
then ended, the changes in its net assets for each of the two years in the
period then ended and the financial highlights for each of the five years in the
period then ended, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Boston, Massachusetts
December 4, 1998
B-29
<PAGE> 47
FINANCIAL STATEMENTS
THE BAUPOST FUND
STATEMENT OF ASSETS AND LIABILITIES
OCTOBER 31, 1998
<TABLE>
<S> <C>
ASSETS:
Investments in securities - at value $ 127,175,446
(cost $136,600,952)
Cash 10,033,281
Foreign cash (cost $25,287) 25,500
Receivable for investments sold 1,784,222
Receivable for investments sold short 1,548,731
Interest and dividends receivable 568,414
Unrealized appreciation on forward foreign
currency contracts 102,622
Other assets 49,272
-------------
Total Assets 141,287,488
LIABILITIES:
Payable for investments purchased 2,381,116
Payable for securities sold short 2,027,212
(proceeds $1,888,813)
Payable for equity swap contracts 1,735,556
Payable to The Baupost Group, L.L.C 424,372
Unrealized depreciation on futures contracts 292,907
Other payables and accrued expenses 278,665
Payable for Fund shares redeemed 72,783
Payable for interest on equity swap contracts 71,974
-------------
Total Liabilities 7,284,585
-------------
NET ASSETS $ 134,002,903
=============
COMPOSITION OF NET ASSETS:
Paid in capital $ 147,727,246
Undistributed net investment income 1,666,008
Accumulated net realized loss on investments
and foreign currency transactions (3,850,498)
Net unrealized depreciation on investments
and assets and liabilities in foreign currencies (11,539,853)
-------------
NET ASSETS $ 134,002,903
=============
NET ASSET VALUE:
Offering and redemption price per share
($134,002,903/11,006,286) $ 12.18
=============
</TABLE>
See notes to financial statements.
B-30
<PAGE> 48
THE BAUPOST FUND
STATEMENT OF OPERATIONS
YEAR ENDED OCTOBER 31, 1998
<TABLE>
<S> <C>
INVESTMENT INCOME:
INCOME:
Dividends (net of foreign withholding taxes of $163,761) $ 5,383,342
Interest 3,199,767
------------
Total Income 8,583,109
EXPENSES:
Investment management fee 1,681,629
Equity swap contract interest expense 566,971
Administrative fee 420,407
Investment expenses 247,959
Interest expense 231,019
Custodian fees 195,155
Legal fees 166,804
Registration and filing fees 50,415
Audit fees 42,431
Directors' fees 34,650
Transfer agent fees 29,678
Miscellaneous 14,561
------------
Total Expenses 3,681,679
Waiver of investment management fee (113,286)
------------
Total Expenses, Net 3,568,393
------------
NET INVESTMENT INCOME 5,014,716
REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS:
Net realized gain/(loss) on:
Investments and equity swap contracts (3,513,065)
Foreign currency transactions (1,573,143)
Short sales 861,454
------------
(4,224,754)
Change in unrealized appreciation/(depreciation) on:
Investments and equity swap contracts (29,895,969)
Foreign currency transactions 932,066
Short sales (197,353)
------------
(29,161,256)
NET REALIZED AND UNREALIZED
LOSS ON INVESTMENTS (33,386,010)
------------
NET DECREASE IN NET ASSETS
RESULTING FROM OPERATIONS $(28,371,294)
============
</TABLE>
See notes to financial statements.
B-31
<PAGE> 49
THE BAUPOST FUND
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
OCTOBER 31, 1998 OCTOBER 31, 1997
---------------- ----------------
<S> <C> <C>
INCREASE/(DECREASE) IN NET ASSETS FROM OPERATIONS:
Net investment income $ 5,014,716 $ 1,956,343
Net realized gain/(loss) on investments and foreign
currency transactions (4,224,754) 23,702,878
Change in unrealized appreciation/(depreciation) on
investments and foreign currency transactions (29,161,256) 5,899,569
------------- -------------
NET INCREASE/(DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS (28,371,294) 31,558,790
DISTRIBUTIONS TO SHAREHOLDERS:
From net investment income (5,190,909) (2,845,958)
From net realized gain on investments (18,216,303) (11,985,697)
------------- -------------
Total Distributions (23,407,212) (14,831,655)
CAPITAL SHARE TRANSACTIONS:
Net proceeds from sales of shares 43,396,229 32,346,659
Reinvestment of dividends 23,195,673 14,363,821
Cost of shares redeemed (33,768,809) (19,267,341)
------------- -------------
NET INCREASE/(DECREASE) IN NET ASSETS
RESULTING FROM SHARE TRANSACTIONS 32,823,093 27,443,139
------------- -------------
TOTAL INCREASE/(DECREASE) IN NET ASSETS (18,955,413) 44,170,274
NET ASSETS AT BEGINNING OF PERIOD 152,958,316 108,788,042
------------- -------------
NET ASSETS AT END OF PERIOD
(including undistributed net
investment income of $1,666,008
and $670,056, respectively) $ 134,002,903 $ 152,958,316
============= =============
OTHER INFORMATION:
Shares sold 2,829,353 2,137,346
Shares issued in reinvestment of dividends 1,538,174 989,255
Shares redeemed (2,310,138) (1,250,566)
------------- -------------
Net increase/(decrease) 2,057,389 1,876,035
============= =============
</TABLE>
See notes to financial statements.
B-32
<PAGE> 50
THE BAUPOST FUND
SCHEDULE OF INVESTMENTS
OCTOBER 31, 1998
<TABLE>
<CAPTION>
NUMBER OF
SHARES, UNITS OR
FACE VALUE MARKET VALUE
---------------- --------------
<S> <C> <C> <C>
COMMON STOCKS - 53.63%
UNITED STATES - 17.91%
WHOLESALE - FOOD - 8.74%
272,500 TLC BEATRICE INTERNATIONAL HOLDINGS $ 11,717,500
CHEMICAL PREPARATIONS - 3.44%
238,150 CHEMFIRST INC 4,614,156
MANUFACTURING - OPHTHALMIC GOODS - 2.09%
145,650 SOLA INTERNATIONAL INC 2,794,659 *
BUSINESS SERVICES - 1.20%
295,530 AZTEC TECHNOLOGY PARTNERS 1,606,944 *
TRAVEL AGENCIES - 0.91%
211,422 NAVIGANT INTERNATIONAL INC 1,215,677 *
CARBON & GRAPHITE PRODUCTS - 0.79%
59,300 UCAR INTERNATIONAL INC 1,067,400 *
ELECTRIC HOUSEWARES & FANS - 0.39%
95,700 GLOBAL-TECH APPLIANCES INC 526,350 *
MISCELLANEOUS - 0.35%
110 FIDELITY BANKSHARES INC 2,530
198 FIRST FEDERAL SAVINGS BANK OF SIOUXLAND 3,960
6,250 MFC BANCORP 37,500
1,949 MID-CENTRAL FINANCIAL CORPORATION 46,776
16,400 OMEGA WORLDWIDE 57,400 *
938,000 REGENCY EQUITIES CORPORATION 14,070 *
26,350 VENTAS INC 301,378 *
---------------
463,614
TOTAL COMMON STOCKS - UNITED STATES $ 24,006,300
===============
(Total Cost $22,575,025)
SWEDEN - 10.82%
REAL ESTATE AGENTS & MANAGERS - 5.13%
804,500 ASTICUS AB $ 6,875,185 *
COMMUNICATION SERVICES - 3.53%
428,300 MODERN TIMES GROUP AB - B SHARES 4,733,509 *
</TABLE>
B-33
<PAGE> 51
THE BAUPOST FUND
SCHEDULE OF INVESTMENTS
OCTOBER 31, 1998
<TABLE>
<CAPTION>
NUMBER OF
SHARES, UNITS OR
FACE VALUE MARKET VALUE
------------------- --------------
<S> <C> <C> <C>
HOLDING COMPANIES - 2.16%
449,381 TRUSTOR AB - B SHARES $ 2,887,496 *
---------------
TOTAL COMMON STOCKS - SWEDEN $ 14,496,190
===============
(Total Cost $14,723,781)
UNITED KINGDOM - 10.79%
INSURANCE AGENTS, BROKERS & SERVICES - 5.18%
413,500 JARDINE LLOYD THOMPSON GROUP PLC $ 1,477,501
3,300,000 LAMBERT FENCHURCH GROUP PLC 5,467,684
---------------
6,945,185
FABRICATED TEXTILE PRODUCTS - 2.02%
5,125,100 COATS VIYELLA PLC 2,701,887
HOLDING COMPANIES - 1.16%
2,018,000 TRANSTEC PLC 1,553,579
MANUFACTURING INDUSTRIES - 0.87%
553,100 FKI PLC 1,170,977
OIL & GAS - 0.47%
1,043,072 BURREN ENERGY PLC 625,843 *+
MEDIA, SATELLITE BROADCAST - 0.45%
74,800 BRITISH SKY BROADCASTING GROUP PLC 609,656
ELECTRONIC COMPONENTS - 0.41%
757,300 ASTEC (BSR) PLC 544,993
WHOLESALE - LUMBER & OTHER CONSTRUCTION MATERIALS - 0.23%
115,000 ADAM & HARVEY GROUP PLC 303,133
---------------
TOTAL COMMON STOCKS - UNITED KINGDOM $ 14,455,253
===============
(Total Cost $20,632,754)
FRANCE - 5.23%
HOLDING COMPANIES - 5.06%
51,465 CHARGEURS SA $ 2,588,232
13,180 FIN MARC DE LACHARRIERE SA (FIMALAC) 1,377,940
945 PATHE SA 180,732
5,185 SOCIETE EURAFRANCE SA 2,636,567
---------------
6,783,471
</TABLE>
B-34
<PAGE> 52
THE BAUPOST FUND
SCHEDULE OF INVESTMENTS
OCTOBER 31, 1998
<TABLE>
<CAPTION>
NUMBER OF
SHARES, UNITS OR
FACE VALUE MARKET VALUE
------------------- --------------
<S> <C> <C> <C>
MOTION PICTURE PRODUCTION SERVICES - 0.17%
3,568 GAUMONT SA $ 230,247
---------------
TOTAL COMMON STOCKS - FRANCE $ 7,013,718
===============
(Total Cost $6,453,233)
RUSSIA - 2.29%
OIL & GAS - 1.58%
1,606,200 KRASNOYARSKENERGO $ 8,031 *
118,700 LUKOIL OIL COMPANY SPONSORED ADR 1,899,200
7,233,000 SURGUTNEFTEGAZ PREFERRED 91,136
43,160 SURGUTNEFTEGAZ PREFERRED SPONSORED ADR 43,160
31,500 SURGUTNEFTEGAZ SPONSORED ADR 70,875
---------------
2,112,402
ELECTRIC UTILITIES - 0.71%
195,700 IRKUTSKENERGO SPONSORED ADR 345,534
91,400 PERMENERGO 18,280 *
448,510 SAMARAENERGO SPONSORED ADR 134,553 *
152,492 UNIFIED ENERGY SYSTEMS SPONSORED GDR 457,476
---------------
955,843
METAL & MINING SERVICES - 0.00%
28,300 NORILSK NICKEL 11,037 *
---------------
TOTAL COMMON STOCKS - RUSSIA $ 3,079,282
===============
(Total Cost $4,720,140)
SWITZERLAND - 1.52%
HOLDING COMPANIES - 1.52%
7,550 VALORA HOLDING AG $ 2,036,689
---------------
TOTAL COMMON STOCKS - SWITZERLAND $ 2,036,689
===============
(Total Cost $1,558,396)
CZECH REPUBLIC - 1.39%
ELECTRIC UTILITIES - 1.39%
17,600 CEZ 1 CESKE ENERGETICKE ZAVOD AS $ 401,929 *
79,900 CEZ 2 CESKE ENERGETICKE ZAVOD AS II 1,456,300 *
---------------
TOTAL COMMON STOCKS - CZECH REPUBLIC $ 1,858,229
===============
(Total Cost $2,369,623)
</TABLE>
B-35
<PAGE> 53
THE BAUPOST FUND
SCHEDULE OF INVESTMENTS
OCTOBER 31, 1998
<TABLE>
<CAPTION>
NUMBER OF
SHARES, UNITS OR
FACE VALUE MARKET VALUE
------------------- --------------
<S> <C> <C> <C>
THE NETHERLANDS - 1.09%
TOWING & TUGBOAT SERVICES - 1.09%
64,544 SMIT INTERNATIONALE NV $ 1,456,140
---------------
TOTAL COMMON STOCKS - THE NETHERLANDS $ 1,456,140
===============
(Total Cost $1,622,386)
POLAND - 0.80%
CONSTRUCTION - 0.80%
201,672 BUDIMEX SA $ 1,064,664 *
---------------
TOTAL COMMON STOCKS - POLAND $ 1,064,664
===============
(Total Cost $890,253)
HONG KONG - 0.75%
ELECTRONIC & OTHER ELECTRICAL EQUIPMENT - 0.40%
12,379,576 SEMI-TECH GLOBAL LTD $ 535,407
23,760 SEMI-TECH GLOBAL LTD SPONSORED ADR 3,564
---------------
538,971
MANUFACTURING TOYS & DOLLS - 0.30%
6,953,400 PLAYMATES TOYS HOLDINGS LTD 399,476
HOTELS & MOTELS - 0.05%
1,088,000 LAI SUN HOTELS INTERNATIONAL LTD 71,636
---------------
TOTAL COMMON STOCKS - HONG KONG $ 1,010,083
===============
(Total Cost $982,940)
NORWAY - 0.60%
MISCELLANEOUS PUBLISHING - 0.60%
75,800 SCHIBSTED ASA $ 799,315
---------------
TOTAL COMMON STOCKS - NORWAY $ 799,315
===============
(Total Cost $1,162,695)
BRAZIL - 0.26%
TELEPHONE COMMUNICATIONS - 0.26%
1,982,000 TELEMIG CELULAR SA PREFERENCE C $ 18,610 *
6,458,900 TELEPAR CELULAR SA COMMON 151,672 *
</TABLE>
B-36
<PAGE> 54
THE BAUPOST FUND
SCHEDULE OF INVESTMENTS
OCTOBER 31, 1998
<TABLE>
<CAPTION>
NUMBER OF
SHARES, UNITS OR
FACE VALUE MARKET VALUE
------------------- --------------
<S> <C> <C> <C>
858,000 TELEPAR CELULAR SA PREFERENCE B $ 36,326 *
8,468,000 TELERJ CELULAR SA COMMON 138,436 *
---------------
TOTAL COMMON STOCKS - BRAZIL $ 345,044
===============
(Total Cost $749,010)
ROMANIA - 0.13%
CONCRETE PRODUCTS - 0.13%
42,000 ROMCIM BUCHAREST $ 180,118 *
---------------
TOTAL COMMON STOCKS - ROMANIA $ 180,118
===============
(Total Cost $588,230)
BAHAMAS - 0.03%
CRUDE PETROLEUM - 0.03%
170,430 BASIC PETROLEUM INTERNATIONAL LTD UNIT TRUST $ 42,608 *
---------------
TOTAL COMMON STOCKS - BAHAMAS $ 42,608
===============
(Total Cost $175,032)
CANADA - 0.02%
OIL & GAS - 0.02%
13,800 HURRICANE HYDROCARBONS LTD $ 28,463 *
---------------
TOTAL COMMON STOCKS - CANADA $ 28,463
===============
(Total Cost $67,685)
TOTAL COMMON STOCKS $ 71,872,096
===============
(TOTAL COST $79,271,183)
COMPANIES IN LIQUIDATION - 5.56%
3,150 EHLCO LIQUIDATING TRUST $ 394 *+
DEM 15,000,000 MAXWELL COMM. CORP. PLC 6.000% 06/15/93 725,953 *
CHF 5,500,000 MAXWELL COMM. CORP. PLC 5.000% 06/16/95 325,636 *
836,059 MBO PROPERTIES INC 6,395,851 ***
---------------
TOTAL COMPANIES IN LIQUIDATION $ 7,447,834
===============
(Total Cost $16,004)
</TABLE>
B-37
<PAGE> 55
THE BAUPOST FUND
SCHEDULE OF INVESTMENTS
OCTOBER 31, 1998
<TABLE>
<CAPTION>
NUMBER OF
SHARES, UNITS OR
FACE VALUE MARKET VALUE
------------------- --------------
<S> <C> <C> <C>
CLOSED-END MUTUAL FUNDS - 2.78%
45,200 BALKAN FUND $ 101,700
60,000 FIVE ARROWS CHILE INVESTMENT TRUST WARRANTS 3.2617 5/31/1999 1,200
282,000 KAZAKHSTAN FUND LIMITED 705,000
17,200 KOMERCNI BANK IF 273,460 *
194,189 NIF I 199,963 *
27,800 NIF II 26,207 *
165,705 NIF III 175,438 *
9,743 NIF IV 11,304 *
22,695 NIF V 30,941 *
151,615 NIF VI 173,714 *
27,800 NIF VII 26,611 *
219,210 NIF VIII 292,492 *
27,052 NIF IX 37,273 *
52,961 NIF X 72,970 *
300 NIF XI 300 *
27,800 NIF XII 36,287 *
290,338 NIF XIII 429,507 *
108,117 NIF XIV 150,533 *
27,575 NIF XV 26,795 *
17,892 POLISH NATIONAL INVESTMENT FUND (NIF CERTIFICATES) 305,133 *
700 RESTITUCNI INVESTICINI FOND CESKE (RIF) 22,358
44,900 ZIVNOBANKA INVESTICNI FOND 611,212
---------------
TOTAL CLOSED-END MUTUAL FUNDS $ 3,710,398
===============
(Total Cost $7,112,946)
OPTIONS - 2.22%
76 FRANCE OAT 5.25% 04/25/2008 97.00 PUTS 04/23/1999 $ 1,372
76 FRANCE OAT 5.25% 04/25/2008 97.11 PUTS 10/22/1999 16,470
76 FRANCE OAT 5.25% 04/25/2008 96.95 PUTS 10/25/1999 15,097
76 FRANCE OAT 5.25% 04/25/2008 97.04 PUTS 10/25/1999 1,372
143,816 FRF PUTS / DEM 3.4145 CALLS 11/20/1998 0
143,891 FRF PUTS / DEM 3.4148 CALLS 11/20/1998 1,480
147,638 FRF PUTS / DEM 3.3805 CALLS 12/02/1998 2,947
176 GENERAL ELECTRIC 90.00 PUTS 12/28/1998 97,310
569 GOLD 550 CALLS 04/05/2001 17,055
569 GOLD 550 CALLS 04/09/2001 17,624
500 GOLD 550 CALLS 04/19/2001 40,000
563 GOLD 550 CALLS 07/19/2001 22,520
13,742 HONG KONG DOLLAR 7.910 PUTS 02/01/1999 34,891
13,647 HONG KONG DOLLAR 7.965 PUTS 02/04/1999 65,575
387 ITL PUTS / DEM 1043.40 CALLS 11/23/1998 0
299 ITL PUTS / DEM 1016.80 CALLS 12/02/1998 2,690
3,500,000,000 JAPANESE GOVERNMENT BOND 182 101.00 PUTS 12/17/1998 301
3,956,000,000 JAPANESE GOVERNMENT BOND 203 100.00 PUTS 03/10/1999 20,436
1,978,000,000 JAPANESE GOVERNMENT BOND 203 100.00 PUTS 03/10/1999 18,733
1,978,000,000 JAPANESE GOVERNMENT BOND 203 102.00 PUTS 03/10/1999 35,762
989,000,000 JAPANESE GOVERNMENT BOND 203 95.00 PUTS 09/13/1999 12,772
2,967,000,000 JAPANESE GOVERNMENT BOND 203 97.50 PUTS 09/13/1999 120,059
1,483,500,000 JAPANESE GOVERNMENT BOND 203 100.00 PUTS 09/13/1999 88,129
2,405,000,000 JAPANESE GOVERNMENT BOND 203 97.50 PUTS 09/16/1999 97,318
1,683,500,000 JAPANESE GOVERNMENT BOND 203 97.50 PUTS 03/14/2000 81,167
200 MICROSOFT CORPORATION 105.00 PUTS 12/02/1998 83,440
56,450 RJR STUB 5.22 CALLS 5/01/2000 89,756
</TABLE>
B-38
<PAGE> 56
THE BAUPOST FUND
SCHEDULE OF INVESTMENTS
OCTOBER 31, 1998
<TABLE>
<CAPTION>
NUMBER OF
SHARES, UNITS OR
FACE VALUE MARKET VALUE
------------------- --------------
<S> <C> <C> <C>
92 S&P 500 INDEX 1080.000 PUTS 11/09/1998 $ 101,678
33 S&P 500 INDEX 719.695 PUTS 12/04/1998 502
55 S&P 500 INDEX 919.785 PUTS 12/18/1998 39,076
49 S&P 500 INDEX 1103.330 PUTS 12/22/1998 209,720
102 S&P 500 INDEX 1120.000 PUTS 01/11/1999 593,048
53 S&P 500 INDEX 1122.980 PUTS 01/28/1999 336,577
270 S&P 500 INDEX 904.990 PUTS 07/30/1999 714,096
---------------
TOTAL OPTIONS $ 2,978,973
===============
(Total Cost $7,008,354)
PURCHASED BANK DEBT & TRADE CLAIMS - 1.15%
2,453,801 MAXWELL COMM. BANK DEBT - BAKER NYE $ 211,282 *+
5,000,000 MAXWELL COMM. BERLITZ OBLIGATIONS 425,000 *+
167,868 MAXWELL COMM. REVOLVING BANK DEBT - FIRST CHICAGO 14,791 *+
943,496 MAXWELL COMM. REVOLVING BANK DEBT - HALYCON 83,408 *+
396,015 MAXWELL COMM. REVOLVING BANK DEBT - HALYCON II 34,894 *+
875,543 MAXWELL COMM. REVOLVING BANK DEBT - LAZARD FRERES 77,093 *+
264,059 MAXWELL COMM. REVOLVING BANK DEBT - MERRILL LYNCH 23,266 *+
823,981 MAXWELL COMM. REVOLVING BANK DEBT - SAN PAOLO 72,813 *+
1,015,000 MAXWELL COMM. REVOLVING BANK DEBT - TCC ASSOCIATES 89,657 *+
579,133 MAXWELL COMM. TERM BANK DEBT - FIRST CHICAGO 49,226 *+
1,678,704 MAXWELL COMM. TERM BANK DEBT - HALYCON 142,690 *+
702,221 MAXWELL COMM. TERM BANK DEBT - HALYCON II 59,689 *+
426,846 MAXWELL COMM. TERM BANK DEBT - LAZARD FRERES 36,282 *+
468,269 MAXWELL COMM. TERM BANK DEBT - MERRILL LYNCH 39,803 *+
325,093 MAXWELL COMM. TERM BANK DEBT - SAN PAOLO 27,633 *+
1,806,952 MAXWELL COMM. TERM BANK DEBT - TCC ASSOCIATES 153,591 *+
---------------
TOTAL PURCHASED BANK DEBT & TRADE CLAIMS $ 1,541,118
===============
(Total Cost $0)
PARTNERSHIPS - 0.96%
EMERGING EUROPE FUND FOR SUSTAINABLE DEVELOPMENT LP $ 160,149 +
NCH INVESTORS FUND LP 187,425 +
NEW CENTURY CAPITAL PARTNERS II LP 414,348 +
SIGMA / UKRAINE LP 175,946 +
SIGMA / UKRAINE CLASS C LP 101,166 +
TEMPLETON EMERGING EUROPE FUND II LP 99,229 +
UKRAINIAN GROWTH FUND II LP 153,000 +
---------------
TOTAL PARTNERSHIPS $ 1,291,263
===============
(Total Cost $4,472,436)
COLLATERALIZED MORTGAGE OBLIGATIONS - 0.41%
509,641 RTC SERIES 1991 M2 CLASS B FRN 9/25/2020 $ 95,558
19,803,269 STRUCTURED ASSET SECURITIES CORP 1996-CFL CLASS X2 2/25/2028 451,762
---------------
TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS $ 547,320
===============
(Total Cost $824,203)
</TABLE>
B-39
<PAGE> 57
THE BAUPOST FUND
SCHEDULE OF INVESTMENTS
OCTOBER 31, 1998
<TABLE>
<CAPTION>
NUMBER OF
SHARES, UNITS OR
FACE VALUE MARKET VALUE
------------------- --------------
<S> <C> <C> <C>
CORPORATE BONDS - 0.00%
11,000 CHARTWELL CONTINGENT INTEREST NOTES 8.00% 6/30/2006 $ 7,212 +
---------------
TOTAL CORPORATE BONDS $ 7,212
===============
(Total Cost $7,212)
TREASURY OBLIGATIONS - 28.19%
U.S. TREASURY OBLIGATIONS - 11.87%
5,000,000 U.S. TREASURY BILLS 11/27/1998 $ 4,988,125 ~
3,000,000 U.S. TREASURY BILLS 12/10/1998 2,987,650 ~
5,000,000 U.S. TREASURY BILLS 12/31/1998 4,966,567 ~
3,000,000 U.S. TREASURY BILLS 02/18/1999 2,962,470
---------------
TOTAL U.S. TREASURY OBLIGATIONS 15,904,812
U.K. TREASURY OBLIGATIONS - 8.90%
ECU 10,110,000 UK TREASURY BILLS 01/14/1999 11,928,461
French Treasury Obligations - 3.71%
FRF 27,801,800 FRENCH DISCOUNT TREASURY BILLS 01/21/1999 4,974,513
BELGIAN TREASURY OBLIGATIONS - 3.71%
BEF 170,802,000 BELGIAN TREASURY BILLS 01/07/1999 4,971,446
---------------
TOTAL TREASURY OBLIGATIONS $ 37,779,232
===============
(Total Cost $37,888,614)
TOTAL INVESTMENTS - 94.90% $ 127,175,446
===============
(Total Cost $136,600,952)
</TABLE>
* Non-income producing security.
+ Restricted securities - securities not registered under the Securities Act
of 1933. See Note C.
~ A portion of the security is serving as collateral or is segregated for
securities sold short.
** Affiliated company.
Foreign Currency Abbreviations
BEF Belgian Franc
CHF Swiss Franc
DEM Deutschemark
ECU European Currency Unit
FRF French Franc
The percentage shown for each investment category is the total value of that
category expressed as a percentage of total net assets of the Fund.
See notes to financial statements.
B-40
<PAGE> 58
THE BAUPOST FUND
SCHEDULE OF FORWARD FOREIGN CURRENCY CONTRACTS
OCTOBER 31, 1998
<TABLE>
<CAPTION>
MARKET UNREALIZED
VALUE GAIN/(LOSS)
--------------- -------------
CONTRACTS TO SELL
<S> <C> <C> <C> <C>
BEF 577,044,000 Belgian Franc due 11/06/1998 $ 4,975,203 $ (2,187)
(Receivable amount $4,973,016)
BPS 7,245,456 British Pound Sterling due 01/27/1999 12,080,929 149,401
(Receivable amount $12,230,330)
BRL 1,327,848 Brazilian Real due 11/09/1998 1,107,398 (18,998)
(Receivable amount $1,088,400)
CHF 34,432 Swiss Franc due 11/03/1998 25,482 (9)
(Receivable amount $25,473)
CHF 4,257,900 Swiss Franc due 01/27/1999 3,180,362 21,067
(Receivable amount $3,201,429)
CSK 44,771,000 Czech Koruna due 03/01/1999 1,510,193 2,596
(Receivable amount $1,512,789)
CSK 25,410,000 Czech Koruna due 03/22/1999 853,859 833
(Receivable amount $854,692)
CSK 9,747,000 Czech Koruna due 07/12/1999 321,354 (359)
(Receivable amount $320,995)
ECU 10,031,045 European Currency Unit due 11/06/1998 11,925,910 3,009
(Receivable amount $11,928,919)
FRF 27,690,000 French Franc due 11/05/1998 4,994,444 (306)
(Receivable amount $4,994,138)
FRF 88,837,058 French Franc due 01/27/1999 16,075,178 156,698
(Receivable amount $16,231,876)
NLG 577,954,500 Dutch Guilder due 01/27/1999 1,389,851 14,042
(Receivable amount $1,403,893)
NOK 6,026,100 Norwegian Krone due 06/28/1999 808,216 (12,362)
(Receivable amount $795,854)
</TABLE>
B-41
<PAGE> 59
THE BAUPOST FUND
SCHEDULE OF FORWARD FOREIGN CURRENCY CONTRACTS
OCTOBER 31, 1998
<TABLE>
<CAPTION>
MARKET UNREALIZED
VALUE GAIN/(LOSS)
--------------- -------------
CONTRACTS TO SELL - CONTINUED
<S> <C> <C> <C> <C>
PLN 2,366,189 Polish Zloty due 12/15/1998 682,194 (63,194)
(Receivable amount $619,000)
PLN 2,365,199 Polish Zloty due 12/17/1998 681,653 (62,653)
(Receivable amount $619,000)
PLN 1,151,484 Polish Zloty due 12/23/1998 331,381 (22,631)
(Receivable amount $308,750)
PLN 2,182,120 Polish Zloty due 03/08/1999 616,192 (64,692)
(Receivable amount $551,500)
SEK 79,568,362 Swedish Krona due 12/09/1998 10,240,182 (64,189)
--------------- -------------
(Receivable amount $10,175,993)
TOTAL CONTRACTS TO SELL $ 71,799,981 36,066
=============== -------------
(Receivable amount $71,836,047)
CONTRACTS TO BUY
BPS 3,594,949 British Pound Sterling due 01/27/1999 $ 5,994,146 (14,092)
(Payable amount $6,008,238)
BRL 656,033 Brazilian Real due 11/09/1998 547,118 2,918
(Payable amount $544,200)
CHF 1,444,650 Swiss Franc due 01/27/1999 1,079,055 1,280
(Payable amount $1,077,775)
FRF 22,814,697 French Franc due 01/27/1999 4,128,349 (37)
(Payable amount $4,128,386)
SEK 20,612,365 Swedish Krona due 12/09/1998 2,652,742 76,487
(Payable amount $2,576,255) --------------- -------------
TOTAL CONTRACTS TO BUY $ 14,401,410 66,556
=============== -------------
(Payable amount $14,334,854)
$ 102,622
=============
</TABLE>
See notes to financial statements.
B-42
<PAGE> 60
THE BAUPOST FUND
SCHEDULE OF SECURITIES SOLD SHORT
OCTOBER 31, 1998
<TABLE>
<CAPTION>
MARKET
NUMBER OF SHARES VALUE
---------------- -----
SECURITIES SOLD SHORT - 1.52%
<S> <C> <C>
COMMON STOCK - 1.28%
95,600 British Sky Broadcasting Group PLC $ 779,186
2,186 Essilor International 886,584
75 L'Oreal 42,923
------------------
TOTAL COMMON STOCK 1,708,693
(Total Proceeds $1,519,237)
OPTIONS - 0.24%
270 S&P 500 Index 791.870 Puts expiring 07/30/1999 318,519
------------------
TOTAL OPTIONS 318,519
------------------
(Total Proceeds $369,576)
TOTAL SECURITIES SOLD SHORT $ 2,027,212
===================
(Total Proceeds $1,888,813)
</TABLE>
The percentage shown for each investment category is
the total value of that category expressed as a
percentage of total net assets of the Fund.
See notes to financial statements.
B-43
<PAGE> 61
THE BAUPOST FUND
NOTES TO FINANCIAL STATEMENTS
OCTOBER 31, 1998
NOTE A - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
The Baupost Fund (the "Fund") was established as a Massachusetts business trust
under an Agreement and Declaration of Trust dated June 29, 1990, and is
registered under the Investment Company Act of 1940, as amended, as a no-load,
non-diversified, open-end management investment company.
The following is a summary of significant accounting policies followed by the
Fund in the preparation of its financial statements. The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that may affect the
reported amounts of assets and liabilities. Actual results could differ from
those estimates.
SECURITY VALUATION: Portfolio securities (other than certain foreign
securities), options and futures contracts for which market quotations are
available and which are traded on an exchange or on NASDAQ are valued at the
last quoted sale price or, if there is no such reported sale that day, at the
closing bid price. Securities, options and forward contracts traded in the
over-the-counter market (other than those traded on NASDAQ) and other unlisted
securities are valued at the most recent bid price as obtained from one or more
dealers that make markets in the securities. Portfolio securities which are
traded both in the over-the-counter market and on one or more stock exchanges
are valued according to the broadest and most representative market. To the
extent the Fund engages in "naked" short sales (i.e., it does not own the
underlying security or a security convertible into the underlying security
without the payment of any further consideration) the Fund will value such short
position as described above, except that the valuation, where necessary, will be
based on the ask price instead of the bid price. Securities traded in foreign
markets are valued at their current market value, which, depending on local
custom, may or may not be the last quoted sale price (or the closing bid price).
Assets for which no quotations are readily available are valued at fair value as
determined in good faith in accordance with procedures adopted by the Trustees
of the Fund. Determination of fair value is based upon such factors as are
deemed relevant under the circumstances, including the financial condition and
operating results of the issuer, recent third-party transactions (actual or
proposed) relating to such securities and, in extreme cases, the liquidation
value of the issuer.
Certain investments held by the Fund are restricted as to public sale in
accordance with the Securities Act of 1933. Whenever possible, such assets are
valued based on bid prices obtained from reputable brokers or market makers as
of the valuation date. For assets not priced by brokers or market makers, fair
value is determined by The Baupost Group, L.L.C. ("Baupost") in accordance with
procedures adopted by the Trustees of the Fund.
FOREIGN CURRENCY TRANSLATION: The value of foreign securities is translated into
U.S. dollars at the rate of exchange on the day of valuation. Purchases and
sales of foreign securities, as well as income and expenses relating to such
securities, are translated into U.S. dollars at the exchange rate on the dates
of the transactions. The portion of both realized and unrealized gains and
losses on investments that results from fluctuations in foreign exchange rates
is not separately disclosed.
B-44
<PAGE> 62
THE BAUPOST FUND
NOTES TO FINANCIAL STATEMENTS
OCTOBER 31, 1998
NOTE A - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
SECURITIES TRANSACTIONS AND INVESTMENT INCOME: Securities transactions are
recorded on the trade date. Gains and losses on securities sold are determined
using the specific identification method. Dividend income is recorded on the
ex-dividend date, except income on certain foreign dividends, where the
ex-dividend date may have passed, is recorded as soon as the Fund becomes aware
of the dividends. Interest income, including original issue discount, where
applicable, is recorded on an accrual basis, except for bonds in default for
which there is some concern as to whether interest will be received in cash, in
which case interest is recorded when received.
SHORT SALES: The Fund engages in short-selling which obligates the Fund to
replace the security borrowed by purchasing the security at the then current
market value. The Fund would incur a loss if the price of the security increases
between the date of the short sale and the date on which the Fund replaces the
borrowed security. The Fund would realize a gain if the price of the security
declines between those dates. Until the Fund replaces the borrowed security, the
Fund maintains daily, in a segregated account with its custodian, cash or
securities sufficient to cover its short exposure. At October 31, 1998, the Fund
had approximately $3,900,000 of U.S. Treasury bills in a segregated account
relating to its short positions. Securities sold short at October 31, 1998 and
their related market values and proceeds are set forth in the Schedule of
Securities Sold Short.
FORWARD FOREIGN CURRENCY CONTRACTS: The Fund may enter into forward foreign
currency contracts for the purchase or sale of a specific foreign currency at a
fixed price on a future date. The U.S. dollar value of the currencies the Fund
has committed to buy or sell is shown in the Schedule of Forward Foreign
Currency Contracts. Losses may arise from changes in the value of a foreign
currency relative to the U.S. dollar or from the potential inability of the
counterparties to meet the terms of their contracts. The Fund uses forward
foreign currency contracts to hedge the risks associated with holding securities
denominated in foreign currencies.
FUTURES: The Fund may enter into index futures contracts for non-hedging
purposes and in order to hedge against the effects of fluctuations in market
conditions. The potential risk to the Fund is that the change in value of the
futures contracts may not correspond to the change in value of the securities
held by the Fund in those markets. In addition, for non-listed futures
contracts, losses may arise if there is an illiquid secondary market for the
contracts or if the counterparty to the contracts is unable to perform.
Currently, the Fund holds only listed futures contracts. At the time the Fund
enters into a futures contract, it is required to deposit with its broker cash
or U.S. government securities as collateral, calculated on a per contract basis.
Subsequent payments to and from the broker are made on a daily basis as the
market price of the futures contract fluctuates. Daily adjustments arising from
this "mark to market" are recorded by the Fund as unrealized gains or losses.
When the contracts are closed, the Fund recognizes a gain or loss. If a futures
contract is considered a Section 1256 contract for federal income tax purposes,
it will be marked to market at year end with the change in value recorded as 40%
short-term capital gain or loss and 60% long-term capital gain or loss in
accordance with U.S. federal tax law.
B-45
<PAGE> 63
THE BAUPOST FUND
NOTES TO FINANCIAL STATEMENTS
OCTOBER 31, 1998
NOTE A - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
At October 31, 1998, open positions in futures contracts were as follows:
<TABLE>
<CAPTION>
Unrealized
Expiration Open Contracts Position Appreciation/(Depreciation)
---------- -------------- -------- ---------------------------
<S> <C> <C> <C>
December 18, 1998 71 FTSE 100 Index Futures Short ($292,907)
</TABLE>
SWAPS: The Fund has entered into equity swap contracts to gain exposure to
specific foreign equities. A swap is an agreement that obligates two parties to
exchange a series of cash flows at specified intervals based upon or calculated
by reference to changes in specified security prices or interest rates. The
payment flows are usually netted against each other, with the difference being
paid by one party to the other. At the time the Fund enters into an equity swap
contract it may be required to deposit collateral, cash or Treasury bills with
its broker.
Risks may arise as a result of the failure of another party to the swap contract
to comply with the terms of the swap contract. The loss incurred by the failure
of a counterparty is generally limited to the net payment to be received by the
Fund and/or the termination value at the end of the contract. The loss incurred
by the failure of a counterparty could include the collateral, in certain
circumstances, if there is no required segregation of cash collateral from other
assets. Therefore, the Fund considers the creditworthiness of each counterparty
to a swap contract in evaluating potential credit risk. Additionally, risks may
arise from unanticipated movements in interest rates or in the value of the
underlying equities.
The Fund records a net receivable or payable for the amount expected to be
received or paid under the contract. The interest component of the equity swap
contract is recorded as swap interest income or expense and the fluctuation in
the market value of the underlying security is recorded as unrealized
appreciation or depreciation on investments. Premium payments made to enter into
a swap contract, if any, are capitalized and amortized over the life of the swap
contract.
At October 31, 1998, the Fund had outstanding equity swap contracts with the
following terms:
<TABLE>
<CAPTION>
SWAP NOTIONAL AMT. TERMINATION UNDERLYING PAYMENTS MADE BY OR
COUNTERPARTY LONG/(SHORT) DATE SHARES UNDERLYING EQUITY RECEIPTS TO THE FUND
------------ ------------ ---- ------ ----------------- --------------------
<S> <C> <C> <C> <C> <C>
CS First Boston ($805,642) 01/18/2000 24,700 Assicurazioni Generali Three Month ITL LIBOR
Less 1.95%
SBC Warburg $7,791,417 09/30/1999 2,861,100 Inchcape PLC One Year USD-LIBOR-BBA
Plus .50%
</TABLE>
REPURCHASE AGREEMENTS: The Fund may enter into repurchase agreements with
institutions that Baupost has determined are creditworthy. Each repurchase
agreement is recorded at cost. The Fund requires that the securities purchased
in a repurchase transaction be transferred to the custodian in a manner
sufficient to enable the Fund to obtain those securities in the event of a
default under the repurchase agreement. The Fund monitors, on a daily basis, the
value of the collateral to ensure that its value, including accrued interest, is
greater than the amounts owed to the Fund under each such repurchase agreement.
B-46
<PAGE> 64
THE BAUPOST FUND
NOTES TO FINANCIAL STATEMENTS
OCTOBER 31, 1998
NOTE A - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
OPTIONS: The Fund may either write or purchase call and put options for both
hedging and non-hedging activities. The risk associated with purchasing an
option is that the Fund pays a premium whether or not the option is exercised.
Also, for non-listed options, the Fund bears the risk of loss of premium and
market value should the counterparty not perform under the contract. The Fund's
exposure to market risk relating to the securities is affected by a number of
factors including the size and composition of the options held, the time period
during which the options may be exercised, the volatility of the underlying
security or index, and the relationship between the current market price of the
underlying security or index and the strike or exercise price of the option.
FEDERAL INCOME TAXES AND DISTRIBUTIONS: The Fund is a regulated investment
company, as defined under Subchapter M of the Internal Revenue Code (the Code).
By complying with Code provisions, the Fund is not subject to federal income tax
provided that substantially all of its taxable income is distributed to
shareholders. Therefore, no provision has been made for federal income taxes.
The Fund's income and capital gain distributions are determined in accordance
with income tax regulations which may differ from generally accepted accounting
principles. These differences are primarily due to different treatment for
certain of the Fund's foreign securities. Differences in the recognition or
classification of income between the financial statements and tax earnings and
profits, which result in temporary overdistributions for financial statement
purposes, are classified as distributions in excess of net investment income or
accumulated net realized gains. During the year ended October 31, 1998, there
were reclassifications between undistributed net investment income, accumulated
net realized gain on investments and paid in capital due to differences between
book and tax accounting for passive foreign investment companies, foreign
currency transactions, and shareholder distributions. This change had no effect
on the net assets or net asset value per share. At October 31, 1998, the Fund,
for federal income tax purposes, had a capital loss carryforward of $3,846,000
which may be applied against any net taxable realized gains of each succeeding
year until the earlier of its utilization or expiration on October 31, 2006. The
Fund utilizes earnings and profits distributed to shareholders upon redemption
of shares as a part of the dividends paid deduction for income tax purposes.
NOTE B - INVESTMENT TRANSACTIONS
Purchases and sales of investment securities (excluding short-term investments)
for the period ended October 31, 1998 aggregated $162,536,000 and $166,722,000,
respectively.
For federal income tax purposes, the identified cost of investments at October
31, 1998 was $137,324,903. Unrealized appreciation/(depreciation), on a federal
income tax basis, for all securities was as follows:
<TABLE>
<CAPTION>
Year Ended
October 31, 1998
----------------
<S> <C>
Gross unrealized appreciation $17,285,517
Gross unrealized depreciation (27,434,974)
-------------
Net unrealized depreciation ($10,149,457)
=============
</TABLE>
B-47
<PAGE> 65
THE BAUPOST FUND
NOTES TO FINANCIAL STATEMENTS
OCTOBER 31, 1998
NOTE C - RESTRICTED SECURITIES
At October 31, 1998, the Fund held the following securities which are restricted
as to public sale in accordance with the Securities Act of 1933:
<TABLE>
<CAPTION>
Earliest
Value at Acquisition
Cost October 31, 1998 Date
---- ---------------- ----
<S> <C> <C> <C>
Purchased Bank Debt & Trade Claims:
Maxwell Communications Corporate Debt $ 0 $1,541,118 11/22/93
Corporate Bonds:
Chartwell Contingent Interest Notes 8.00% due 06/30/2006 7,212 7,212 12/21/95
Partnerships:
Emerging Europe Fund for Sustainable Development, L.P. 119,845 160,149 02/25/97
NCH Investors Fund, L.P. 1,598,618 187,425 12/18/95
New Century Capital Partners II, L.P. 978,292 414,348 11/30/95
Sigma / Ukraine, L.P. 661,184 175,946 05/14/96
Sigma / Ukraine Class C, L.P. 404,663 101,166 11/27/96
Templeton Emerging Europe Fund II, L.P. 113,758 99,229 12/08/97
Ukrainian Growth Fund II, L.P. 596,076 153,000 03/31/97
Common Stock:
Burren Energy PLC 858,852 625,843 04/14/98
Companies in Liquidation:
Ehlco Liquidating Trust 12 394 01/30/89
---------- ----------
TOTAL RESTRICTED SECURITIES (2.59% of Net Assets) $5,338,512 $3,465,830
========== ==========
</TABLE>
The Fund does not have the right to demand that such securities be registered.
The Fund does not anticipate any significant costs associated with the
disposition of these securities.
NOTE D - INVESTMENT MANAGEMENT CONTRACT AND OTHER TRANSACTIONS WITH AFFILIATES
The Fund retains Baupost as its investment adviser and administrator. Certain
individuals who are officers and trustees of the Fund are also officers,
directors and shareholders of Baupost.
The Fund pays Baupost a quarterly management fee at an annual rate of 1% of
average net assets of the Fund, and an administrative fee at an annual rate of
0.25% of average net assets of the Fund to serve as investment adviser and
administrator. Baupost has agreed with the Fund to reduce its management fee by
up to 0.75% of the Fund's average net assets until further notice to the extent
that the Fund's total annual expenses (including the management fee,
administrative fee and certain other expenses, but excluding brokerage
commissions, transfer taxes, interest and expenses relating to preserving the
value of the Fund's investments) would otherwise exceed 1.5% of the Fund's
average net assets. For the purpose of determining the applicable management and
administrative fees, average net assets is determined by taking an average of
the determination of such net asset values during each quarter at the close of
business on the last business day of each month during such quarter before any
month-end share purchases or redemptions.
B-48
