<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1996
----------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission File Number 0-18944
THE SECTOR STRATEGY FUND/SM/ II L.P.
--------------------------------------
(Exact Name of Registrant as
specified in its charter)
Delaware 13-3584544
- ---------------------------------------- ------------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
c/o Merrill Lynch Investment Partners Inc.
(formerly ML Futures Investment Partners Inc.)
Merrill Lynch World Headquarters - South Tower, 6th Fl.
World Financial Center New York, New York 10080-6106
-----------------------------------------------------
(Address of principal executive offices)
(Zip Code)
212-236-4161
------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
----- _____
This document contains 14 pages.
There are no exhibits and no exhibit index filed with this document.
1
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
THE SECTOR STRATEGY FUND/SM/ II L.P.
------------------------------------
(a Delaware limited partnership)
STATEMENTS OF FINANCIAL CONDITION
---------------------------------
March 31, December 31,
1996 1995
----------- -----------
ASSETS
Accrued interest (Note 2) $ 195,637 $ 244,493
Equity in commodity futures trading accounts:
Cash and option premiums 50,905,372 58,223,935
Net unrealized gain on open contracts 1,448,418 2,484,535
------------- -------------
TOTAL $52,549,427 $60,952,963
============= =============
LIABILITIES AND PARTNERS' CAPITAL
- ---------------------------------
LIABILITIES:
Administration payable $ 10,946 $ -
Redemptions payable 1,393,731 2,747,867
Brokerage commissions 410,777 478,555
payable (Note 2)
Profit shares payable 10,438 133,285
------------- -------------
Total liabilities 1,825,892 3,359,707
------------- -------------
PARTNERS' CAPITAL:
General Partner:
2,145 and 2,145 SECTOR II units outstanding 262,691 268,488
3,905 and 3,905 SECTOR III units outstanding 468,879 500,814
Limited Partners:
152,206 and 162,396 SECTOR II units outstanding 18,637,477 20,324,051
261,109 and 284,576 SECTOR III units outstanding 31,354,488 36,499,903
------------- -------------
Total partners' capital 50,723,535 57,593,256
------------ -------------
TOTAL $52,549,427 $60,952,963
============= ============
NET ASSET VALUE PER UNIT
SECTOR II UNITS
(Based on 154,351 and 164,541 Units outstanding) $122.45 $125.15
=========== ===========
SECTOR III UNITS
(Based on 265,014 and 288,481 Units outstanding) $120.08 $128.26
=========== ===========
See notes to financial statements.
2
<PAGE>
THE SECTOR STRATEGY FUND/SM/ II L.P.
--------------------------------------
(a Delaware limited partnership)
------------------------------
STATEMENTS OF OPERATIONS
------------------------
For the three For the three
months ended months ended
March 31, 1996 March 31, 1995
------------------- ----------------
REVENUES:
Trading profit (loss):
Realized $ (907,146) $ 7,490,617
Change in unrealized (1,036,117) 2,507,640
--------------- -------------
Total trading results (1,943,263) 9,998,257
--------------- -------------
Interest income (Note 2) 605,889 1,007,961
--------------- -------------
Total revenues (1,337,374) 11,006,218
--------------- -------------
EXPENSES:
Profit shares 10,437 868,639
Brokerage commissions (Note 2) 1,303,436 1,751,442
Administrative expense 34,722 -
--------------- -------------
Total expenses 1,348,595 2,620,081
--------------- -------------
NET (LOSS) INCOME $(2,685,969) $ 8,386,137
=============== =============
NET (LOSS) INCOME PER UNIT
Weighted average number of Units
outstanding (Note 5) 442,240 650,848
=========== ===========
Weighted average net
(loss) income per Unit $(6.07) $12.88
=========== ===========
See notes to financial statements.
3
<PAGE>
THE SECTOR STRATEGY FUND/SM/ II L.P.
---------------------------------------
(a Delaware limited partnership)
------------------------------
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
------------------------------------------
<TABLE>
<CAPTION>
SECTOR II SECTOR III Limited Partners General Partner
----------------- ----------------
Units Units SECTOR II SECTOR III SECTOR II SECTOR III Total
----------- ----------- ----------------- ---------------- ---------- ----------- ------------
PARTNERS' CAPITAL,
<S> <C> <C> <C> <C> <C> <C> <C>
DECEMBER 31, 1994 245,400 423,752 $26,691,989 $49,057,046 $366,106 $668,412 $76,783,553
Redemptions (30,616) (36,273) (3,619,092) (4,471,582) - - (8,090,674)
Net income - - 3,353,504 4,913,899 48,831 69,903 8,386,137
------------ ----------- ------------------ ----------------- ----------- ------------ -------------
PARTNERS' CAPITAL,
MARCH 31, 1995 214,784 387,479 $26,426,401 $49,499,363 $414,937 $738,315 $77,079,016
============ ============ ================== ================= =========== ============ =============
PARTNERS' CAPITAL,
DECEMBER 31, 1995 164,541 288,481 $20,324,051 $36,499,903 $268,488 $500,814 $57,593,256
Redemptions (10,190) (23,467) (1,279,425) (2,904,327) - - (4,183,752)
Net loss - - (407,149) (2,241,088) (5,797) (31,935) (2,685,969)
------------ ------------ ------------------- ----------------- ----------- ------------ ------------
PARTNERS' CAPITAL,
MARCH 31, 1996 154,351 265,014 $18,637,477 $31,354,488 $262,691 $468,879 $50,723,535
============ ============ ================== ================= =========== ============ =============
See notes to financial statements.
</TABLE>
4
<PAGE>
THE SECTOR STRATEGY FUND/SM/ II L.P.
(A Delaware Limited Partnership)
------------------------------
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The SECTOR Strategy Fund/SM/ II L.P. (the "Partnership" or the "Fund") was
organized under the Delaware Revised Uniform Limited Partnership Act on August
21, 1990 and commenced trading activities on December 5, 1990. The
Partnership engages in the speculative trading of futures, options and forward
contracts on a wide range of commodities. The Partnership raised $136,410,000
for its initial capitalization ("Sector II Units") and raised an additional
$194,005,000 in a second offering of Units of limited partnership interest
("Sector III Units") and commenced trading activities with respect to its
Sector III Units on July 5, 1991. These capitalization balances included
investments from The SECTOR Strategy FundSM International II Ltd. (the
"Company"). On March 1, 1994 the Company redeemed its investments from the
Partnership with respect to both the Sector II Units and Sector III Units to
become a stand-alone trading company. Merrill Lynch Investment Partners Inc.
(formerly ML Futures Investment Partners Inc.) ("MLIP" or the "General
Partner"), a wholly-owned subsidiary of Merrill Lynch Group, Inc., which in
turn is a wholly-owned subsidiary of Merrill Lynch & Co., Inc. ("Merrill
Lynch",) is the general partner of the Partnership, and Merrill Lynch Futures
Inc. ("MLF"), also a Merrill Lynch affiliate, is its commodity broker. The
General Partner has agreed to maintain a general partner's interest of at
least 1% of the total capital in the Partnership. The General Partner and
each Limited Partner share in the profits and losses of the Partnership in
proportion to their respective interest in it.
The financial information included herein has been prepared by management
without audit by independent certified public accountants who do not express
an opinion thereon. The statement of financial condition as of December 31,
1995 has been derived from but does not include all the disclosures contained
in the audited financial statements for the year ended December 31, 1995. The
information furnished includes all adjustments which are, in the opinion of
management, necessary for a fair statement of results for the interim period.
The results of operations as presented, however, should not be considered
indicative of the results to be expected for the entire year.
MLIP selects independent advisors (the "Advisors" or the "Trading Advisors")
to manage the Partnership's assets, and allocates and reallocates the
Partnership's trading assets among existing, replacement and additional
Advisors.
MLIP also determines what percentage of the Partnership's total capital to
allocate to trading from time to time, attempting to balance the desirability
of reducing the opportunity costs of the Partnership's "principal protection"
structure by allocating 100% (or more) of the Partnership's assets to trading
against the necessity of preventing Merrill Lynch & Co., Inc. from ever being
required to make any payments to the Partnership under the Merrill Lynch &
Co., Inc. guarantee. (See Note 6.)
Estimates
---------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Revenue Recognition
-------------------
Commodity futures, options and forward contract transactions are recorded on
the trade date and open contracts are reflected in the financial statements at
the fair value on the last business day of the reporting period. The
difference between the original contract amount and fair value is reflected in
income as an unrealized gain or loss. Fair value is based on quoted market
prices. All commodity futures, options and forward contracts are reflected at
fair value in the financial statements.
Operating Expenses
------------------
MLIP pays for all routine operating expenses (including legal, accounting,
printing, postage and similar administrative expenses) of the Partnership.
5
<PAGE>
Income Taxes
------------
No provision for income taxes has been made in the accompanying financial
statements as each partner is individually responsible for reporting income or
loss based on their respective share of the Partnership's income and expenses
as reported for income tax purposes.
Distributions
-------------
The Unitholders are entitled to receive, equally per Unit, any distribution
which may be made by the Partnership. No such distributions have been made as
of March 31, 1996.
Redemptions
-----------
A Limited Partner may require the Partnership to redeem some or all of such
partner's Units of limited partnership interest at Net Asset Value as of the
close of business on the last business day of any month upon ten calendar
days' notice.
Dissolution of the Partnership
------------------------------
The Partnership will terminate on December 31, 2010 or at an earlier date if
certain conditions occur, as well as under certain other circumstances as set
forth in the Limited Partnership Agreement.
2. RELATED PARTY TRANSACTIONS
All of the Partnership's assets are deposited with MLF. As a means of
approximating the interest rate which would be earned by the partnership had
100% of its Net Assets on deposit with MLF been invested in 91-day Treasury
bills, MLF pays the partnership interest on its account equity on deposit with
MLF at a rate of 0.5% of 1% per annum below the prevailing 91-day Treasury
bill rate. In the case of its trading in certain foreign futures contracts,
the Fund deposits margin in foreign currency denominated instruments or cash
and earns interest generally at a rate of 0.5 of 1% per annum below the
prevailing short-term government interest rate in the country in question. Any
additional economic benefit derived from possession of the Partnership's
assets accrues to MLF or its affiliates.
The Partnership pays brokerage commission to MLF a flat rate monthly brokerage
fee equal to 0.833 of 1% (a 10% annual rate) of the Partnership's month-end
net assets allocated to trading. The percentage was reduced to 0.75 of 1% (a
9% annual rate) with respect to Series II Units of the Partnership's month-end
Net Assets, as defined, on January 1, 1994. Assets allocated to trading are
not reduced, for purposes of calculating brokerage commissions, by any accrued
but unpaid brokerage commissions, profit shares or other fees or charges.
Effective January 1, 1996, the brokerage commission the Partnership pays to
the Commodity Broker was reduced to .729% (a 8.75% annual rate), and the
Partnership began paying an administrative fee to the General Partner of
.020833% (a .25% annual rate). The General Partner estimates that the round-
turn equivalent commission rate charged to the Partnership during the quarters
ended March 31, 1996 and 1995 was approximately $27.
MLF pays the Advisors annual Consulting Fees ranging from 2% to 4% of the
Partnership's average month-end assets allocated to them for management, after
reduction for a portion of the brokerage commissions.
The Partnership trades forward contracts through a Foreign Exchange Desk (the
"F/X Desk") established by MLIP that contacts at least two counterparties,
along with Merrill Lynch International Bank ("MLIB") for all of the
Partnership's currency trades. All counterparties other than MLIB are
unaffiliated with any Merrill Lynch entity. The F/X Desk charges a service
fee equal (at current exchange rates) to approximately $5.00 to $12.50 on each
purchase or sale of a futures contract equivalent face amount of a foreign
currency. No service fees are charged on trades awarded to MLIB (which
receives a "bid-ask" spread on such trades). MLIB is awarded trades only if
its price (which includes no service fee) is equal to or better than the best
price (including the service fee) offered by any of the other counterparties
contacted.
The F/X Desk trades on the basis of credit lines provided by a Merrill Lynch
entity. The Partnership is not required to margin or otherwise guarantee its
F/X Desk trading.
Certain of the Partnership's currency trades are executed in the form of
"exchange of futures for physical" ("EFP") transactions involving MLIB and
MLF. In these transactions, a spot or forward (collectively referred to as
"cash") currency position is acquired and exchanged for an equivalent futures
position on the Chicago Mercantile Exchange's International Monetary Market.
In its EFP trading, the Partnership acquires cash currency positions through
the F/X Desk in the same manner and on the same terms as in the case of the
Partnership's other F/X Desk trading. When the Partnership exchanges these
positions for futures, there is a "differential" between the prices of these
two positions. This "differential" reflects, in part, the different
settlement dates of
-6-
<PAGE>
the cash and the futures contracts as well as prevailing
interest rates, but also includes a pricing spread in favor of MLIB or another
Merrill Lynch entity.
The Partnership's F/X Desk service fee and EFP differential costs have, to
date, totaled no more than 0.25 of 1% per annum of the Partnership's average
month-end Net Assets.
3. AGREEMENTS
The Partnership and the Advisors have each entered into Advisory Agreements.
These Advisory Agreements generally terminate one year after they are entered
into, subject to certain renewal rights exercisable by the Partnership. The
Advisors determine the commodity futures and forward contract trades to be
made on behalf of their respective Partnership accounts, subject to certain
Partnership trading policies and to certain rights reserved for the General
Partner.
Profit shares, generally ranging from 15% to 25% of any New Trading Profit,
as defined, recognized by each Advisor considered individually irrespective
of the overall performance of the Partnership, as of the end of each calendar
quarter are paid by the partnership to each Advisor. Such payments are also
made in respect of Units redeemed as of the end of interim months during a
calendar quarter, to the extent of the applicable percentage of any New
Trading Profit attributable to such Units.
4. INCOME (LOSS) PER UNIT
The profit and loss of the Sector II and Sector III units for the quarters
ended March 31, 1996 and 1995 are as follows:
Sector II Sector III
---------------------- ------------------------
1996 1995 1996 1995
--------- ---------- ----------- ----------
REVENUES:
Trading profits (loss):
Realized $ (74,504) $2,531,137 $ (832,642) $4,959,480
Change in unrealized (103,238) 1,315,200 (932,879) 1,192,440
--------- ---------- ----------- ----------
Total trading results (177,742) 3,846,337 (1,765,521) 6,151,920
Interest income 223,233 351,001 382,656 656,960
--------- ---------- ----------- ----------
Total revenues 45,491 4,197,338 (1,382,865) 6,808,880
--------- ---------- ----------- ----------
EXPENSES:
Profit share expense 1,831 219,109 8,606 1,175,548
Brokerage commissions 443,923 575,894 859,513 649,530
Administrative expense 12,683 - 22,039 -
--------- ---------- ----------- ----------
Total expenses 458,437 795,003 890,158 1,825,078
--------- ---------- ----------- ----------
NET (LOSS) INCOME $(412,946) $3,402,335 $(2,273,023) $4,983,802
========= ========== ----------- ----------
NET (LOSS) INCOME
PER UNIT:
Weighted average number of
units outstanding 160,639 237,607 281,601 413,241
========= ========== =========== ==========
Weighted average net
income (loss) per unit $(2.57) $14.32 $(8.07) $12.06
========= ========== =========== ==========
5. WEIGHTED AVERAGE UNITS
The weighted average number of Units outstanding was computed for purposes of
disclosing net income (loss) per weighted average Unit. The weighted average
number of Units outstanding at March 31, 1996 and 1995 equals the Units
outstanding as of such date, adjusted proportionately for Units redeemed
based on the respective length of time each was outstanding during the
preceding period.
6. MERRILL LYNCH & CO., INC. GUARANTEE
Merrill Lynch & Co., Inc. has guaranteed to the Partnership that it will have
sufficient Net Assets with respect to Series II and Series III Units as of
the Principal Assurance Date, as defined, that the Net Asset Value per Unit
as of such Principal Assurance Date will equal, after adjustment for all
liabilities to third parties, $100.12 and $100 per Unit, respectively.
-7-
<PAGE>
7. FAIR VALUE AND OFF-BALANCE SHEET RISK
The Partnership trades futures, options and forward contracts in interest rates,
stock indices, commodities, currencies, energy and metals. The Partnership's
revenues by reporting category for the quarter ended March 31, 1996 was as
follows:
1996
------------
Financial Instruments $ (795,410)
Stock indices 33,064
Commodities (582,918)
Currencies 391,050
Energy (355,225)
Metals (633,825)
-------------
$(1,943,263)
=============
Market Risk
-----------
Derivative instruments involve varying degrees of off-balance sheet market
risk, and changes in the level or volatility of interest rates, foreign
currency exchange rates or the market values of the financial instruments or
commodities underlying such derivative instruments frequently result in
changes in the Partnership's unrealized gain or loss on such derivative
instruments as reflected in the Statements of Financial Condition. The
Partnership's exposure to market risk is influenced by a number of factors,
including the relationships among the derivative instruments held by the
Partnership as well as the volatility and liquidity of the markets in which
the derivative instruments are traded.
The General Partner has procedures in place intended to control market risk,
although there can be no assurance that they will, in fact, succeed in doing
so. These procedures focus primarily on monitoring the trading of the
Advisors selected from time to time for the Partnership, adjusting the
percentage of the Partnership's total assets allocated to trading, calculating
the Net Asset Value of the Advisors' respective Partnership accounts as of the
close of business on each day and reviewing outstanding positions for over-
concentration both on an Advisor-by-Advisor and on an overall Partnership
basis. While the General Partner does not itself intervene in the markets to
hedge or diversify the Partnership's market exposure (although the General
Partner does adjust the percentage of the Partnership's total assets allocated
to trading), the General Partner may urge Advisors to reallocate positions, or
itself reallocate Partnership assets among Advisors (although typically only
as of the end of a month) in an attempt to avoid over-concentrations.
However, such interventions are unusual. Except in cases in which it appears
that an Advisor has begun to deviate from past practice or trading policies or
to be trading erratically, the General Partner's basic risk control procedures
consist simply of the ongoing process of Advisor monitoring and selection,
with the market risk controls being applied by the Advisors themselves.
Fair Value
----------
The derivative instruments used in the Partnership's trading activities are
marked to market daily with the resulting unrealized gains or losses recorded
in the Statements of Financial Condition and the related profit or loss
reflected in trading revenues in the Statements of Operations. The
contract/notional values of the Partnership's open derivative instrument
positions as of March 31, 1996 and December 31, 1995 were as follows:
<TABLE>
<CAPTION>
1996 1995
- ------------------------------------------------------- ------------------------
<S> <C> <C> <C> <C>
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards Options & Forwards)
--------------------- ------------------ ------------------ -------------------
Financial
Instruments $ 43,768,321 $250,836,544 $292,254,904 $ 77,509,306
Stock indices 10,332,735 2,952,109 9,378,960 2,754,169
Commodities 21,656,153 9,235,926 33,273,629 17,528,208
Currencies 48,171,777 84,618,400 40,905,041 91,007,028
Energy 3,147,705 835,174 9,838,738 2,394,174
Metals 9,173,453 7,113,720 6,194,568 14,595,594
---------------- ------------------- ------------- --------------------
$136,250,144 $355,591,873 $391,845,840 $205,788,479
================ =================== ============= ====================
</TABLE>
-8-
<PAGE>
Substantially all of the Partnership's derivative instruments outstanding as
of March 31, 1996 expire within one year.
The contract/notional value of the Trading Partnership's exchange-traded and
non-exchange-traded derivative instrument positions as of March 31, 1996 and
December 31, 1995 was as follows:
<TABLE>
<CAPTION>
1996 1995
--------------------------------------------------- --------------------------------------------
<S> <C> <C> <C> <C>
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Option & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
------------------ -------------------- ------------------ -------------------
Exchange
traded $ 86,970,506 $282,308,708 $349,493,443 $136,040,389
Non-Exchanged
traded 49,279,638 73,283,165 42,352,397 69,748,090
------------------ -------------------- ------------------ -------------------
$136,250,144 $355,591,873 $391,845,840 $205,788,479
==================== ==================== ================== ===================
</TABLE>
The average fair value of the Partnership's derivative instrument positions
which were open as of the end of each calendar month during the quarter ended
March 31, 1996 and the year ended December 31, 1995 was as follows:
<TABLE>
<CAPTION>
1996 1995
- ------------------------------------------------------- ---------------------------------------------
<S> <C> <C> <C> <C>
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
---------------------- ------------------ ------------------ ---------------------
Financial
Instruments $130,650,261 $229,837,571 $224,509,594 $ 40,878,254
Stock indices 12,192,277 2,706,654 6,305,821 16,376,164
Commodities 26,759,460 11,503,605 22,199,424 10,544,846
Currencies 84,819,937 124,725,168 123,591,622 119,192,407
Energy 2,762,718 1,737,490 3,878,403 4,293,076
Metals 14,390,347 7,435,896 9,417,938 19,517,640
---------------------- ------------------ ----------------- ---------------------
$271,575,000 $377,946,384 $389,902,802 $210,802,387
====================== ================== ================== =====================
</TABLE>
A portion of the amounts indicated as off-balance sheet risk reflects offsetting
commitments to purchase and sell the same derivative instrument on the same date
in the future. These commitments are economically offsetting but are not, as a
technical matter, offset in the forward market until the settlement date.
Credit Risk
- -----------
The risks associated with exchange-traded contracts are typically perceived to
be less than those associated with over-the-counter (non-exchange-traded)
transactions, because exchanges typically (but not universally) provide
clearinghouse arrangements in which the collective credit (in some cases limited
in amount, in some cases not) of the members of the exchange is pledged to
support the financial integrity of the exchange. In over-the-counter
transactions, on the other hand, traders must rely solely on the credit of their
respective individual counterparties. Margins, which may be subject to loss in
the event of a default, are generally required in exchange trading, and
counterparties may also require margin in the over-the-counter markets.
The fair value amounts in the above tables represent the extent of the
Partnership's market exposure in the particular class of derivative instrument
listed, but not the credit risk associated with counterparty nonperformance.
The credit risk associated with these instruments from counterparty
nonperformance is the net unrealized gain, if any, included in the Statements of
Financial Condition. The Partnership also has credit risk because the sole
counterparty or broker with respect to most of the Partnership's assets is MLF.
As of March 31, 1996 and December 31, 1995, $48,022,426 and $34,145,683 of the
Partnership's assets, respectively, were held in segregated accounts at MLF in
accordance with Commodity Futures Trading Commission regulations.
-9-
<PAGE>
The gross unrealized gain and the net unrealized gain on the Partnership's open
derivative instrument positions as of March 31, 1996 and December 31, 1995 were
as follows:
March 31, 1996 December 31, 1995
Gross Net Gross Net
Unrealized Unrealized Unrealized Unrealized
Gain Gain (Loss) Gain Gain (Loss)
---------- ----------- ---------- -----------
Exchange
traded $2,094,423 $1,564,005 $4,187,956 $2,841,079
Non-Exchanged
traded 441,625 (115,587) 449,710 (356,544)
------------ ------------ ----------- -------------
$2,536,048 $1,448,418 $4,637,666 $2,484,535
============ ============ =========== =============
The Partnership controls credit risk by dealing almost exclusively with Merrill
Lynch entities as brokers and counterparties.
Item 2: Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations
-------------
Operational Overview; Advisor Selections
- ----------------------------------------
Due to the nature of the Fund's business, its results of operations
depend on MLIP's ability to select Advisors and determine the appropriate
percentage of each series' assets to allocate to them for trading, as well as
the Advisors' ability to recognize and capitalize on trends and other profit
opportunities in different sectors of the world commodity markets. MLIP's
Advisor selection procedure and leveraging analysis, as well as the Advisors'
trading methods, are confidential, so that substantially the only information
that can be furnished regarding the Fund's results of operations is contained in
the performance record of its trading. Unlike operating businesses, general
economic or seasonal conditions do not directly affect the profit potential of
the Fund, and its past performance is not necessarily indicative of future
results. Because of the speculative nature of its trading, operational or
economic trends have little relevance to the Fund's results. MLIP believes,
however, that there are certain market conditions, for example, markets with
strong price trends, in which the Fund has a better likelihood of being
profitable than in others.
As of April 1, 1996, the Partnership's assets were allocated as
follows:
SECTOR II UNITS:
---------------
%
TRADING ADVISOR SECTOR ALLOCATION
--------------- ------ ----------
John W. Henry & Co., Inc. Financial/
Metals 25.86
Hyman Beck & Company, Inc. Diversified 27.30
DNB Capital Management Ltd. Interest Rates 17.06
Trendstat Capital Management, Inc. Currencies 18.48
Range Wise, Inc. Agriculture 11.30
------
100.00%
SECTOR III UNITS:
----------------
%
TRADING ADVISOR SECTOR ALLOCATION
--------------- ------ ----------
John W. Henry & Co., Inc. Financial/
Metals 24.66
ARA Portfolio Management Company Diversified 14.24
Range Wise, Inc. Agriculture 13.54
Blenheim Investments, Inc. Diversified 12.97
Millburn Ridgefield Corporation Financial/
Metals 12.58
ITF Management Diversified 11.70
Rabar Market Research, Inc. Diversified 10.31
------
100.00%
MLIP expects to continue to change both allocations and Advisor
selections from time to time without advance notice to existing investors.
Results of Operations - General
- -------------------------------
MLIP believes that multi-Advisor futures funds should be regarded as
medium- to long-term investments but, unlike an operating business, it is
difficult to identify "trends" in the Fund's
-10-
<PAGE>
operations and virtually impossible to make any predictions regarding future
results based on results to date.
Markets in which sustained price trends occur with some frequency tend
to be more favorable to managed futures investments than "whipsaw," "choppy"
markets, but (i) this is not always the case, (ii) it is impossible to predict
when trending markets will occur and (iii) different Advisors are affected
differently by trends in general as well as by particular types of trends.
The Fund controls credit risk in its trading in the derivatives markets
by trading only through Merrill Lynch entities which MLIP believes to be
creditworthy. The Fund attempts to control the market risk inherent in its
derivatives trading by utilizing a multi-advisor, multi-strategy structure.
This structure purposefully attempts to diversify the Fund's Advisor group among
different strategy types and market sectors in an effort to reduce risk
(although the Fund's portfolio currently emphasizes technical and trend-
following approaches).
Performance Summary
- -------------------
SECTOR II UNITS:
---------------
During the first quarter of 1995, the Fund's average month-end Net
Assets equalled $26,413,074, and the Fund recognized gross trading gains of
$3,846,337 or 14.56% of such average month-end Net Assets. Brokerage
commissions of $575,894 or 2.18% and Profit Shares of $219,109 or .83% of
average month-end Net Assets were paid. Interest income of $351,002 or 1.33% of
average month-end Net Assets resulted in a net gain of $3,402,335 or 12.88% of
average month-end Net Assets, which resulted in a 13.34% increase in the Net
Asset Value per Unit since December 31, 1994.
During the first quarter of 1996, the Fund's average month-end Net
Assets equalled $19,977,627, and the Fund recognized gross trading loss of
$(177,742) or 0.89% of such average month-end Net Assets. Brokerage commissions
of $443,923 or 2.22% and Profit Shares of $1,831 or .01% of average month-end
Net Assets were paid. Interest income of $223,233 or 1.12% of average month-end
Net Assets resulted in net loss of $(412,946) or (2.07)% of average month-end
Net Assets which resulted in a 2.16% decrease in the Net Asset Value of the Fund
per Unit since December 31, 1995.
During the first quarter of 1996 and 1995, the Fund experienced 3
profitable months and 3 unprofitable months.
MONTH-END NET ASSET VALUE PER SECTOR II UNIT
Jan. Feb. Mar.
1995 $108.34 $115.58 $124.97
1996 $129.65 $123.52 $122.45
SECTOR III UNITS:
----------------
During the first quarter of 1995, the Fund's average month-end Net
Assets equalled $48,936,341, and the Fund recognized gross trading gains of
$6,151,920 or 12.57% of such average month-end Net Assets. Brokerage
commissions of $1,175,548 or 2.40% and Profit Shares of $649,530 or 1.33% of
average month-end Net Assets were paid. Interest income of $656,960 or 1.34% of
average month-end Net Assets resulted in net income of $4,983,802 or 10.18% of
average month-end Net Assets, which resulted in a 10.49% increase in the Net
Asset Value per Unit since December 31, 1994.
During the first quarter of 1996, the Fund's average month-end Net
Assets equalled $35,635,244, and the Fund recognized gross trading losses of
$1,765,521 or (4.95)% of such average month-end Net Assets. Brokerage
commissions of $859,513 or 2.41% and Profit Shares of $8,606 or .02% of average
month-end Net Assets were paid. Interest income of $382,656 or 1.07% of average
month-end Net Assets resulted in net loss of $(2,273,023) or (6.38)% of average
month-end Net Assets which resulted in a (6.38)% decrease in the overall Net
Asset Value per Unit since December 31, 1995.
During the first quarter of 1996 and 1995, the Fund experienced 3
profitable months and 3 unprofitable months.
MONTH-END NET ASSET VALUE PER SECTOR III UNIT
Jan. Feb. Mar.
1995 $114.71 $122.70 $129.65
1996 $132.39 $120.96 $120.08
Importance of Market Factors
- ----------------------------
Comparisons between the Fund's performance in a given period in one
fiscal year to the same period in a prior year are unlikely to be meaningful,
given the uncertainty of price movements in the markets traded by the Fund. In
general, MLIP expects that the Fund is most likely to trade
-11-
<PAGE>
successfully in markets which exhibit strong and sustained price trends. The
current Advisor group emphasizes technical and trend-following methods.
Consequently, one would expect that in trendless, "choppy" markets the Fund
would likely be unprofitable, while in markets in which major price movements
occur, the Fund would have its best profit potential (although there could be no
assurance that the Fund would, in fact, trade profitably). However, trend-
followers not infrequently will miss major price movements, and market
corrections can result in rapid and material losses (sometimes as much as 5% in
a single day). Although MLIP monitors market conditions and Advisor performance
on an ongoing basis in overseeing the Fund's trading, MLIP does not attempt to
"market forecast" or to "match" trading styles with predicted market conditions.
Rather, MLIP concentrates on quantitative and qualitative analysis of
prospective Advisors, as well as on statistical studies of the historical
performance parameters of different Advisor combinations in selecting Advisors
and allocating and reallocating Fund assets among them.
Because managed futures advisors' strategies are proprietary and
confidential and market movements unpredictable, selecting advisors to implement
speculative trading strategies involves considerable uncertainty. Furthermore,
the concentration of the Fund's current Advisor portfolio, both in terms of the
number of managers retained and the common emphasis of their strategies on
technical and trend-following methods, increases the risk that unexpectedly bad
performance, turbulent market conditions or a combination of the two will result
in significant losses.
MLIP's Advisor Selections
- -------------------------
MLIP has no timetable or schedule for making Advisor changes or
reallocations, and generally intends to make a medium- to long-term commitment
to all Advisors selected. However, there can be no assurance as to the
frequency or number of the Advisor changes which may take place in the future,
or as to how long any of the current Advisors will continue to manage assets for
the Fund.
Liquidity
- ---------
Most of the Partnership's assets are held as cash which, in turn, is
used to margin its futures positions and earn interest income and is withdrawn,
as necessary, to pay redemptions and fees.
The futures contracts in which the Partnership trades may become illiquid
under certain market conditions. Commodity exchanges limit fluctuations in
futures prices during a single day by regulations referred to as "daily limits."
During a single day no trades may be executed at prices beyond the daily limit.
Once the price of a futures contract for a particular commodity has increased or
decreased by an amount equal to the daily limit, positions in the commodity can
generally neither be taken nor liquidated unless traders are willing to effect
trades at or within the limit. Futures contracts have occasionally moved to the
daily limit for several consecutive days with little or no trading. Such market
conditions could prevent the Partnership from promptly liquidating its futures
(including its options) positions. There are no limitations on the daily price
moves in trading foreign currency forward contracts through banks, although
illiquidity may develop in the forward markets due to large spreads between
"bid" and "ask" prices quoted. (Forward contracts are the bank version of
currency futures contracts and are not traded on exchanges.)
Capital Resources
- -----------------
The Partnership does not have, nor does it expect to have, any capital
assets and has no material commitments for capital expenditures. The
Partnership uses its assets to supply the necessary margin or premiums for, and
to pay any losses incurred in connection with, its trading activity and to pay
redemptions and fees.
Inflation is not a significant factor in the Fund's profitability,
although inflationary cycles can give rise to the type of major price movements
which can have a materially favorable or adverse impact on the Fund's
performance.
Changes in the level of prevailing interest rates (a factor generally
associated with inflation) could have a material effect on the percentage of the
total capital attributable to various series of Units which is committed to
trading, as interest rates affect the calculation of the discounted minimum Net
Asset Value per Unit which Merrill Lynch & Co., Inc. has guaranteed to
investors.
-12-
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
--------
There are no exhibits required to be filed as part of this document.
(b) Reports on Form 8-K
-------------------
There were no reports on Form 8-K filed during the first quarter of
fiscal 1996.
-13-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE SECTOR STRATEGY FUND/SM/ II L.P.
By: MERRILL LYNCH INVESTMENT PARTNERS INC.
(General Partner)
Date: May 13, 1996 By /s/JOHN R. FRAWLEY, JR.
-----------------------
John R. Frawley, Jr.
President, Chief Executive Officer
and Director
Date: May 13, 1996 By /s/JAMES M. BERNARD
-------------------
James M. Bernard
Chief Financial Officer
Treasurer and Senior Vice President
<TABLE> <S> <C>
<PAGE>
<ARTICLE> BD
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONSOLIDATED
STATEMENTS OF FINANCIAL CONDITIONS, CONSOLIDATED STATEMENTS OF OPERATIONS,
CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENT.
</LEGEND>
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1995 DEC-31-1994
<PERIOD-START> JAN-01-1996 JAN-01-1995
<PERIOD-END> MAR-31-1996 MAR-31-1995
<CASH> 0 0
<RECEIVABLES> 52,549,427 82,307,807
<SECURITIES-RESALE> 0 0
<SECURITIES-BORROWED> 0 0
<INSTRUMENTS-OWNED> 0 0
<PP&E> 0 0
<TOTAL-ASSETS> 52,549,427 82,307,807
<SHORT-TERM> 0 0
<PAYABLES> 1,825,892 51,288,781
<REPOS-SOLD> 0 0
<SECURITIES-LOANED> 0 0
<INSTRUMENTS-SOLD> 0 0
<LONG-TERM> 0 0
0 0
0 0
<COMMON> 0 0
<OTHER-SE> 50,723,535 77,079,026
<TOTAL-LIABILITY-AND-EQUITY> 52,549,427 0
<TRADING-REVENUE> (1,943,263) 9,998,257
<INTEREST-DIVIDENDS> 605,889 1,007,961
<COMMISSIONS> 1,348,595 2,620,081
<INVESTMENT-BANKING-REVENUES> 0 0
<FEE-REVENUE> 0 0
<INTEREST-EXPENSE> 0 0
<COMPENSATION> 0 0
<INCOME-PRETAX> (2,685,969) 8,386,137
<INCOME-PRE-EXTRAORDINARY> (2,685,969) 8,386,137
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (2,685,969) 8,386,137
<EPS-PRIMARY> (6.07) 12.88
<EPS-DILUTED> (6.07) 12.88
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