<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 September 30, 1999
------------------
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.
Princeton Corporate Campus
800 Scudders Mill Road - Section 2G
Plainsboro, New Jersey 08536
----------------------------
(Address of principal executive offices)
(Zip Code)
609-282-6996
------------
(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 ___
---
<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
---------------------------------
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
--------------- ---------------
ASSETS
- ------
<S> <C> <C>
Investment 29,328,354 $ 33,791,182
Receivable from investment 398,167 662,200
--------------- --------------
TOTAL $ 29,726,521 $ 34,453,382
=============== ==============
LIABILITY AND PARTNERS' CAPITAL
- -------------------------------
Liability-Redemptions payable $ 398,167 $ 662,200
PARTNERS' CAPITAL:
General Partner:
(832 and 832 SECTOR II Units) 129,710 132,067
(1,595 and 1,595 SECTOR III Units) 261,174 265,921
Limited Partners:
(57,979 and 66,576 SECTOR II Units) 9,039,101 10,567,998
(121,521 and 136,907 SECTOR III Units) 19,898,369 22,825,196
--------------- --------------
Total partners' capital 29,328,354 33,791,182
--------------- --------------
TOTAL $ 29,726,521 $ 34,453,382
=============== ==============
NET ASSET VALUE PER UNIT:
SECTOR II UNITS
(Based on 58,811 and 67,408 Units outstanding) $ 155.90 $ 158.74
=============== ==============
SECTOR III UNITS
(Based on 123,116 and 138,502 Units outstanding) $ 163.74 $ 166.72
=============== ==============
</TABLE>
See notes to financial statements.
2
<PAGE>
THE SECTOR STRATEGY FUND(SM) II L.P.
------------------------------------
(a Delaware limited partnership)
------------------------------
STATEMENTS OF OPERATIONS
------------------------
<TABLE>
<CAPTION>
For the three For the three For the nine For the nine
months ended months ended months ended months ended
September 30, September 30, September 30, September 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUES:
Trading (loss) profits:
Realized $ - $ (62,630) $ - $ 1,169,961
Change in unrealized - 62,636 - (671,259)
----------- ---------- ----------- -----------
Total trading results - 6 - 498,702
----------- ---------- ----------- -----------
Interest income (1,096) 598,157
Income from investments (585,328) 2,695,723 (547,659) 1,352,154
----------- ---------- ----------- -----------
Total revenues (585,328) 2,694,633 (547,659) 2,449,013
----------- ---------- ----------- -----------
EXPENSES:
Profit Shares - - - 301,644
Brokerage commissions - - - 1,015,128
Administrative fees - - - 29,003
----------- ---------- ----------- -----------
Total expenses - - - 1,345,775
----------- ---------- ----------- -----------
NET INCOME (LOSS) $ (585,328) $2,694,633 $ (547,659) $ 1,103,238
=========== ========== =========== ===========
NET INCOME (LOSS) PER UNIT:
Weighted average number of units
outstanding 186,771 226,064 194,792 240,299
=========== ========== =========== ===========
Weighted average net income (loss)
per Limited Partner
and General Partner unit $ (3.13) $ 11.92 $ (2.81) $ 4.59
=========== ========== =========== ===========
</TABLE>
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
------------------------------------------
For the nine months ended September 30, 1999 and 1998
-----------------------------------------------------
<TABLE>
<CAPTION>
Units Limited Partners General Partner
----- ---------------- ---------------
SECTOR II SECTOR III SECTOR II SECTOR III SECTOR II SECTOR III Total
UNITS UNITS UNITS UNITS UNITS UNITS -----
----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C>
PARTNERS' CAPITAL, 88,445 168,686 $13,494,521 $26,199,645 $335,409 $620,882 $40,650,457
December 31, 1997
Redemptions (15,163) (23,175) (2,082,016) (3,291,713) (192,459) (355,953) (5,922,141)
Net income (loss) - - 68,168 1,045,633 (11,110) 547 1,103,238
------- ------- ----------- ----------- -------- -------- ------------
PARTNERS' CAPITAL,
September 30, 1998 73,282 145,511 $11,480,673 $23,953,565 $131,840 $265,476 $35,831,554
====== ======= =========== =========== ======== ======== ===========
PARTNERS' CAPITAL,
December 31, 1998 67,408 138,502 $10,567,998 $22,825,196 $132,067 $265,921 $33,791,182
Redemptions (8,597) (15,386) (1,359,660) (2,555,509) - - (3,915,169)
Net income (loss) - - (169,237) (371,318) (2,357) (4,747) (547,659)
------ ------- ----------- ------------ -------- -------- -----------
PARTNERS' CAPITAL,
September 30, 1999 58,811 123,116 $ 9,039,101 $19,898,369 $129,710 $261,174 $29,328,354
====== ======= =========== =========== ======== ======== ===========
</TABLE>
See notes to financial statements.
4
<PAGE>
THE SECTOR STRATEGY FUND(SM) II L.P.
(A Delaware limited partnership)
------------------------------
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
These financial statements have been prepared without audit. In the opinion
of management, the financial statements contain all adjustments (consisting
of only normal recurring adjustments) necessary to present fairly the
financial position of The SECTOR Strategy Fund(SM) II L.P. (the
"Partnership" or the "Fund") as of September 30, 1999, and the results of
its operations for the three and nine month periods ended September 30,
1999 and 1998. However, the operating results for the interim periods may
not be indicative of the results expected for the full year.
Certain information and footnote disclosures normally included in annual
financial statements prepared in accordance with generally accepted
accounting principles have been omitted. It is suggested that these
financial statements be read in conjunction with the financial statements
and notes thereto included in the Partnership's Annual Report on Form 10-K
filed with the Securities and Exchange Commission for the year ended
December 31, 1998 (the "Annual Report").
2. INVESTMENTS
As of September 30, 1999 and December 31, 1998, the Partnership had an
investment in MM LLC of $29,328,354 and $33,791,182, respectively.
Total revenues and fees with respect to the Fund's investments are set
forth as follows:
<TABLE>
<CAPTION>
For the three months
ended September 30, Total Brokerage Administrative Profit Income (loss) from
1999 Revenue Commissions Fees Shares Investments
-------------- --------------- ------------------ -------------- ---------------------
<S> <C> <C> <C> <C> <C>
SECTOR II Units
- ---------------
MM LLC $ 30,357 $ 208,899 $ 5,969 $ (2,699) $ (181,812)
============ ============= =============== ============ ===================
SECTOR III Units
- ----------------
MM LLC $ 68,657 $ 464,890 $ 13,283 $ (6,000) $ (403,516)
============ ============= =============== ============ ===================
Total All Units
- ---------------
MM LLC $ 99,014 $ 673,789 $ 19,252 $ (8,699) $ (585,328)
============ ============= =============== ============ ===================
</TABLE>
<TABLE>
<CAPTION>
For the three months
ended September 30, Total Brokerage Administrative Profit Income (loss) from
1998 Revenue Commissions Fees Shares Investments
-------------- --------------- ------------------ -------------- ---------------------
<S> <C> <C> <C> <C> <C>
SECTOR II Units
- ---------------
MM LLC $ 1,349,860 $ 259,591 $ 7,417 $ 205,804 $ 877,048
============ ============= =============== ============ ===================
SECTOR III Units
- ----------------
MM LLC $ 2,801,115 $ 538,694 $ 15,392 $ 428,354 $ 1,818,675
============ ============= =============== ============ ===================
Total All Units
- ---------------
MM LLC $ 4,150,975 $ 798,285 $ 22,809 $ 634,158 $ 2,695,723
============ ============= =============== ============ ===================
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
For the nine months
ended September 30, Total Brokerage Administrative Profit Income (loss) from
1999 Revenue Commissions Fees Shares Investments
------------- ----------------- --------------- ------------- ----------------------
<S> <C> <C> <C> <C> <C>
SECTOR II Units
- ---------------
MM LLC $ 537,762 $ 658,283 $ 18,808 $ 32,265 $ (171,594)
============ =============== ============= ============= ====================
SECTOR III Units
- ----------------
MM LLC $ 1,190,395 $ 1,454,197 $ 41,549 $ 70,714 $ (376,065)
============ =============== ============= ============= ====================
Total All Units
- ---------------
MM LLC $ 1,728,157 $ 2,112,480 $ 60,357 $ 102,979 $ (547,659)
============ =============== ============= ============= ====================
</TABLE>
<TABLE>
<CAPTION>
For the nine months
ended September 30, Total Brokerage Administrative Profit Income (loss) from
1998 Revenue Commissions Fees Shares Investments
------------- ----------------- --------------- ------------- ----------------------
<S> <C> <C> <C> <C> <C>
SECTOR II Units
- ---------------
JWH LLC $ (222,269) $ 71,032 $ 2,029 $ - $ (295,330)
MM LLC 1,473,720 344,908 9,855 224,254 894,703
------------- -------------- ------------- ------------- --------------------
Total $ 1,251,451 $ 415,940 $ 11,884 $ 224,254 $ 599,373
============= ============== ============= ============= ====================
SECTOR III Units
- ----------------
JWH LLC $ (711,700) $ 228,238 $ 6,521 $ - $ (946,459)
MM LLC 3,053,522 712,532 20,359 479,984 1,840,647
Millburn LLC (31,859) 106,408 3,040 100 (141,407)
------------- -------------- ------------- ------------- --------------------
Total $ 2,309,963 $ 1,047,178 $ 29,920 $ 480,084 $ 752,781
============= ============== ============= ============= ====================
Total All Units
- ---------------
JWH LLC $ (933,969) $ 299,270 $ 8,550 $ - $ (1,241,789)
MM LLC 4,527,242 1,057,440 30,214 704,238 2,735,350
Millburn LLC (31,859) 106,408 3,040 100 (141,407)
------------- -------------- ------------- ------------- --------------------
Total $ 3,561,414 $ 1,463,118 $ 41,804 $ 704,338 $ 1,352,154
============= ============== ============= ============= ====================
</TABLE>
During the second quarter of 1998, the Partnership withdrew its investment in
JWH LLC and Millburn LLC.
6
<PAGE>
Condensed statements of financial condition and statements of operations for
MM LLC are set forth as follows:
<TABLE>
<CAPTION>
MM LLC MM LLC
------------------ -------------------
September 30, 1999 December 31, 1998
<S> <C> <C>
Assets $ 104,792,599 $ 125,332,558
================ ================
Liabilities $ 2,593,473 $ 4,949,082
Members' Capital 102,199,126 120,383,476
---------------- ----------------
Total $ 104,792,599 $ 125,332,558
================ ================
</TABLE>
MM LLC
<TABLE>
<CAPTION>
For the three months For the three months
ended September 30, ended September 30,
1999 1998
-------------------- --------------------
<S> <C> <C>
Revenues $ 356,464 $ 14,430,272
Expenses 2,331,302 5,049,934
---------------- ----------------
$ (1,974,838) $ 9,380,338
Net Income ================ ================
</TABLE>
MM LLC
<TABLE>
<CAPTION>
For the nine months For the nine months
ended September 30, ended September 30,
1999 1998
-------------------- --------------------
<S> <C> <C>
Revenues $ 6,112,547 $ 15,738,047
Expenses 7,824,068 6,237,337
---------------- ----------------
Net Income $ (1,711,521) $ 9,500,710
================ ================
</TABLE>
7
<PAGE>
3. INCOME PER UNIT
The profit and loss of the Sector II and Sector III Units for the three and
nine months ended September 30, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
Sector II Sector III Total
UNITS UNITS All Units
------------------ ------------------ ------------------
For the three For the three For the three
months ended months ended months ended
September 30, 1999 September 30, 1999 September 30, 1999
------------------ ------------------ ------------------
<S> <C> <C> <C>
REVENUES:
Trading (loss) profits: $ - $ - $ -
Realized - - -
Change in unrealized - - -
---------- ---------- ----------
Total trading results
Interest income
Income from investments (181,812) (403,516) (585,328)
---------- ---------- ----------
Total revenues (181,812) (403,516) (585,328)
---------- ---------- ----------
EXPENSES
Profit Shares - - -
Brokerage commissions - - -
Administrative fees - - -
---------- ---------- ----------
Total expenses - - -
---------- ---------- ----------
NET INCOME (LOSS) $ (181,812) $ (403,516) (585,328)
========== ========== ==========
NET INCOME PER UNIT:
Weighted average number of
units outstanding 59,885 126,886 186,771
---------- ---------- ----------
Weighted average net income (loss) per
Limited Partner and General Partner Unit $ (3.04) $ (3.18) $ (3.14)
========== ========== ==========
<CAPTION>
Sector II Sector III Total
UNITS UNITS All Units
------------------ ------------------ ------------------
For the three For the three For the three
months ended months ended months ended
September 30, 1998 September 30, 1998 September 30, 1998
------------------ ------------------ ------------------
<S> <C> <C> <C>
REVENUES:
Trading (loss) profits:
Realized $ (16,741) $ (44,659) $ (61,400)
Change in unrealized 16,741 44,665 61,406
--------- ---------- ----------
Total trading results - 6 6
Interest income (406) (690) (1,096)
Income from investments 877,048 1,818,675 2,695,723
--------- ---------- ----------
Total revenues 876,642 1,817,991 2,694,633
--------- ---------- ----------
EXPENSES
Profit Shares - - -
Brokerage commissions - - -
Administrative fees - - -
--------- ---------- ----------
Total expenses - - -
--------- ---------- ----------
NET INCOME $ 876,642 $1,817,991 $2,694,633
========= ========== ==========
NET INCOME PER UNIT:
Weighted average number of
units outstanding 76,117 149,947 226,064
--------- ---------- ----------
Weighted average net income per
Limited Partner and General Partner Unit $ 11.52 $ 12.12 $ 11.92
========= ========== ==========
</TABLE>
8
<PAGE>
<TABLE>
<CAPTION>
Sector II Sector III Total
UNITS UNITS All Units
------------------ ------------------ ------------------
For the nine For the nine For the nine
months ended months ended months ended
September 30, 1999 September 30, 1999 September 30, 1999
------------------ ------------------ ------------------
<S> <C> <C> <C>
REVENUES:
Trading (loss) profits:
Realized $ - $ - $ -
Change in unrealized - - -
------------------ ------------------ ------------------
Total trading results - - -
Interest income - - -
Income from investments (171,594) (376,065) (547,659)
------------------ ------------------ ------------------
Total revenues (171,594) (376,065) (547,659)
------------------ ------------------ ------------------
EXPENSES
Profit Shares - - -
Brokerage commissions - - -
Administrative fees - - -
------------------ ------------------- -------------------
Total expenses - - -
------------------ ------------------- -------------------
NET INCOME (LOSS) $ (171,594) $ (376,065) $ (547,659)
================== =================== ===================
NET INCOME PER UNIT:
Weighted average number of
units outstanding 62,772 132,020 194,792
------------------ ------------------- -------------------
Weighted average net income (loss)
per Limited Partner
and General Partner Unit $ (2.73) $ (2.85) $ (2.81)
================== =================== ===================
<CAPTION>
Sector II Sector III Total
UNITS UNITS All Units
------------------ ------------------ ------------------
For the nine For the nine For the nine
months ended months ended months ended
September 30, 1998 September 30, 1998 September 30, 1998
------------------ ------------------ ------------------
<S> <C> <C> <C>
REVENUES:
Trading (loss) profits:
Realized $ (259,121) $ 1,430,312 $ 1,171,191
Change in unrealized (106,144) (566,345) (672,489)
------------------ ------------------ ------------------
Total trading results (365,265) 863,967 498,702
Interest income 238,969 359,188 598,157
Income from investments 599,373 752,781 1,352,154
------------------ ------------------ ------------------
Total revenues 473,077 1,975,936 2,449,013
------------------ ------------------ ------------------
EXPENSES
Profit Shares 517 301,127 301,644
Brokerage commissions 403,962 611,166 1,015,128
Administrative fees 11,541 17,462 29,003
------------------ ------------------- -------------------
Total expenses 416,020 929,755 1,345,775
------------------ ------------------- -------------------
NET INCOME $ 57,057 $ 1,046,181 $ 1,103,238
================== =================== ===================
NET INCOME PER UNIT:
Weighted average number of
units outstanding 82,039 158,260 240,299
------------------ ------------------- -------------------
Weighted average net income
per Limited Partner
and General Partner Unit $ 0.70 $ 6.61 $ 4.59
================== =================== ===================
</TABLE>
4. FAIR VALUE AND OFF-BALANCE SHEET RISK
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard ("SFAS") No. 133,
"Accounting for Derivative Instruments and Hedging Activities" (the
"Statement"), effective for fiscal years beginning after June 15,
2000, however, the Fund has adopted the Statement effective January 1,
1999. This Statement supercedes SFAS No. 119 ("Disclosure about
Derivative Financial Instruments and Fair Value of Financial
Instruments") and SFAS No. 105 ("Disclosure of information about
Financial Instruments with Off-Balance Sheet Risk and Financial
Instruments with Concentrations of Credit Risk") whereby disclosure of
average aggregate fair values and contract/notional values,
respectively, of derivative financial instruments is no longer
required for an entity such as the Partnership which carries its
assets at fair value. Such Statement sets forth a much broader
definition of a derivative instrument. The General Partner does not
believe that the application of the provisions of such statement has a
significant effect on the financial statements.
SFAS No. 133 defines a derivative as a financial instrument or other
contract that has all three of the following characteristics (1) one
or more underlyings, notional amounts or payment provisions (2)
requires no initial net investment or a smaller initial net investment
than would be required relative to changes in market factors (3) terms
require or permit net settlement. Generally, derivatives include a
future, forward, swap or option contract, or other financial
instrument with similar characteristics such as caps, floors and
collars.
As of June 1, 1998, the Partnership invested all of its assets in MM
LLC. The Partnership is thus, invested indirectly in the trading of
derivative instruments.
9
<PAGE>
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 net unrealized profit (loss) on such derivative instruments as
reflected in the Statements of Financial Condition or, with respect to
Partnership assets invested in Trading LLCs and in MM LLC, the net unrealized
profit (loss) as reflected in the respective Statements of Financial Condition
of the Trading LLCs and MM LLC. The Partnership's exposure to market risk is
influenced by a number of factors, including the relationships among the
derivative instruments held directly by the Partnership or indirectly through
the Trading LLCs and MM LLC, as well as the volatility and liquidity of
the markets in which such derivative instruments are traded.
The General Partner has procedures in place intended to control market risk
exposure, 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 or MM LLC, adjusting the
percentage of the Partnership's, the Trading LLC's or MM LLC's total assets
allocated to trading, calculating the Net Asset Value of the Advisors'
respective Partnership accounts' Trading LLC accounts or MM LLC accounts as of
the close of business on each day and reviewing outstanding positions for over-
concentrations both on an Advisor-by-Advisor and on an overall Partnership
basis. While the General Partner does not itself intervene in the markets to
hedge or diversify the Partnership's market exposure (although the General
Partner does adjust the percentage of the Partnership's total assets allocated
to trading), the General Partner may urge Advisors to reallocate positions, or
itself reallocate Partnership assets among Advisors (although typically only as
of the end of a month) in an attempt to avoid over-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.
One important aspect of the General Partner's risk controls is its adjustments
to the leverage at which the Partnership trades. By controlling the percentage
of the Partnership's assets allocated to trading, the General Partner can
directly affect the market exposure of the Partnership. Leverage control is the
principal means by which the General Partner hopes to be able to ensure that
Merrill Lynch is never required to make any payments under its guarantee that
the Net Asset Value per Unit (Both Sector II and Sector III Units) will equal no
less than a specified minimum as of the Principal Assurance Date.
Credit Risk
- -----------
The risks associated with exchange-traded contracts are typically perceived to
be less than those associated with over-the-counter (non-exchange-traded)
transactions, because exchanges typically (but not universally) provide
clearinghouse arrangements in which the collective credit (in some cases limited
in amount, in some cases not) of the members of the exchange is pledged to
support the financial integrity of the exchange. In over-the-counter
transactions, on the other hand, traders must rely solely on the credit of their
respective individual counterparties. Margins, which may be subject to loss in
the event of a default, are generally required in exchange trading, and
counterparties may require margin in the over-the-counter markets.
The credit risk associated with these instruments from counterparty
nonperformance, is the net unrealized profit included on the Statements of
Financial Condition or, with respect to the Partnership's assets invested in
Trading LLCs and in MM LLC, the net unrealized profit included in the respective
statements of Financial Condition of the Trading LLCs and MM LLC.
10
<PAGE>
The Partnership has credit risk in respect of its counterparties and brokers,
but attempts to control this risk by dealing almost exclusively with Merrill
Lynch entities as counterparties and brokers.
The Partnership, in its normal course of business, entered into various
contracts, with Merrill Lynch Futures (" MLF"), a Merrill Lynch & Co., Inc.
affiliate, acting as its commodity broker
Item 2: Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations
---------------------
MONTH-END NET ASSET VALUE PER SECTOR II UNIT
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------
Jan. Feb. Mar. Apr. May Jun. Jul. Aug. Sep.
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1998 $155.45 $151.98 $150.75 $145.57 $146.58 $146.91 $147.09 $155.15 $155.08
-------------------------------------------------------------------------------------
1999 $156.73 $158.61 $157.90 $159.63 $158.37 $158.96 $159.28 $158.21 $155.90
-------------------------------------------------------------------------------------
</TABLE>
MONTH-END NET ASSET VALUE PER SECTOR III UNIT
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------
Jan. Feb. Mar. Apr. May Jun. Jul. Aug. Sep.
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1998 $159.04 $156.52 $159.24 $151.72 $154.09 $154.27 $154.50 $162.95 $166.44
-------------------------------------------------------------------------------------
1999 $164.61 $166.59 $165.84 $167.65 $166.34 $166.96 $167.29 $166.16 $163.74
-------------------------------------------------------------------------------------
</TABLE>
Performance Summary
January 1, 1998 to September 30, 1998
- -------------------------------------
January 1, 1998 to March 31, 1998
The Fund's positions in the global interest rate markets were profitable during
the quarter. In Europe, an extended bond market rally continued despite an
environment of robust growth in the United States, Canada and the United
Kingdom, as well as a strong pick-up in growth in continental Europe.
Gold prices drifted sideways and lower as Asian demand continued to slow and
demand in the Middle East was affected by low oil prices. Initially buoyed on
concerns about a U.S.-led military strike against Iraq, crude oil fell to a nine
year low, as the globally warm winter, the return of Iraq as a producer and the
Asian economic crisis added to OPEC's supply glut problems.
Trading results in stock index markets were mixed, but unprofitable, despite a
strong first-quarter performance by the U.S. equity market as several
consecutive weekly gains were recorded with most market averages setting new
highs. Results in currency trading were also mixed, but profitable. In
particular, the Swiss franc weakened versus the U.S. dollar.
Agricultural commodity markets provided profitable trading results overall. Live
cattle and hog prices trended downward throughout the quarter. Cotton prices
moved mostly upward during the quarter, but prices dropped off sharply at the
end of March.
April 1, 1998 to June 30, 1998
As swings in the U.S. dollar and developments in Japan affected bond markets,
the Fund's interest rate trading during the quarter resulted in losses,
particularly in Eurodollar deposits. Early in the quarter, U.S. Treasury trading
was range-bound, as concern that the economy might be overheating was balanced
by the potential impact of the Asian recession. Additionally, Australian bonds
and bills saw a dramatic drop in prices in early June, as dollar-bloc currencies
remained under pressure versus the U.S. dollar due to the Japanese/Asian crisis.
Metals and energy trading provided mixed results. The depressed gold market
weakened further following news of a European Central Bank consensus that ten to
fifteen percent of reserves should be made up of gold bullion which was at the
low end of expectations. Despite production cuts initiated by OPEC at the end of
March, world oil supplies remained excessive and oil prices stood at relatively
low levels throughout the quarter.
Results in currency trading were unprofitable, despite strong gains realized
from Japanese yen positions, which weakened during June to an eight-year low
versus the U.S. dollar. Trading results in stock index markets were
unprofitable, as the Asia-Pacific region's equity markets weakened across the
board. In
11
<PAGE>
particular, Hong Kong's Hang Seng index trended downward during most of the
quarter and traded at a three-year low.
Agricultural commodity trading produced profits. The U.S. soybean crop got off
to a good start which contributed to higher yield expectations and a more
burdensome supply outlook and soybean prices traded in a volatile pattern for
the second half of the quarter. Sugar futures maintained mostly a downtrend, as
no major buyers emerged to support the market. Similarly, coffee prices trended
downward, as good weather conditions in Central America and Mexico increased the
prospects of more output from these countries.
July 1, 1998 to September 30, 1998
Fund performance in July was essentially flat. In August and continuing into
September, financial markets in general were characterized by a flight to
quality that resulted from uncertainty over Russia's solvency, continued
weakness in Asia, and concerns that recessionary conditions would spread to the
United States and Europe. These factors, combined with generally less liquid
market conditions, led to a marked widening in bond credit spreads and a broad
sell-off in world-wide equity markets. Managed futures funds exhibited strong
non-correlation to world markets in August and again in September, generating
significant profits on the long side of interest rates and the short side of the
commodity markets.
Interest rate trading was particularly profitable during the quarter in
positions in Eurodollars, German and Japanese bonds, and U.S. Treasury notes and
bonds. The growth rate of the world bond market declined to its lowest level
since 1987 at 7.7%, down 4.0% from the last peak in 1993. Global investors
poured funds into such instruments as U.S. Treasury issues and German Bunds,
staging a major flight to quality. As a result, there was a significant widening
of credit spreads on a global basis. Global fund managers also increased their
already-overweight exposure to U.S. Treasuries to a record high. The impact of
these events was that in September, the yield on the Japanese 5-year bond fell
to .67%, an all-time low, German 10-year Bunds fell to 3.89%, representing
almost a 100-year low, and the 30-year bond in the U.S. dropped to its lowest
level on record.
The Fund profited from its currency trading during the quarter with significant
gains from short Japanese yen and Canadian dollar positions, as well as long
Deutsche mark positions. In the currency markets, Japan's problems spread to
other sectors of the global economy, causing commodities prices to decline as
demand from the Asian economies weakened, in turn putting pressure on Canada's
commodity-sensitive currency. In Germany, the federal election resulted in a
shift to the left, as Chancellor Helmut Kohl, after sixteen years in office,
lost to Gerhard Schroder. Surprisingly, this promoted a continued strengthening
of the Deutsche mark versus the U.S. dollar.
As U.S. equity markets declined in July and August, the Fund profited from short
positions in the S&P 500(R), most notably during August, when the index dropped
14.5%. Volatility in September made for a difficult trading environment, and the
Fund incurred modest losses in the stock index sector during September, but
remained profitable for the quarter overall in these markets. Energy trading
also resulted in gains for the quarter. Short crude oil positions proved
profitable for the Fund as prices remained under pressure from excessive
physical availability. Unleaded gas positions also generated strong profits for
the Fund.
The agricultural sector generated profits overall for the quarter. As commodity
markets collapsed in August, profits were generated on the short side of corn
and sugar positions, which offset losses in the soybean complex. The harvest of
the second largest U.S. corn crop on record resulted in prices dropping to the
lowest levels in over 10 years. Prospects for a large production surplus of
sugar kept pressure on the sugar market and also resulted in low prices.
However, in September, the Fund was caught on the long side of the soybean
complex resulting in losses as the U.S. soybean crop increased relative to the
USDA's production estimate as a result of timely rains, which contributed to
lower prices.
In the metals markets, gold prices attempted to move higher against a backdrop
of volatility in major equity markets, increasing concerns about emerging
markets, economic chaos in Russia, weakness in the U.S. dollar, and increasing
worries about global economic conditions. However, gold was unable to extend
rallies and build any significant upside momentum resulting in a trendless
environment and resulting losses in gold positions for the Fund.
January 1, 1999 to September 30, 1999
- -------------------------------------
January 1, 1999 to March 31, 1999
The Fund profited from trading in crude oil, heating oil, and unleaded gas. As
the year opened, the global oil balance continued to show signs of being
lopsided with estimated year-end 1998 inventories at their highest levels since
1984. During January, petroleum stocks rose by 21 million barrels compared with
a typical gain of 6 to 7 million barrels. Then, on March 23, OPEC ratified new
production cuts totaling 1.716 million barrels per day at its conference. These
new production cuts were scheduled to go into effect on April 1 and proved to be
harbingers of higher prices for crude.
12
<PAGE>
Agricultural trading was also profitable overall, as gains in live hogs and live
cattle offset losses in corn positions. Hog prices plummeted due to a glut of
hogs in the market. At the beginning of the quarter, the corn market continued
to struggle despite a stretch of solid export business. The market's negative
sentiment was deepened by ongoing favorable weather in South America which
continued through February, even though there was a sharp reduction in
Argentina's planted area. Lack of enthusiasm for new crop and less than
spectacular demand continued to depress the corn market throughout the quarter.
Interest rate trading proved profitable for the Fund as well, as losses in
Japanese 10-year government bonds were offset by gains in 10-year U.S. Treasury
notes and German 10-year bonds. Early in January, the yield on the Japanese
government 10-year bond increased to 1.8%, sharply above the record low of
0.695% it reached on October 7, 1998. This was triggered by the Japanese Trust
Fund Bureau's decision to absorb a smaller share of future issues, leaving the
burden of financing future budget deficits to the private sector.
Losses in aluminum overshadowed slight gains in copper during the first quarter.
In January, burdensome warehouse stocks and questionable demand prospects
weighed on base metals as aluminum fell to a 5-year low and copper fell to
nearly an 11-year low. Major surpluses in both metals were expected, keeping
prices down, and there was no supply side response to weak demand and lower
prices. However, the end of March showed copper and aluminum leading a surge in
base metals as prices recovered from multi-year lows.
The Fund also suffered losses in currency trading during the quarter, as losses
in Japanese yen overpowered gains in Swiss francs. On a trade-weighted basis,
the Swiss franc ended the quarter at close to a seven-month low, mostly as a
result of the stronger U.S. dollar. In January, the yen had advanced by nearly
35% against the dollar since early in August, and the Bank of Japan lowered
rates to keep the economy sufficiently liquid so as to allow fiscal spending to
restore some growth to the economy and to drive down the surging yen.
Stock index trading was also unprofitable, as losses were sustained in Hang Seng
and CAC40 positions. Also of note, the Dow Jones Industrial Average closed above
the 10,000 mark for the first time ever at the end of March, setting a record
for the index.
April 1, 1999 to June 30, 1999
The Fund profited in interest rate trading from short positions in Euro dollars,
U.S. 10-year Treasury notes and U.S. Treasury bonds as the flight to quality in
the bond market reversed during the first half of 1999 and concerns about higher
interest rates continued to rattle the financial markets.
Stock indices trading also resulted in gains overall for the quarter, as
positions in the Hang Seng, Nikkei 225 and Topix Indices all generated profits
as the equity indices rallied worldwide in April and June.
Trading in the agricultural markets also proved profitable for the Fund. Gains
from live cattle and live hog positions offset losses from short corn positions.
Agricultural commodities, in particular corn, were weak almost across the board
as they were saddled with supply/demand imbalances. In the beginning of the
quarter, continued wetness across the corn belt led to early planting delays.
The energy sector was profitable as positions in crude oil offset losses from
short positions in natural gas and gas oil trading. The focus of attention in
the natural gas markets since the end of winter was the sharply lower than year-
ago storage injection activity. Crude oil prices rallied much higher and faster
than expected following last quarter's ratification of an OPEC/non-OPEC
agreement to cut production by over 2 million barrels per day. Natural gas
prices also rallied sharply over the quarter, reflecting, in part, growing
concerns about a decline in US natural gas production.
Currency trading resulted in losses for the Fund. Gains in Euro trading were
offset by losses sustained in British pound trading and from short positions in
the Canadian dollar. After suffering under the weight of lower commodity prices
and the Asian recession, the Canadian dollar underwent a significant rally in
the first half of 1999, moving up about 3 cents from the end of 1998.
In the metals sector, gains from short gold positions were overshadowed by
losses in copper and nickel trading. Throughout the first half of 1999, gold
prices were in a state of gradual erosion and in early June, prices hit their
lowest levels in over 20 years. Gold continued to show a lack of response to
political and military events such as Kosovo and also lost much of its role as a
monetary asset and flight to safety
13
<PAGE>
vehicle. The economic scenario for Asia, Brazil, emerging market nations and
Europe helped keep copper and other base metals on the defensive as demand
receded with virtually no supply side response.
July 1, 1999 to September 30, 1999
The Fund profited in the energy sector with long positions in light crude oil
resulting in strong gains. Crude oil prices received a jolt owing to a report in
August indicating Russia's plan to cut 70% its fuel oil and gasoil exports for
August and completely eliminate gasoil exports in order to satisfy domestic
needs. Short positions in natural gas trading were unprofitable as high levels
of energy consumption and weather scares throughout the country early in the
quarter added to the bullish tone for the market. However, these losses were not
substantial enough to affect the profitability of the sector overall for the
quarter.
Trading in the metals markets was also profitable as positions in nickel, gold
and aluminum all resulted in gains. Collectively, the base metals sector was a
strong performer this quarter. A major statement from the President of the
European Central Bank was beneficial for long gold positions as it sent gold
prices sharply higher in late September. A key part of the statement was the
fact that the banks have agreed not to expand their gold lending. This initiated
the first bullish bias in years. The Fund's long positions in aluminum trading
were also profitable. Despite a 5-year low in early March, aluminum prices have
gained nearly 25 percent this year. Steady Japanese consumer buying and the
strength in the yen versus the dollar have played a part in this.
Interest rate trading was unprofitable for the third quarter as losses were
sustained in Eurodollar, Japanese 10 year government bonds and Eurobund futures
trading. Long positions in Eurodollar trading were unprofitable given the
speculations of the probability of a tightening bias by the US Federal Reserve.
Eurodollar contracts gave up much of the gains that they enjoyed following the
Federal Open Market Committee's adoption of a neutral bias.
The Fund suffered losses in stock index positions as trading throughout the
quarter was volatile. Though the S&P finished the third quarter by breaking the
post-October 1998 highs, the Fund suffered losses in stock index trading due to
significant volatility globally. For the quarter, losses were sustained in the
S&P, FTSE-Financial Times Stock Index, and the DAX German Stock Index resulting
in losses for the sector overall.
Currency trading resulted in minimal losses for the quarter as profitable
positions in the Japanese yen were offset by losses in Euro currency and Swiss
franc trading. Long yen positions resulted in strong gains as the Bank of Japan
refused to ease monetary policy and investors added to their yen exposure, which
reached a two-year high during the quarter. The most positive sign in Japan was
that, for the second quarter in a row, domestic consumption exceeded that of the
year ago quarter. Losses were sustained in Euro currency trading as it continued
to trade in the same choppy pattern that has been evident for the past few
quarters.
The Fund also was unprofitable in the agricultural markets as losses were
sustained in the hog, coffee and soymeal markets. Agricultural trading began the
quarter with an increase in prices as there was a sharp decline in crop ratings
due to wet conditions in the Eastern Belt during July. This in conjunction with
forecasters' outlooks for additional declines in the weeks ahead helped jump-
start the first major weather scare of the season. As a result, short positions
in soymeal proved unprofitable as there was a sharp upturn in soy prices.
Additionally, long coffee positions were unprofitable as the coffee market
plunged to 5-year lows during the quarter when cold temperatures in Brazil
skirted the major coffee belt and failed to harm trees.
Year 2000 Compliance
As the Year 2000 approaches, Merrill Lynch has undertaken initiatives to address
the Year 2000 problem (the "Y2K problem"), as more fully described in the 1998
Annual Report. The failure of Merrill Lynch's technology systems relating to a
Y2K problem would likely have a material adverse effect on the company's
business, results of operations, and financial condition. This effect could
include disruption of normal business transactions, such as the settlement,
execution, processing, and recording of trades in securities, commodities,
currencies, and other assets. The Y2K problem could also increase Merrill
Lynch's exposure to risk and legal liability and its need for liquidity.
14
<PAGE>
The renovation phase of Merrill Lynch's Year 2000 system efforts, as described
in the 1998 Annual Report, was 100% completed as of June 30, 1999, and
production testing was 100% completed as of that date. In March and April 1999,
Merrill Lynch successfully participated in U.S. industrywide testing sponsored
by the Securities Industry Association. These tests involved an expanded number
of firms, transactions, and conditions compared with those previously conducted.
Merrill Lynch has participated in and continues to participate in numerous
industry tests throughout the world.
Merrill Lynch's business units have developed and tested contingency plans. The
plans identify critical processes, potential Y2K problems, and personnel,
processes, and available resources needed to maintain operations. However, the
failure of exchanges, clearing organizations, vendors, service providers,
clients and counterparties, regulators, or others to resolve their own
processing issues in a timely manner could have a material adverse effect on
Merrill Lynch's business, results of operations, and financial condition.
In light of the interdependency of the parties in or serving the financial
markets, there can be no assurance that all Y2K problems will be identified and
remedied on a timely basis or that all remediation and contingency planning will
be successful. Public uncertainty regarding successful remediation of the Y2K
problem may cause a reduction in activity in the financial markets. This could
result in reduced liquidity as well as increased volatility. Disruption or
suspension of activity in the world's financial markets is also possible. In
some non-U.S. markets in which Merrill Lynch does business, the level of
awareness and remediation efforts relating to the Y2K problem are thought to be
less advanced than in the U.S. Management is unable at this point to ascertain
whether all significant third parties will successfully address the Y2K problem.
Merrill Lynch will continue to monitor third parties' Year 2000 readiness to
determine if additional or alternative measures are necessary. Contingency plans
have been established for all business units. Merrill Lynch's year-end balance
sheet levels will depend on Y2K risks and many other factors, including business
opportunites and customer demand.
As of September 24, 1999, the total estimated expenditures of existing and
incremental resources for the Year 2000 compliance initiative was approximately
$520 million. This estimate includes $104 million of occupancy, communications,
and other related overhead expenditures, as Merrill Lynch is applying a fully
costed pricing methodology for this project. Of the total estimated
expenditures, approximately $40 million, related to continued testing,
contingency planning, and risk management. There can be no assurance that the
costs associated with such efforts will not exceed those currently anticipated
by Merrill Lynch, or that the possible failure of such efforts will not have a
material adverse effect on Merrill Lynch's business, results of operations, or
financial condition.
15
<PAGE>
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The following table indicates the trading Value at Risk associated with the
Fund's open positions by market category as of September 30, 1999 and December
31, 1998, and the average of the nine months for January 1999 through September
1999. As of September 30, 1999 and December 31, 1998, the Fund's total
capitalization was approximately $29 million and $34 million, all of which was
allocated to trading.
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
------------------------------- -----------------------------------
% OF TOTAL % OF TOTAL
MARKET SECTOR VALUE AT RISK CAPITALIZATION VALUE AT RISK CAPITALIZATION
- ------------- ------------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
Interest Rates 276,034 0.94% $ 159,263 0.47%
Currencies 217,742 0.74% 294,936 0.89
Stock Indices 133,268 0.45% 79,470 0.23
Metals 137,116 0.47% 115,273 0.34
Commodities 15,353 0.06% 78,680 0.23
Energy 147,231 0.50% 63,550 0.18
------------- -------------- ------------- --------------
926,744 3.16% $ 791,172 2.34%
============= ============== ============= ==============
</TABLE>
<TABLE>
<CAPTION>
Average month-end Average month-end
For the Period For the Period
July 1999 through September 1999 January 1999 through September 1999
-------------------------------- -----------------------------------
% OF TOTAL % OF TOTAL
MARKET SECTOR VALUE AT RISK CAPITALIZATION VALUE AT RISK CAPITALIZATION
- ------------- ------------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
Interest Rates 348,054 1.16% $ 552,106 1.76%
Currencies 277,916 0.92% 304,522 0.97
Stock Indices 189,617 0.63% 285,779 0.91
Metals 152,898 0.51% 123,860 0.39
Commodities 42,425 0.14% 105,133 0.33
Energy 180,993 0.60% 155,686 0.50
------------- -------------- ------------- --------------
1,191,903 3.96% $ 1,527,086 4.86%
============= ============== ============= ==============
</TABLE>
16
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
There are no pending proceedings to which the Partnership or the
General Partner is a party.
Item 2. Changes in Securities and Use of Proceeds
(a) None.
(b) None.
(c) None.
(d) 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 report.
(b) Reports on Form 8-K
-------------------
There were no reports on Form 8-K filed during the first nine months
of fiscal 1999.
17
<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: November 12, 1999 By /s/ JOHN R. FRAWLEY, JR.
------------------------
John R. Frawley, Jr.
Chairman, Chief Executive Officer,
President and Director
Date: November 12, 1999 By /s/ MICHAEL L. PUNGELLO
-----------------------
Michael L. Pungello
Vice President, Chief Financial Officer
and Treasurer
18
<TABLE> <S> <C>
<PAGE>
<ARTICLE> BD
<S> <C> <C>
<PERIOD-TYPE> 9-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1998
<PERIOD-START> JAN-01-1999 JAN-01-1998
<PERIOD-END> SEP-30-1999 SEP-30-1998
<CASH> 0 0
<RECEIVABLES> 29,726,521 34,453,382
<SECURITIES-RESALE> 0 0
<SECURITIES-BORROWED> 0 0
<INSTRUMENTS-OWNED> 0 0
<PP&E> 0 0
<TOTAL-ASSETS> 29,726,521 34,453,382
<SHORT-TERM> 0 0
<PAYABLES> 398,167 662,200
<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> 29,328,354 33,791,182
<TOTAL-LIABILITY-AND-EQUITY> 29,726,521 34,453,382
<TRADING-REVENUE> 0 498,702
<INTEREST-DIVIDENDS> 0 598,157
<COMMISSIONS> 0 1,345,775
<INVESTMENT-BANKING-REVENUES> (547,659) 1,352,154
<FEE-REVENUE> 0 0
<INTEREST-EXPENSE> 0 0
<COMPENSATION> 0 0
<INCOME-PRETAX> (547,659) 1,103,238
<INCOME-PRE-EXTRAORDINARY> (547,659) 1,103,238
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (547,659) 1,103,238
<EPS-BASIC> (2.81) 4.59
<EPS-DILUTED> (2.81) 4.59
</TABLE>
