PAGE 1
Keystone Capital Preservation and Income Fund
Seeks a high level of current income consistent with low volatility of
principal.
Dear Shareholder:
We are pleased to report on the activities of Keystone Capital Preservation and
Income Fund for the fiscal year which ended September 30, 1996. Following our
letter to you we have included a discussion with your Fund manager and complete
financial information.
Performance
Your Fund provided the following total returns, which include income and price
changes, for the twelve-month period ended September 30, 1996.
Class A shares returned 6.56%.
Class B shares returned 5.90%.
Class C shares returned 5.91%.
The six-month U.S. Treasury bill, a benchmark for short-term income-oriented
obligations, returned 5.25% for the same twelve-month period.
Keystone Capital Preservation and Income Fund's excellent performance was
achieved during a difficult environment for bond investors. Short-term interest
rates rose during the period resulting in generally higher yields for fund
shareholders than at the beginning of the fiscal period. The adjusting feature
of adjustable-rate mortgage securities (ARMS) helped to minimize the effects of
price declines which were experienced by investors who held fixed-rate
investments.
We believe your Fund performed as intended, exhibiting a relatively high
degree of stability in an unusually volatile environment for bond investors.
Evidence of your Fund's solid performance was reported by Morningstar which
assigned Keystone Capital Preservation and Income Fund Class C shares (four
stars)--its second highest rating--for the Fund's risk-adjusted performance
among 1506 fixed-income funds as of September 30, 1996.(1) We attribute these
results to our conservative investment strategy and careful security selection
process.
Your Fund invests primarily in adjustable-rate mortgage securities (ARMS) and
fixed-rate mortgage-backed and U.S. government and agency securities. We
consider geographic diversification, mortgage rate adjustment dates, as well as
our interest rate outlook in selecting securities for the portfolio. We did not
invest in any derivative securities during the twelve-month reporting period.
Investment environment
Bond investors experienced varying investment climates during the period,
resulting in higher yields and lower bond prices for many investors. The bond
market rally of 1995 reversed course with the appearance of stronger than
expected employment reports in the first quarter of 1996. Concerned that this
strength would stimulate robust economic activity and future inflation,
investors pushed interest rates higher in the first quarter of 1996, and prices
declined.
--continued--
(1)Source: Morningstar, Inc. Morningstar's proprietary ratings reflect the
Fund's historical risk-adjusted performance as of September 30, 1996. Ratings
are subject to change monthly. They are calculated based on the Fund's 1-, 3-,
5- and 10-year average annual return in excess or below the 90-day Treasury bill
return. Ratings are not adjusted for sales charges, but are adjusted for other
fees. The top 10% of the funds in an investment category receive 5 stars, the
next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive
2 stars and the bottom 10% receive 1 star. In the fixed-income category, Class C
shares received a 5-star rating for the 1-year and a 3-star rating for the
3-year periods. Class C was not rated for the five- or ten-year periods because
it does not have a five- or ten-year performance record. There were 1506 funds
in the 1-year category, 948 funds in the 3-year category, and 500 funds in the
5-year category. Past performance is no guarantee of future results.
<PAGE>
PAGE 2
Keystone Capital Preservation and Income Fund
By late summer, news of slower growth was evident among some economic
statistics. This helped rates to retreat as relieved investors believed that
inflation remained well-contained. Investors were still cautious, but became
more confident that economic activity and inflation would continue to be
manageable. We believe these developments helped to reduce price volatility in
the fixed-income market.
In the months ahead, we anticipate slower economic growth and continued low
inflation. We believe this type of environment should bode well for fixed-income
investors, enabling bonds to provide positive performance though the beginning
of 1997.
A place for safety and liquidity
We believe the environment experienced by fixed-income investors over the past
twelve months demonstrates the value of investing in adjustable-rate mortgage
securities. Keystone Capital Preservation and Income Fund is designed to provide
investors with attractive income, as well as safety and liquidity. These
characteristics can be particularly critical during periods of market
uncertainty. We believe your Fund is an excellent choice for investors seeking
long-term stability and current income. The Fund also is well-suited to serve as
the liquid portion of a balanced investment portfolio.
Keystone to be acquired by First Union Corporation
We are pleased to inform you that Keystone has agreed to be acquired by First
Union Corporation. The acquisition is subject to a number of conditions,
including approvals of investment advisory agreements with Keystone by fund
shareholders. First Union is a financial services firm based in Charlotte, North
Carolina. It is the nation's sixth largest bank holding company with assets of
approximately $140 billion. First Union, through its wholly-owned subsidiary
Evergreen Asset Management Corp., manages more than $16 billion in 36 mutual
funds. Keystone will remain a separate entity after its acquisition and will
continue to provide investment advisory and management services to the Fund. We
believe First Union's acquisition of Keystone should strengthen the investment
management services we provide to you.
We appreciate your continued support of Keystone Capital Preservation and
Income Fund. If you have any questions or comments about your Fund, we encourage
you to write to us.
Sincerely,
/s/ Albert H. Elfner, III
Albert H. Elfner, III
Chairman and President
Keystone Investments, Inc.
/s/ George S. Bissell
George S. Bissell
Chairman of the Board
Keystone Funds
November 1996
(Elfner photograph) (Bissell photograph)
Albert H. Elfner, III George S. Bissell
<PAGE>
PAGE 3
A Discussion With
Your Fund Manager
(Photograph of Christopher P. Conkey)
Christopher P. Conkey is portfolio manager of your Fund and heads Keystone's
high grade bond team. A Chartered Financial Analyst, Mr. Conkey has 13 years of
experience managing fixed-income investments. He holds a BA in economics from
Clark University and an MBA in finance from Boston University. Together with
analysts David J. Bowers and Gary E. Pzegeo the team evaluates credit quality
and the economic environment in selecting securities for your Fund.
Q What was the investment environment like over the past twelve months?
A For most bond investors, the twelve-month period which ended September 30,
1996 was a challenging environment, as rising interest rates caused prices of
fixed-rate bonds to fall. Adjustable-rate mortgage securities (ARMS) performed
relatively well because of their short effective maturities and the adjusting
component of the securities.
Sharply changing market conditions characterized the fixed-income market.
Through the end of 1995, interest rates fell as the Federal Reserve Board
pursued a policy of lowering interest rates. This was based on an outlook for
slow economic growth, low inflation and a reduction in the federal budget
deficit. In early 1996, however, interest rates reversed course as there were
signs of strong growth in employment, and heightened consumer activity and
housing starts. Investors were concerned that this strength could be a precursor
to future inflation, resulting in higher interest rates.
Since mid-year, investors have focused on the moderating growth that has taken
place in parts of the economy. This has helped to offset reports of
strengthening employment. Though investors are keeping an eye on potential wage
inflation, inflation in general has been well-contained. The recent reports have
given investors greater confidence that economic growth and inflation will
continue to be manageable. We believe this perception has reduced some of the
bond market's price volatility.
Q How did you structure the Fund in light of the changing interest rate
environment?
A We lowered the Fund's holdings in ARMS from 92% of net assets on September 30,
1995 to 84% as of September 30, 1996. The proceeds were reinvested in U.S.
Treasury securities, which rose from 2% of net assets to 11% over the same time
span. The remainder of the Fund's assets were invested in fixed-rate mortgages
and cash equivalents.
Fund Profile
Objective: Seeks a high level of current income consistent with low
volatility of principal primarily from adjustable-rate mortgage securities
(ARMS).
Commencement of investment operations: July 1, 1991
Average maturity: 4 years
Average quality: AAA
Net assets: $71 million
Newspaper listing: "CapPre"
<PAGE>
PAGE 4
Keystone Capital Preservation and Income Fund
Yields on 6-Month Treasury Bills
[line chart]
Yield September 30, 1991 to September 30, 1996
9/27/96 5.220
9/20/96 5.480
9/13/96 5.360
9/06/96 5.550
8/30/96 5.470
8/23/96 5.300
8/16/96 5.300
8/09/96 5.300
8/02/96 5.300
7/26/96 5.500
7/19/96 5.480
7/12/96 5.500
7/05/96 5.580
6/28/96 5.350
6/21/96 5.460
6/14/96 5.460
6/07/96 5.510
5/31/96 5.340
5/24/96 5.310
5/17/96 5.310
5/10/96 5.290
5/03/96 5.320
4/26/96 5.210
4/19/96 5.220
4/12/96 5.250
4/05/96 5.230
3/29/96 5.180
3/22/96 5.120
3/15/96 5.220
3/08/96 5.180
3/01/96 4.920
2/23/96 4.960
2/16/96 4.870
2/09/96 4.880
2/02/96 4.910
1/26/96 5.080
1/19/96 5.030
1/12/96 5.150
1/05/96 5.190
12/29/95 5.190
12/22/95 5.280
12/15/95 5.330
12/08/95 5.400
12/01/95 5.300
11/24/95 5.400
11/17/95 5.370
11/10/95 5.510
11/03/95 5.460
10/27/95 5.500
10/20/95 5.530
10/13/95 5.520
10/06/95 5.550
9/29/95 5.530
9/22/95 5.490
9/15/95 5.480
9/08/95 5.540
9/01/95 5.490
8/25/95 5.560
8/18/95 5.680
8/11/95 5.670
8/04/95 5.610
7/28/95 5.580
7/21/95 5.660
7/14/95 5.580
7/07/95 5.470
6/30/95 5.550
6/23/95 5.580
6/16/95 5.670
6/09/95 5.820
6/02/95 5.520
5/26/95 5.850
5/19/95 5.920
5/12/95 5.930
5/05/95 5.810
4/28/95 6.050
4/21/95 5.940
4/14/95 5.950
4/07/95 6.060
3/31/95 6.090
3/24/95 6.070
3/17/95 6.120
3/10/95 6.180
3/03/95 6.190
2/24/95 6.160
2/17/95 6.240
2/10/95 6.380
2/03/95 6.330
1/27/95 6.390
1/20/95 6.480
1/13/95 6.360
1/06/95 6.600
12/30/94 6.490
12/23/94 6.480
12/16/94 6.500
12/09/94 6.440
12/02/94 6.370
11/25/94 5.970
11/18/94 6.030
11/11/94 5.900
11/04/94 5.850
10/28/94 5.650
10/21/94 5.660
10/14/94 5.460
10/07/94 5.530
9/30/94 5.410
9/23/94 5.400
9/16/94 5.210
9/09/94 5.130
9/02/94 5.020
8/26/94 5.040
8/19/94 5.110
8/12/94 5.070
8/05/94 5.070
7/29/94 4.840
7/22/94 4.930
7/15/94 4.840
7/08/94 5.010
7/01/94 4.810
6/24/94 4.750
6/17/94 4.640
6/10/94 4.680
6/03/94 4.690
5/27/94 4.800
5/20/94 4.680
5/13/94 4.830
5/06/94 4.790
4/29/94 4.420
4/22/94 4.330
4/15/94 4.120
4/08/94 4.080
4/01/94 3.900
3/25/94 3.900
3/18/94 3.940
3/11/94 3.890
3/04/94 3.840
2/25/94 3.700
2/18/94 3.570
2/11/94 3.490
2/04/94 3.460
1/28/94 3.180
1/21/94 3.190
1/14/94 3.210
1/07/94 3.240
12/31/93 3.280
12/24/93 3.270
12/17/93 3.300
12/10/93 3.320
12/03/93 3.350
11/26/93 3.340
11/19/93 3.360
11/12/93 3.330
11/05/93 3.340
10/29/93 3.260
10/22/93 3.230
10/15/93 3.160
10/08/93 3.140
10/01/93 3.090
9/24/93 3.130
9/17/93 3.150
9/10/93 3.130
9/03/93 3.100
8/27/93 3.180
8/20/93 3.170
8/13/93 3.190
8/06/93 3.260
7/30/93 3.260
7/23/93 3.320
7/16/93 3.200
7/09/93 3.180
7/02/93 3.130
6/25/93 3.260
6/18/93 3.260
6/11/93 3.260
6/04/93 3.370
5/28/93 3.300
5/21/93 3.180
5/14/93 3.130
5/07/93 3.040
4/30/93 3.050
4/23/93 3.000
4/16/93 3.040
4/09/93 3.080
4/02/93 3.070
3/26/93 3.110
3/19/93 3.140
3/12/93 3.160
3/05/93 3.170
2/26/93 3.120
2/19/93 3.090
2/12/93 3.160
2/05/93 3.130
1/29/93 3.140
1/22/93 3.130
1/15/93 3.150
1/08/93 3.280
1/01/93 3.360
12/25/92 3.390
12/18/92 3.410
12/11/92 3.490
12/04/92 3.450
11/27/92 3.560
11/20/92 3.510
11/13/92 3.450
11/06/92 3.380
10/30/92 3.300
10/23/92 3.280
10/16/92 3.110
10/09/92 3.050
10/02/92 2.880
9/25/92 2.950
9/18/92 2.990
9/11/92 3.050
9/04/92 3.050
8/28/92 3.320
8/21/92 3.260
8/14/92 3.220
8/07/92 3.260
7/31/92 3.340
7/24/92 3.320
7/17/92 3.280
7/10/92 3.340
7/03/92 3.410
6/26/92 3.820
6/19/92 3.890
6/12/92 3.840
6/05/92 3.910
5/29/92 3.950
5/22/92 3.890
5/15/92 3.820
5/08/92 3.840
5/01/92 3.890
4/24/92 3.910
4/17/92 3.880
4/10/92 3.890
4/03/92 4.180
3/27/92 4.280
3/20/92 4.370
3/13/92 4.350
3/06/92 4.280
2/28/92 4.120
2/21/92 4.180
2/14/92 4.010
2/07/92 3.890
1/31/92 4.050
1/24/92 4.050
1/17/92 4.010
1/10/92 3.970
1/03/92 4.010
12/27/91 3.890
12/20/91 3.830
12/13/91 4.180
12/06/91 4.230
11/29/91 4.400
11/22/91 4.510
11/15/91 4.600
11/08/91 4.690
11/01/91 4.780
The benchmark six-month (182-day) Treasury bill began the period with a yield
of 5.53% on September 30, 1995. Yields declined to a low of 4.83% on February
13, 1996 and then rose, peaking at 5.58% on September 5. The six-month Treasury
bill closed the period with a yield of 5.28% on September 30, 1996.
Source: Fact Set
Q Why did you make these changes?
A Our interest rate outlook played a major role in structuring the portfolio. As
interest rates rose, we reduced the portion of the Fund invested in ARMS and
increased holdings in U.S. Treasuries with short- and intermediate-term
maturities. This enabled the Fund to lock in higher yields while lowering
prepayment risk. Prepayment risk is the possibility that a mortgage holder will
make additional payments to reduce his/her mortgage principal. Prepayments lower
the outstanding balance of the security and reduce the corresponding income that
otherwise would be earned by the portfolio. U.S. Treasury securities carry no
risk of prepayment and yields are locked in until the security reaches its
maturity date.
Q Turning to the ongoing nature of the Fund, in what do you invest?
A The Fund invests primarily in adjustable-rate mortgage securities (ARMS). It
can also invest in selected fixed-rate mortgages and U.S. Treasury and agency
securities.
Q What are the different types of ARMS?
A There are conventional ARMS which include ARMS issued by the Federal National
Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage
Corporation ("Freddie Mac"). There are also ARMS issued by the Government
National Mortgage Association ("Ginnie Maes") which are guaranteed as to
principal and interest; and whole loan ARMS, which are not guaranteed by the
U.S. government. We only invest in conventional, Ginnie Mae, Fannie Mae, and
Freddie Mac ARMS. We tend to emphasize Fannie Maes because their structure is a
little more flexible than Ginnie Mae's. Fannie Mae's have a 2% rate cap, versus
a 1% cap for Ginnie Mae's.
Q How do you manage the Fund?
A We seek to achieve a greater total return than other short-term alternatives,
without incurring additional price volatility. We believe the Fund can serve as
the liquid portion of an investor's portfolio and also as a safe-haven in an
uncertain market environment. We believe the price volatility most recently
endured by the bond market underscores the benefits of the Fund's emphasis on
diversification, liquidity and income.
Q How do you determine which securities best fit the portfolio's objectives?
A The portfolio's investments undergo a careful selection process that includes
a review of a security's geographic diversification, mortgage rate adjustment
dates, and its fit with our interest rate outlook. We maintain high credit
standards, investing only in those securities that are government guaranteed or
issued by a U.S. government agency. We believe these factors have contributed to
the Fund's price stability and liquidity.
<PAGE>
PAGE 5
Asset Allocation
as of September 30, 1996
[pie chart]
ARMS 84.4%
Fixed-rate mortgage securities 3.1%
U.S. Treasury securities 11.1%
Other(2) 1.4%
(as a percentage of net assets)
Q What is your outlook for this market over the next six months?
A We believe the economy will experience slower growth through the end of this
year and into early 1997, although we do not expect a recession. Household debt
has reached a level that we believe will cause consumers to curtail spending.
Further, we
- -----------------
(2)Includes repurchase agreement and other assets and liabilities.
anticipate that the higher interest rates we have seen this year should have a
negative effect on other economic activity, such as housing.
We expect inflation should continue to be well-contained, although there are
some preliminary pressures for wage-inflation. A low inflation environment,
combined with slower economic growth historically has provided a positive
backdrop for the bond market. We think interest rates will continue to trade in
a narrow range through 1997.
[diamond]
This column is intended to answer
questions about your Fund. If you have a question
you would like answered, please write to:
Keystone Investment Distributors Company
Attn: Shareholder Communications, 22nd Floor
200 Berkeley Street, Boston, Massachusetts 02116-5034.
<PAGE>
PAGE 6
Keystone Capital Preservation and Income Fund
Your Fund's Performance
Growth of an investment in
Keystone Capital Preservation and Income Fund
Class B
[mountain chart]
In Thousands
Initial Investment Reinvested Distributions
7/91 10010 10068
10060 10243
9/92 9880 10623
9910 11065
9/94 9620 11129
9680 11776
9/96 9750 12470
Total Value: $12,470
A $10,000 investment in Keystone Capital Preservation and Income Fund Class B
made on July 1, 1991 with all distributions reinvested was worth $12,470 on
September 30, 1996. Past performance is no guarantee of future results.
Twelve-Month Performance as of September 30, 1996
Class A Class B Class C
Total returns* 6.56% 5.90% 5.91%
Net asset value 9/30/95 $9.68 $9.68 $9.67
9/30/96 $9.74 $9.75 $9.74
Distributions $0.56 $0.49 $0.49
Capital gains None None None
* Before deducting sales charges.
Historical Record as of September 30, 1996
Cumulative total returns Class A Class B Class C
Without sales charge
1-year 6.56% 5.90% 5.91%
5-year -- 21.75% --
Since inception 13.33% 24.70% 16.43%
With sales charge
1-year 3.36% 2.90% 5.91%
5-year -- 21.75% --
Since inception 9.93% 24.70% 16.43%
Average Annual Returns
1-year 3.36% 2.90% 5.91%
5-year -- 4.01% --
Since inception 5.55% 4.29% 4.24%
Commencement of
operations 12/30/94 7/1/91 2/1/93
Class A share performance is reported after deducting the maximum front-end
sales charge of 3%.
Class B shares are sold without a front-end sales charge. Performance reflects
the deduction of the maximum contingent deferred sales charge of 3% assuming
shares were redeemed at the end of the period. If you have not redeemed, your
return was greater than the figure listed.
Class C shares are sold without a front-end sales charge. Performance reflects
the return you would have received after holding shares for one year or more and
redeeming after the end of that period.
The investment return and principal value will fluctuate so that your shares,
when redeemed, may be worth more or less than the original cost.
Performance for each Class may differ.
Shareholders may exchange shares for another Keystone fund. The exchange fee
is waived for individual investors who request an exchange through Keystone's
Automated Response Line (KARL). Investors who exchange by calling or writing to
Keystone directly are subject to a $10 exchange fee. The Fund reserves the right
to change or terminate the exchange offer.
<PAGE>
PAGE 7
Growth of an Investment
Comparison of change in value of a $10,000 investment in Keystone Capital
Preservation & Income Fund Class B, 6-month Treasury Bills and the Consumer
Price Index.
In Thousands July 1, 1991 through September 30, 1996
[3-line chart]
Class B 6-month Treasury Bill (6 mo. T-Bill) Consumer Price Index (CPI)
10000 10000 10000
9/91 10243 10137 10088
9/92 10623 10536 10390
9/93 11065 10870 10669
9/94 11129 11312 10985
9/95 11776 10775 11265
9/96 12470 11341 11566
Average Annual Total Return
1 Year 5 Year Life of Class
Class A 3.36% - 5.55%
Class B 2.90% 4.01% 4.29%
Class C 5.91% - 4.24%
Class B
$12,470
CPI
$11,566
6-mo. T-Bill
$11,341
Past performance is no guarantee of future results. The performance of Class A
or Class C shares will be greater or less than the line shown based on
difference in loads and fees paid by the shareholder investing in the different
classes. Class A shares were introduced on December 30, 1994; Class B shares
were introduced on July 1, 1991; and Class C shares were introduced on February
1, 1993. The Consumer Price Index and the 6-mo. T-Bill are from June 30, 1991.
Consumer Price Index is through August 31, 1996.
This chart graphically compares your Fund's performance to certain investment
indexes. It is the result of fund performance guidelines issued by the
Securities and Exchange Commission. The intent is to provide investors with more
information about their investment.
Components of the chart
The chart is composed of several lines that represent the accumulated value of
an initial $10,000 investment for the period indicated. The lines illustrate a
hypothetical investment in:
1. Keystone Capital Preservation and Income Fund Class B
The Fund seeks high income and stability of principal primarily from
adjustable-rate mortgage securities. The return is quoted after deducting sales
charges (if applicable), fund expenses, and transaction costs and assumes
reinvestment of all distributions.
2. 6-month U.S. Treasury Bill (6-mo T-bill)
The total return of 6-month Treasury bill is a recognized benchmark for the
performance of short-term obligations. U.S. Treasury securities are guaranteed
by the full faith and credit of the United States government and may have
different performance than the securities your Fund invests in.
3. Consumer Price Index (CPI)
This index is a widely recognized measure of the cost of goods and services
produced in the U.S. The index contains factors such as prices of services,
housing, food, transportation and electricity which are compiled by the U.S.
Bureau of Labor Statistics. The CPI is generally considered a valuable benchmark
for investors who seek to outperform increases in the cost of living.
These indexes do not include transaction costs associated with buying and
selling securities, and do not hold cash to meet redemptions. It would be
difficult for most individual investors to duplicate these indexes.
Understanding what the chart means
The chart demonstrates your Fund's performance in relation to a well known
investment index and to increases in the cost of living. It is important to
understand what the chart shows and does not show.
This illustration is useful because it charts Fund and index performance over
the same time frame and over a long period. Long-term performance is a more
reliable and useful measure of performance than measurements of short-term
returns or temporary swings in the market. Your financial adviser can help you
evaluate fund performance in conjunction with the other important financial
considerations such as safety, stability and consistency.
<PAGE>
PAGE 8
Keystone Capital Preservation and Income Fund
Limitations of the chart
The chart, however, limits the evaluation of Fund performance in several ways.
Because the measure is based on total returns over an extended period of time,
the comparison often favors those funds which emphasize capital appreciation
when the market is rising. Likewise, when the market is declining, the
comparison usually favors those funds which take less risk.
Performance can be distorted
Funds which are more conservative in their orientation and which place an
emphasis on capital preservation will tend to compare less favorably when the
market is rising. In addition, funds which have income as one of their
objectives also will tend to compare less favorably to relevant indexes.
Indexes may also reflect the performance of some securities which a fund may
be prohibited from buying. A bond fund, for example, may be limited to
investments in only high quality bonds, or a stock fund may only be able to buy
stocks that have been traded on a stock exchange for a minimum number of years
or stocks that have a certain market capitalization. Indexes usually do not have
the same investment restrictions as your Fund.
Indexes do not include costs of investing
The comparison is further limited in its utility because the indexes do not take
into account any deductions for sales charges, transaction costs or other fund
expenses. Your Fund's performance figures do reflect such deductions. Sales
charges--whether up-front or deferred--pay for the cost of the investment advice
of your financial adviser. Transaction costs pay for the costs of buying and
selling securities for your Fund's portfolio. Fund expenses pay for the costs of
investment management and various shareholder services. None of these costs are
reflected in index total returns. The comparison is not completely realistic
because an index cannot be duplicated by an investor--even an unmanaged
index--without incurring some charges and expenses.
One of several measures
The chart is one of several tools you can use to understand your investment. It
should be read in conjunction with the Fund's prospectus, and annual and
semiannual reports. Also, your financial adviser, who understands your personal
financial situation, can best explain the features of your Keystone fund and how
it applies to your financial needs.
Future returns may be different
Shareholders also should be mindful that the long-run performance of either the
Fund or the indexes is not representative of what shareholders should expect to
receive from their Fund investment in the future; it is presented to illustrate
only past performance and is not a guarantee of future returns.
<PAGE>
PAGE 9
Glossary of
Mutual Fund Terms
MUTUAL FUND--A company which combines the investment money of many people
whose financial goals are similar, and invests that money in a variety of
securities. A mutual fund allows the smaller investor the benefits of
diversification, professional management and constant supervision usually
available only to large investors.
PORTFOLIO MANAGER--An investment professional who is responsible for managing
a portfolio's assets prudently and making appropriate investment decisions, such
as which securities to buy, hold and sell, based on the investment objectives of
the portfolio.
STOCK--Equity or ownership interest in a corporation, which represents a claim
on the corporation's assets and earnings.
BOND--Security issued by a government or corporation to those from whom it has
borrowed money. A bond usually promises to pay interest income to the bondholder
at regular intervals and to repay the entire amount borrowed at maturity date.
CONVERTIBLE SECURITY--A corporate security (usually preferred stock or bonds)
that is exchangeable for a set number of another security type (usually common
stocks) at a pre-stated price.
MONEY MARKET FUND--A mutual fund whose assets are invested in a diversified
portfolio of short-term securities, including commercial paper, bankers'
acceptances, certificates of deposit and other short-term instruments. The fund
pays income which can fluctuate daily. Liquidity and safety of principal are
primary objectives.
NET ASSET VALUE (NAV) PER SHARE--The value of one share of a mutual fund. The
NAV per share is determined by subtracting a fund's total liabilities from its
total assets, and dividing that amount by the number of fund shares outstanding.
DIVIDEND--A per share distribution of the income earned from the fund's
portfolio holdings. When a dividend distribution is made, the fund's net asset
value drops by the amount of the distribution because the distribution is no
longer considered part of the fund's assets.
CAPITAL GAIN--The profit from the sale of securities, less any losses. Capital
gains are paid to fund shareholders on a per share basis. When a capital gain
distribution is made, the fund's net asset value drops by the amount of the
distribution because the distribution is no longer considered part of the fund's
assets.
YIELD--The annualized rate of income as measured against the current net asset
value of fund shares.
TOTAL RETURN--The change in value of a fund investment over a specified period
of time, taking into account the change in a fund's market price and the
reinvestment of all fund distributions.
SHORT-TERM--An investment with a maturity of one year or less.
LONG-TERM--An investment with a maturity of greater than one year.
AVERAGE MATURITY--The average number of days until the notes, drafts,
acceptances, bonds or other debt instruments in a portfolio become due and
payable.
OFFERING PRICE--The offering price of a share of a mutual fund is the price at
which the share is sold to the public.
<PAGE>
PAGE 10
Keystone Capital Preservation and Income Fund
SCHEDULE OF INVESTMENTS--September 30, 1996
<TABLE>
<CAPTION>
Interest Maturity Principal Market
Rate Date Amount Value
- --------------------------------------------- ---------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
ADJUSTABLE RATE MORTGAGE SECURITIES (84.4%)
FHLMC (40.6%)
FHLMC Pool #605386, Cap 12.89%, Margin
2.12% + CMT, Resets Annually 7.77% 09/01/17 $1,642,790 $ 1,708,239
FHLMC Pool #605343, Cap 13.60%, Margin
2.13% + CMT, Resets Annually 7.75 03/01/19 1,842,440 1,904,622
FHLMC Pool #645062, Cap 14.11%, Margin
2.31% + CMT, Resets Annually 7.84 05/01/19 188,456 193,461
FHLMC Pool #785114, Cap 13.23%, Margin
2.13% + CMT, Resets Annually 7.52 07/01/19 175,166 182,446
FHLMC Pool #865220, Cap 15.05%, Margin
2.35% + CMT, Resets Annually 8.35 04/01/20 973,231 998,778
FHLMC Pool #785147, Cap 12.79%, Margin
2.02% + CMT, Resets Annually 7.67 05/01/20 81,119 83,451
FHLMC Pool #606541, Cap 13.56%, Margin
2.04% + CMT, Resets Annually 7.47 03/01/21 771,183 801,429
FHLMC Pool #845039, Cap 12.50%, Margin
2.09% + CMT, Resets Annually 7.68 10/01/21 2,755,886 2,847,175
FHLMC Pool #606679, Cap 12.07%, Margin
2.16% + CMT, Resets Annually 7.80 10/01/21 1,608,729 1,664,278
FHLMC Pool #845063, Cap 12.05%, Margin
2.18% + CMT, Resets Annually 7.78 11/01/21 2,314,655 2,395,668
FHLMC Pool #845070, Cap 11.84%, Margin
2.12% + CMT, Resets Annually 7.67 01/01/22 2,742,414 2,845,255
FHLMC Pool #845082, Cap 12.34%, Margin
1.98% + CMT, Resets Annually 7.46 03/01/22 2,031,491 2,089,897
FHLMC Pool #607352, Cap 13.62%, Margin
2.17% + CMT, Resets Annually 7.65 04/01/22 5,769,042 6,000,554
FHLMC Pool #846298, Cap 13.04%, Margin
1.85% + CMT, Resets Annually 7.17 08/01/22 4,933,484 5,070,697
------------------------------------------- ------ ------ ------ -------
TOTAL FHLMC 28,785,950
------------------------------------------- ------ ------ ------ -------
FNMA (43.8%)
FNMA Pool #094564, Cap 15.86%, Margin 1.98%
+ CMT, Resets Annually 7.36 01/01/16 1,200,671 1,245,888
FNMA Pool #092086, Cap 15.47%, Margin 2.08%
+ CMT, Resets Annually 7.47 10/01/16 582,915 603,043
FNMA Pool #070033, Cap 14.35%, Margin 1.75%
+ CMT, Resets Annually 7.50 10/01/17 843,629 870,650
FNMA Pool #070119, Cap 12.01%, Margin 2.00%
+ CMT, Resets Annually 7.58 11/01/17 3,662,290 3,795,048
FNMA Pool #062610, Cap 12.75%, Margin 2.13%
+ CMT, Resets Annually 7.75 06/01/18 390,517 405,649
FNMA Pool #090678, Cap 13.14%, Margin 2.18%
+ CMT, Resets Annually 7.64 09/01/18 2,916,474 3,042,261
FNMA Pool #114714, Cap 12.62%, Margin 1.75%
+ CMT, Resets Annually 7.31 03/01/19 351,239 362,106
FNMA Pool #105007, Cap 13.13%, Margin 2.03%
+ CMT, Resets Annually 7.57 07/01/19 324,281 333,147
FNMA Pool #095405, Cap 13.70%, Margin 2.08%
+ CMT, Resets Annually 7.60 12/01/19 1,729,829 1,788,211
FNMA Pool #102905, Cap 13.08%, Margin 2.00%
+ CMT, Resets Annually 7.37 07/01/20 922,118 957,851
FNMA Pool #124289, Cap 13.44%, Margin 2.01%
+ CMT, Resets Annually 7.52 09/01/21 8,663,820 9,017,131
FNMA Pool #124204, Cap 13.60%, Margin 2.01%
+ CMT, Resets Annually 7.58 01/01/22 1,119,555 1,167,136
FNMA Pool #124945, Cap 12.73%, Margin 2.11%
+ CMT, Resets Annually 7.62 01/01/31 2,445,125 2,550,583
FNMA Pool #238847, Cap 13.33%, Margin 2.32%
+ CMT, Resets Annually 7.82 06/01/31 4,733,101 4,937,239
------------------------------------------- ------ ------ ------ -------
TOTAL FNMA 31,075,943
------------------------------------------- ------ ------ ------ -------
TOTAL ADJUSTABLE RATE MORTGAGE SECURITIES (COST--$59,620,608) 59,861,893
---------------------------------------------------------------------- ------ -------
FIXED RATE MORTGAGE SECURITIES (3.1%)
FHLMC (0.1%)
FHLMC CMO, Series 11 Class 11C (Est. Mat.
1998) (b) 9.50 04/15/19 32,208 33,245
FHLMC CMO, Series 41 Class 41E (Est. Mat.
1996) (b) 10.00 08/15/19 37,669 37,539
------------------------------------------- ------ ------ ------ -------
TOTAL FHLMC 70,784
------------------------------------------- ------ ------ ------ -------
<PAGE>
PAGE 11
FNMA (3.0%)
FNMA Pool #100051 (Est. Mat. 1999) (b) 9.50% 04/01/05 $ 435,028 $ 455,827
FNMA Pool #002497 (Est. Mat. 2001) (b) 11.00 01/01/16 532,791 588,516
FNMA Pool #058442 (Est. Mat. 2001) (b) 11.00 01/01/18 980,129 1,081,513
------------------------------------------- ------ ------ ------ -------
TOTAL FNMA 2,125,856
------------------------------------------- ------ ------ ------ -------
TOTAL FIXED RATE MORTGAGE SECURITIES (COST--$2,184,634) 2,196,640
---------------------------------------------------------------------- ------ -------
U.S. TREASURY NOTES (11.1%)
U.S. Treasury Notes 6.13 08/31/98 3,900,000 3,901,209
U.S. Treasury Notes 6.00 08/15/99 4,000,000 3,971,880
------------------------------------------- ------ ------ ------ -------
TOTAL U.S. TREASURY NOTES (COST--$7,863,492) 7,873,089
---------------------------------------------------------------------- ------ -------
Maturity
Value
------------------------------------------- ------ ------ ------ -------
REPURCHASE AGREEMENT (0.5%)
Keystone Joint Repurchase Agreement
(Investments in repurchase agreements, in
a joint trading account, purchased
9/30/96) (Cost--$339,000) (c) 5.73 10/1/96 339,054 339,000
------------------------------------------- ------ ------ ------ -------
TOTAL INVESTMENTS (COST--$70,007,734) (A) 70,270,622
OTHER ASSETS AND LIABILITIES--NET (0.9%) 661,669
-------------------------------------------------------- ------ ------ -------
NET ASSETS--(100%) $70,932,291
-------------------------------------------------------- ------ ------ -------
</TABLE>
(a) The cost of investments for federal income tax purposes is identical to book
basis. Gross unrealized appreciation and depreciation of investments, based
on identified tax cost at September 30, 1996 are as follows:
Gross unrealized appreciation $303,441
Gross unrealized depreciation (40,553)
----------
Net unrealized appreciation $262,888
==========
(b) The estimated maturity of a Collateralized Mortgage Obligation ("CMO") is
based on current and projected prepayment rates. Changes in interest rates
can cause the estimated maturity to differ from the listed dates.
(c) The repurchase agreements are fully collateralized by U.S. government
and/or agency obligations based on market prices at September 30, 1996.
Legend of Portfolio Abbreviations
CMO--Collateralized Mortgage Obligation
CMT--1, 3, or 5 year Constant Maturity Treasury Index
FHLMC--Federal Home Loan Mortgage Corporation
FNMA--Federal National Mortgage Association
See Notes to Financial Statements.
<PAGE>
PAGE 12
Keystone Capital Preservation and Income Fund
FINANCIAL HIGHLIGHTS--CLASS A SHARES
(For a share outstanding throughout each year)
<TABLE>
<CAPTION>
December 30, 1994
Year Ended (Date of Initial
September 30, 1996 Public Offering) to
(d) September 30, 1995
====================================================== ==========================================
<S> <C> <C>
Net asset value beginning of year $9.68 $9.51
------------------------------------------------------ ------------------------------------------
Income from investment operations:
Net investment income 0.61 0.46
Net realized and unrealized gain on investments 0.01 0.14
------------------------------------------------ ------------------- ------------------
Total from investment operations 0.62 0.60
------------------------------------------------ ------------------- ------------------
Less distributions from:
Net investment income (0.53) (0.42)
In excess of net investment income 0 (0.01)
Tax basis return of capital (0.03) 0
------------------------------------------------ ------------------- ------------------
Total distributions (0.56) (0.43)
------------------------------------------------ ------------------- ------------------
Net asset value end of year $9.74 $9.68
================================================ =================== ==================
Total return (a) 6.56% 6.36%
Ratios/supplemental data
Ratios to average net assets:
Total expenses (b) 0.91% 0.86%(c)
Total expenses excluding reimbursement 1.33% 1.27%(c)
Net investment income 6.31% 6.37%(c)
Portfolio turnover rate 74% 67%
Net assets end of year (thousands) $22,684 $19,293
================================================ =================== ==================
</TABLE>
(a) Excluding applicable sales charges.
(b) Ratio of total expenses to average net assets includes indirectly paid
expenses. Excluding indirectly paid expenses, the expense ratios would have
been 0.90% for the year ended September 30, 1996 and 0.82% (annualized) for
the period December 30, 1994 (Date of Initial Public Offering) to September
30, 1995.
(c) Annualized.
(d) Calculation based on average shares outstanding.
See Notes to Financial Statements.
<PAGE>
PAGE 13
FINANCIAL HIGHLIGHTS--CLASS B SHARES
(For a share outstanding throughout each year)
<TABLE>
<CAPTION>
July 1, 1991
(Commencement
of
Operations)
Year Ended September 30, to
September
1996 (d) 1995 1994 1993 1992 30, 1991
========================================= ========== ========== ======== ========= ========= ============
<S> <C> <C> <C> <C> <C> <C>
Net asset value beginning of year $9.68 $9.62 $9.91 $9.88 $10.06 $10.00
------------------------------------ --------- --------- ------- -------- -------- -----------
Income from investment operations:
Net investment income 0.55 0.52 0.47 0.45 0.58 0.18
Net realized and unrealized gain
(loss) on investments 0.01 0.03 (0.41) (0.05) (0.21) 0.06
------------------------------------ --------- --------- ------- -------- -------- -----------
Total from investment operations 0.56 0.55 0.06 0.40 0.37 0.24
------------------------------------ --------- --------- ------- -------- -------- -----------
Less distributions from:
Net investment income (0.46) (0.48) (0.34) (0.37) (0.55) (0.18)
In excess of net investment income 0 (0.01) (0.01) 0 0 0
Tax basis return of capital (0.03) 0 0 0 0 0
------------------------------------ --------- --------- ------- -------- -------- -----------
Total distributions (0.49) (0.49) (0.35) (0.37) (0.55) (0.18)
------------------------------------ --------- --------- ------- -------- -------- -----------
Net asset value end of year $9.75 $9.68 $9.62 $9.91 $ 9.88 $10.06
==================================== ========= ========= ======= ======== ======== ===========
Total return (a) 5.90% 5.81% 0.58% 4.16% 3.71% 2.43%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 1.63%(b) 1.53%(b) 1.50% 1.50% 1.36% 1.19%(c)
Total expenses excluding
reimbursement 2.09% 2.09% 1.93% 1.94% 2.03% 3.19%(c)
Net investment income 5.63% 5.46% 4.05% 4.44% 5.50% 6.42%(c)
Portfolio turnover rate 74% 67% 34% 60% 41% 2%
Net assets end of year (thousands) $44,096 $62,998 $95,761 $144,725 $186,742 $25,769
==================================== ========= ========= ======= ======== ======== ===========
</TABLE>
(a) Excluding applicable sales charges.
(b) Ratio of total expenses to average net assets includes indirectly paid
expenses. Excluding indirectly paid expenses, the expense ratios would have
been 1.62% and 1.50% for the years ended September 30, 1996 and 1995,
respectively.
(c) Annualized.
(d) Calculation based on average shares outstanding.
See Notes to Financial Statements.
<PAGE>
PAGE 14
Keystone Capital Preservation and Income Fund
FINANCIAL HIGHLIGHTS--CLASS C SHARES
(For a share outstanding throughout each year)
<TABLE>
<CAPTION>
February 1, 1993
(Date of Initial
Year Ended September 30, Public Offering) to
1996 (d) 1995 1994 September 30, 1993
========================================================= ========= ======= =====================
<S> <C> <C> <C> <C>
Net asset value beginning of year $9.67 $9.60 $9.90 $9.82
- ------------------------------------------- -------- -------- ------ ------------------
Income from investment operations:
Net investment income 0.54 0.52 0.40 0.23
Net realized and unrealized gain (loss) on
investments 0.02 0.04 (0.35) 0.09
- ------------------------------------------- -------- -------- ------ ------------------
Total from investment operations 0.56 0.56 0.05 0.32
- ------------------------------------------- -------- -------- ------ ------------------
Less distributions from:
Net investment income (0.46) (0.48) (0.34) (0.24)
In excess of net investment income 0 (0.01) (0.01) 0
Tax basis return of capital (0.03) 0 0 0
- ------------------------------------------- -------- -------- ------ ------------------
Total distributions (0.49) (0.49) (0.35) (0.24)
- ------------------------------------------- -------- -------- ------ ------------------
Net asset value end of year $9.74 $9.67 $9.60 $9.90
=========================================== ======== ======== ====== ==================
Total return (a) 5.91% 5.93% 0.48% 3.28%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 1.64%(b) 1.53%(b) 1.50% 1.50%(c)
Total expenses excluding reimbursement 2.09% 2.08% 1.94% 1.67%(c)
Net investment income 5.60% 5.51% 4.08% 2.91%(c)
Portfolio turnover rate 74% 67% 34% 60%
Net assets end of year (thousands) $4,152 $2,755 $2,874 $2,077
=========================================== ======== ======== ====== ==================
</TABLE>
(a) Excluding applicable sales charges.
(b) Ratio of total expenses to average net assets includes indirectly paid
expenses. Excluding indirectly paid expenses, the expense ratios would have
been 1.62% and 1.50% for the years ended September 30, 1996 and 1995,
respectively.
(c) Annualized.
(d) Calculations based on average shares outstanding.
See Notes to Financial Statements.
<PAGE>
PAGE 15
STATEMENT OF ASSETS AND LIABILITIES
September 30, 1996
Assets (Notes 2 and 5)
Investments at market value (identified cost--
$70,007,734) $70,270,622
Cash 1,482
Receivable for:
Interest 600,975
Principal paydowns 156,891
Investments sold 148,985
Fund shares sold 85,000
Due from investment adviser 20,993
Prepaid expenses and other assets 3,487
------------------------------------------------ -------------
Total assets 71,288,435
------------------------------------------------ -------------
Liabilities (Notes 2, 4 and 5)
Payable for:
Distributions to shareholders 305,954
Distribution fees 3,916
Due to related parties 2,782
Other accrued expenses 43,492
------------------------------------------------ -------------
Total liabilities 356,144
------------------------------------------------ -------------
Net assets $70,932,291
================================================ =============
Net assets represented by (Note 2)
Paid-in capital $78,124,462
Accumulated distributions in excess of net
investment income (305,808)
Accumulated net realized loss on investments (7,149,251)
Net unrealized appreciation on investments 262,888
------------------------------------------------ -------------
Total net assets $70,932,291
================================================ =============
Net asset value (Note 2)
Class A
Net assets of $22,684,306 / 2,328,385
shares outstanding $9.74
Offering price per share ($9.74 / 0.97)
(based on a sales charge of 3.00% of the
offering price at September 30, 1996) $10.04
Class B
Net assets of $44,096,180 / 4,522,486
shares outstanding $9.75
Class C
Net assets of $4,151,805 / 426,166
shares outstanding $9.74
================================================ =============
See Notes to Financial Statements.
STATEMENT OF OPERATIONS
Year Ended September 30, 1996
Investment income
Interest $5,536,633
- ---------------------------------------- --------- ------------
Expenses (Notes 4 and 5)
Management fee $ 493,147
Distribution Plan expenses 610,933
Transfer agent fees 139,248
Accounting, auditing and legal fees 62,134
Custodian fees 57,386
Registration fees 45,925
Amortization of organization expenses 3,896
Other 34,903
Reimbursement from investment adviser (341,016)
- ---------------------------------------- --------- ------------
Total expenses 1,106,556
Less: Expenses paid indirectly
(Note 6) (12,182)
- ---------------------------------------- --------- ------------
Net expenses 1,094,374
- ---------------------------------------- --------- ------------
Net investment income 4,442,259
- ---------------------------------------- --------- ------------
Net realized and unrealized loss on investments (Note 3)
Net realized loss on investments (549,777)
Net change in unrealized appreciation
(depreciation)
on investments 648,310
- ---------------------------------------- --------- ------------
Net realized and unrealized gain
on investments 98,533
- ---------------------------------------- --------- ------------
Net increase in net assets resulting
from operations $4,540,792
======================================== ========= ============
<PAGE>
PAGE 16
Keystone Capital Preservation and Income Fund
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Ended September 30,
1996 1995
- ---------------------------------------------------------------------------- ------------ --------------
<S> <C> <C>
Operations
Net investment income $ 4,442,259 $ 5,308,068
Net realized loss on investments (549,777) (1,162,200)
Net change in unrealized appreciation (depreciation) on investments 648,310 1,169,382
- ---------------------------------------------------------------------------- ------------ --------------
Net increase in net assets resulting from operations 4,540,792 5,315,250
- ---------------------------------------------------------------------------- ------------ --------------
Distributions to shareholders from (Note 1) Net investment income:
Class A (1,089,444) (909,585)
Class B (2,568,398) (3,706,229)
Class C (147,748) (143,406)
In excess of net investment income:
Class A 0 (26,148)
Class B 0 (106,543)
Class C 0 (4,122)
Tax basis return of capital:
Class A (52,292) 0
Class B (123,279) 0
Class C (7,092) 0
- ---------------------------------------------------------------------------- ------------ --------------
Total distributions to shareholders (3,988,253) (4,896,033)
- ---------------------------------------------------------------------------- ------------ --------------
Capital share transactions (Note 2)
Shares issued in connection with the acquisition of Keystone America Capital
Preservation and Income Fund-Class A (Note 7) 0 23,825,980
Proceeds from shares sold:
Class A 7,859,112 699,481
Class B 2,742,007 26,668,622
Class C 2,090,764 1,440,686
Payments from shares redeemed:
Class A (5,471,951) (6,023,682)
Class B (23,865,587) (62,204,625)
Class C (844,271) (1,696,123)
Net asset value of shares issued in reinvestment of dividends and distributions:
Class A 865,840 689,075
Class B 1,829,883 2,480,740
Class C 127,771 111,984
- ---------------------------------------------------------------------------- ------------ --------------
Net decrease in net assets resulting from capital share transactions (14,666,432) (14,007,862)
- ---------------------------------------------------------------------------- ------------ --------------
Total decrease in net assets (14,113,893) (13,588,645)
- ---------------------------------------------------------------------------- ------------ --------------
Net assets
Beginning of year 85,046,184 98,634,829
- ---------------------------------------------------------------------------- ------------ --------------
End of year [including accumulated distributions in excess of net investment
income as follows: 1996--($305,808) and 1995--($415,117)] (Note 1) $ 70,932,291 $ 85,046,184
============================================================================ ============ ==============
</TABLE>
See Notes to Financial Statements.
<PAGE>
PAGE 17
NOTES TO FINANCIAL STATEMENTS
(1.) Significant Accounting Policies
Keystone Capital Preservation and Income Fund (the "Fund") is a Massachusetts
business trust for which Keystone Investment Management Company ("Keystone") is
the Investment Adviser and Manager. Keystone is a wholly-owned subsidiary of
Keystone Investments, Inc. ("KII"). The Fund is registered under the Investment
Company Act of 1940, as amended (the "1940 Act"), as a diversified, open-end
investment company. The Fund offers several classes of shares. The Fund's
investment objective is to seek a high level of current income consistent with
low volatility of principal. The Fund pursues its investment objective primarily
by investing in adjustable-rate mortgage securities.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles, which
require management to make estimates and assumptions that affect amounts
reported herein. Although actual results could differ from these estimates, any
such differences are expected to be immaterial to the net assets of the Fund.
A. Valuation of Securities
U.S. Government obligations held by the Fund are valued at the mean between the
over-the-counter bid and asked prices as furnished by an independent pricing
service. Mortgage and other asset-backed securities, and other related
securities are valued at prices provided by an independent pricing service. In
determining value for normal institutional-size transactions, the pricing
service uses methods based on market transactions for comparable securities and
various relationships between securities which are generally recognized by
institutional traders. Securities for which valuations are not available from an
independent pricing service (including restricted securities) are valued at fair
value as determined in good faith according to procedures established by the
Board of Trustees.
Short-term investments with remaining maturities of 60 days or less are
carried at amortized cost, which approximates market value. Short-term
securities with greater than 60 days to maturity are valued at market value.
B. Repurchase Agreements
Pursuant to an exemptive order issued by the Securities and Exchange Commission,
the Fund, along with certain other Keystone funds, may transfer uninvested cash
balances into a joint trading account. These balances are invested in one or
more repurchase agreements that are fully collateralized by U.S. Treasury and/or
Federal Agency obligations.
Securities pledged as collateral for repurchase agreements are held by the
custodian on the Fund's behalf. The Fund monitors the adequacy of the collateral
daily and will require the seller to provide additional collateral in the event
the market value of the securities pledged falls below the carrying value of the
repurchase agreement.
C. Reverse Repurchase Agreements
The Fund may enter into reverse repurchase agreements with qualified third-party
broker-dealers. Interest on the value of reverse repurchase agreements is based
upon competitive market rates at the time of issuance. At the time the Fund
enters into a reverse repurchase agreement, it will establish and maintain a
segregated account with the custodian containing liquid assets having a value
not less than the repurchase price (including accrued interest). If the
counterparty to the transaction is rendered insolvent, the ultimate realization
of the securities to be repurchased by the Fund may be delayed or limited.
<PAGE>
PAGE 18
Keystone Capital Preservation and Income Fund
D. Security Transactions and Investment Income
Securities transactions are accounted for no later than one business day after
the trade date. Realized gains and losses are computed on the identified cost
basis. Interest income is recorded on the accrual basis and includes
amortization of discounts.
E. Organization Expenses
The Fund's organization expenses were amortized to operations over a five-year
period on a straight-line basis. As of September 30, 1996, all organization
costs have been fully amortized.
F. Federal Income Taxes
The Fund has qualified and intends to qualify in the future as a regulated
investment company under the Internal Revenue Code of 1986, as amended (the
"Code"). Thus, the Fund is relieved of any federal income tax liability by
distributing all of its net taxable investment income and net taxable capital
gains, if any, to its shareholders. The Fund also intends to avoid excise tax
liability by making the required distributions under the Code. Accordingly, no
provision for federal income taxes is required.
G. Distributions
The Fund declares dividends from net investment income daily and distributes
such dividend monthly and declares and distributes net capital gains, if any, at
least annually. Distributions to shareholders are recorded at the close of
business on the ex-dividend date.
Income and capital gains distributions to shareholders are determined in
accordance with income tax regulations, which may differ from generally accepted
accounting principles. These differences are primarily due to differing
treatment for paydown gains (losses) on mortgage-backed securities.
H. Class Allocations
Class A shares are offered at a public offering price which includes a maximum
sales charge of 3% payable at the time of purchase. Class B shares are sold
subject to a contingent deferred sales charge that is payable upon redemption
and decreases depending on how long the shares have been held. Class B shares
purchased on or after June 1, 1995 that have been outstanding for six years will
automatically convert to Class A shares. Class B shares purchased prior to June
1, 1995 retain their existing conversion or exchange rights. Class C shares are
sold subject to a contingent deferred sales charge payable on shares redeemed
within one year of purchase.
Income, expenses (other than class specific expenses) and realized and
unrealized gains and losses are prorated among the classes based on the relative
net assets of each class. Currently, class specific expenses are limited to
expenses incurred under the Distribution Plans for each class.
(2.) Capital Share Transactions
The Fund's Declaration of Trust authorizes the issuance of an unlimited number
of shares of beneficial interest, with no par value. Shares of beneficial
interest of the Fund are currently divided into Class A, Class B and Class C.
Transactions in shares of the Fund were as follows:
<PAGE>
PAGE 19
December 30, 1994
Year Ended (Date of Initial
September 30, Public Offering) to
1996 September 30, 1995
- ------------------------ ----------------- --------------------
Class A
Shares issued in
connection with
acquisition of
Keystone America
Capital Preservation
Income Fund (Note 7) 0 2,506,041
Shares sold 808,295 72,460
Shares redeemed (563,085) (656,221)
Shares issued in
reinvestment of
dividends and
distributions 89,475 71,420
- ------------------------ --------------- ------------------
Net increase 334,685 1,993,700
======================== =============== ==================
Year Ended September 30,
1996 1995
- ------------------------ --------------- ------------------
Class B
Shares sold 282,004 2,758,618
Shares redeemed (2,455,640) (6,464,191)
Shares issued in
reinvestment of
dividends and
distributions 187,040 257,649
- ------------------------ --------------- ------------------
Net decrease (1,986,596) (3,447,924)
======================== =============== ==================
Class C
Shares sold 215,390 150,700
Shares redeemed (86,982) (176,498)
Shares issued in
reinvestment of
dividends and
distributions 12,718 11,638
- ------------------------ --------------- ------------------
Net increase (decrease) 141,126 (14,160)
======================== =============== ==================
(3.) Securities Transactions
Cost of purchases and proceeds from sales of U.S. government securities
(excluding short-term securities) for the year ended September 30, 1996 were
$55,312,540 and $68,420,761, respectively.
The average daily balance of reverse repurchase agreements outstanding during
the year ended September 30, 1996 was $1,281,151 at a weighted average interest
rate of 5.36%. The maximum amount of reverse repurchase agreements at one time
during the year was $3,498,640 (including accrued interest).
As of September 30, 1996, the Fund has a capital loss carryover for federal
income tax purposes of approximately $7,121,000 which expires as follows:
$59,000--1999, $34,000--2000, $5,935,000--2001, $197,000--2002, $642,000--2003
and $254,000--2004.
(4.) Distribution Plans
The Fund bears some of the costs of selling its shares under Distribution Plans
adopted for its Class A, B and C shares pursuant to Rule 12b-1 under the 1940
Act. Under the Distribution Plans, the Fund pays its principal underwriter,
Keystone Investment Distributors Company ("KIDC"), a wholly-owned subsidiary of
Keystone, amounts which are calculated and paid daily.
The Class A Distribution Plan provides for expenditures, which are currently
limited to 0.25% annually of the average daily net assets of the Class A shares,
to pay expenses related to the distribution of Class A shares. During the year
ended September 30, 1996, the Fund paid $46,809 to KIDC under the Class A
Distribution Plan.
Pursuant to the Fund's Class B and Class C Distribution Plans, the Fund pays a
distribution fee which may not exceed 1.00% of the average daily net assets
<PAGE>
PAGE 20
Keystone Capital Preservation and Income Fund
of Class B and Class C shares, respectively. Of that amount, 0.75% is used to
pay distribution expenses and 0.25% is used to pay service fees.
During the year ended September 30, 1996, under the Class B Distribution
Plans, the Fund paid or accrued $520,801 for Class B shares purchased on or
before June 1, 1995 and $12,568 for Class B shares purchased after June 1, 1995.
The Fund paid $30,755 under the Class C Distribution Plan.
Each of the Distribution Plans may be terminated at any time by vote of the
Independent Trustees or by vote of a majority of the outstanding voting shares
of the respective class. However, after the termination of any Distribution Plan
and subject to the discretion of the Independent Trustees, payments to KIDC may
continue as compensation for services which had been earned while the
Distribution Plan was in effect.
KIDC intends, but is not obligated, to continue to pay distribution costs that
exceed the current annual payments from the Fund. KIDC intends to seek full
payment of such distribution costs from the Fund at such time in the future as,
and to the extent that, payment thereof by the Class B or Class C shares would
be within permitted limits.
At September 30, 1996, total unpaid distribution costs were $8,838,066 for
Class B shares purchased before June 1, 1995 and $93,772 for Class B shares
purchased on or after June 1, 1995. Unpaid distribution costs for Class C were
$520,103 at September 30, 1996.
Contingent deferred sales charges paid by redeeming shareholders are paid to
KIDC.
(5.) Investment Management Agreement and Other Affiliated Transactions
Under the terms of the Investment Management and Advisory Agreement between
Keystone and the Fund, Keystone provides investment management and
administrative services to the Fund. In return, Keystone is paid a management
fee, computed and paid daily, at an annual rate of 2.00% of the Fund's gross
investment income plus an amount determined by applying percentage rates
starting at 0.50% and declining as net assets increase to 0.25% per annum, to
the average daily net asset value of the Fund.
Keystone has voluntarily limited the expenses of Class A shares to 0.90% of
its average daily net assets. Effective December 1, 1995, Keystone limited the
expenses of Class B and C to 1.65% of the average daily net assets of each
respective class. Prior to December 1, 1995, the expenses of Class B and C were
limited to 1.50% of the average daily net assets of each respective class. For
the year ended September 30, 1996, Keystone reimbursed the Fund $341,016.
During the year ended September 30, 1996, the Fund paid or accrued $24,176 to
Keystone for certain accounting services. The Fund paid or accrued $139,248 to
Keystone Investor Resource Center, Inc., a wholly-owned subsidiary of Keystone,
for services rendered as the Fund's transfer and dividend disbursing agent.
Certain officers and/or Directors of Keystone are also officers and/or
Trustees of the Fund. Officers of Keystone and affiliated Trustees receive no
compensation directly from the Fund. Currently the Independent Trustees of the
Fund receive no compensation for their services.
(6.) Expense Offset Arrangement
The Fund has entered into an expense offset arrangement with its custodian. For
the year ended September 30, 1996, the Fund incurred total custody fees of
$57,386 and received a credit of $12,182 pursuant to this expense offset
arrangement, resulting in a net custody expense of $45,204. The assets deposited
with the custodian under this expense offset arrangement could have been
invested in income-producing assets.
<PAGE>
PAGE 21
(7.) Fund Reorganization
On December 30, 1994, the Fund acquired the net assets of Keystone America
Capital Preservation and Income Fund in exchange for Class A Shares of the Fund
pursuant to a plan of reorganization approved by the shareholders of Keystone
America Capital Preservation and Income Fund. The acquisition was accomplished
by a tax-free exchange of 2,506,041 shares of the Fund for the net assets of
Keystone America Capital Preservation and Income Fund. The net assets of
Keystone America Capital Preservation and Income Fund on that date, including
$301,751 of unrealized depreciation on investments, were combined with the Fund.
The aggregate net assets of the Fund and Keystone America Capital Preservation
and Income Fund immediately before the acquisition were $91,920,877 and
$23,825,980, respectively. The net assets of the Fund immediately after the
acquisition were $115,746,857.
(8.) Agreement and Plan of Acquisition
On September 6, 1996, KII entered into an Agreement and Plan of Acquisition and
Merger with First Union Corporation ("First Union") and First Union National
Bank of North Carolina ("FUNB-NC") and certain other parties pursuant to which
KII will be merged with and into a wholly-owned subsidiary of FUNB-NC. Subject
to the receipt of required regulatory and shareholder approvals, the proposed
merger is expected to take place in December 1996.
<PAGE>
PAGE 22
Keystone Capital Preservation and Income Fund
INDEPENDENT AUDITORS' REPORT
The Trustees and Shareholders
Keystone Capital Preservation and Income Fund
We have audited the accompanying statement of assets and liabilities of Keystone
Capital Preservation and Income Fund, including the schedule of investments, as
of September 30, 1996, and the related statement of operations for the year then
ended, the statements of changes in net assets for each of the years in the
two-year period then ended, and the financial highlights for the year ended
September 30, 1996 and the period from December 30, 1994 (Date of Initial Public
Offering) to September 30, 1995 for Class A shares; for each of the years in the
five-year period ended September 30, 1996, and for the period from July 1, 1991
(Commencement of Operations) to September 30, 1991 for Class B shares and for
each of the years in the three-year period ended September 30, 1996, and for the
period from February 1, 1993 (Date of Initial Public Offering) to September 30,
1993 for Class C shares. These financial statements and financial highlights are
the responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
September 30, 1996 by correspondence with the custodian and brokers. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of
Keystone Capital Preservation and Income Fund as of September 30, 1996, the
results of its operations for the year then ended, the changes in its net assets
for each of the years in the two-year period then ended, and the financial
highlights for each of the periods specified in the first paragraph above in
conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Boston, Massachusetts
November 1, 1996
<PAGE>
PAGE 23
FEDERAL TAX STATUS-FISCAL 1996 DISTRIBUTIONS (Unaudited)
The per share distributions paid to you for fiscal 1996, whether taken in shares
or cash, are as follows:
Income Tax Basis
Dividends Return of Capital
Class A Shares 0.53 0.03
- -------------- --------- -----------------
Class B Shares 0.46 0.03
- -------------- --------- -----------------
Class C Shares 0.46 0.03
- -------------- --------- -----------------
In January 1997 complete information on calendar year 1996 distributions will be
forwarded to you to assist in completing your 1996 federal income tax return.
<PAGE>
[wraparound cover]
KEYSTONE AMERICA
FAMILY OF FUNDS
[DIAMOND]
Balanced Fund II
California Insured Tax Free Fund
Capital Preservation and Income Fund
Florida Tax Free Fund
Fund for Total Return
Fund of the Americas
Global Opportunities Fund
Global Resources & Development Fund
Government Securities Fund
Hartwell Emerging Growth Fund, Inc.
Intermediate Term Bond Fund
Massachusetts Tax Free Fund
Missouri Tax Free Fund
New York Insured Tax Free Fund
Omega Fund
Pennsylvania Tax Free Fund
Small Company Growth Fund II
Strategic Income Fund
Tax Free Income Fund
World Bond Fund
-------------------------------
This report was prepared primarily for the information of the Fund's
shareholders. It is authorized for distribution if preceded or accompanied by
the Fund's current prospectus. The prospectus contains important information
about the Fund including fees and expenses. Read it carefully before you invest
or send money. For a free prospectus on other Keystone funds, contact your
financial adviser or call Keystone.
[KEYSTONE LOGO] KEYSTONE
INVESTMENTS
P.O. Box 2121
Boston, Massachusetts 02106-2121
CPI-R-11/96
5.3M [RECYCLE LOGO]
-------------------------------
K E Y S T O N E
[GRAPHIC
OF
MOUNTAINS]
CAPITAL
PRESERVATION AND
INCOME FUND
-------------------------------
[KEYSTONE LOGO]
ANNUAL REPORT
SEPTEMBER 30, 1996
