<PAGE>
KEYSTONE INSTITUTIONAL ADJUSTABLE
RATE FUND
PROSPECTUS JANUARY 8, 1996
Keystone Institutional Adjustable Rate Fund (the "Fund") is a diversified,
open-end management investment company, commonly known as a mutual fund, that
seeks a high level of current income, consistent with low volatility of
principal, by investing under ordinary circumstances at least 65% of its
assets in adjustable rate securities. Such securities include adjustable rate
mortgage securities that are issued or guaranteed by the United States
("U.S.") government, its agencies or instrumentalities. The Fund does not
attempt to maintain a constant price per share. The Fund does, however, follow
a strategy that seeks to minimize changes in its net asset value per share by
investing primarily in adjustable rate securities whose interest rates are
periodically reset when market rates change. The Fund is designed for
institutional investors and seeks to provide a relatively stable net asset
value while providing high current income relative to high-quality, short-term
investment alternatives. Of course, there can be no assurance that the Fund's
objective will be achieved.
The Fund offers two classes of shares. Class Y shares are offered without an
initial sales charge and are not subject to a sales charge when they are
redeemed. Class Y shares make payments (currently limited to 0.25% of the
average daily net asset value of Class Y shares) under a Distribution Plan
adopted pursuant to Rule 12b-1 under the Investment Company Act of 1940 ("1940
Act"). Class Z shares are also offered without a sales charge at the time of
purchase and are not subject to a sales charge when they are redeemed. There
is no Distribution Plan in respect of Class Z shares. Class Z shares are
available to the following investors: officers, directors or trustees, and
employees of the Fund, Keystone Investment Management Company (formerly named
Keystone Custodian Funds, Inc.) ("Keystone"), the Fund's investment adviser,
Fiduciary Investment Company, Inc. ("FICO"), the Fund's principal underwriter,
or any of their affiliates, and members of the immediate families of such
persons, or any trust, pension, profit-sharing, or other retirement or benefit
plan for the benefit of such persons; present shareholders of Class Z shares
of the Fund; and existing investment advisory clients of Keystone
Institutional Company, Inc. (formerly named Keystone Investment Management
Corporation) ("KIC"), FICO, or any of their affiliates. See "How to Buy
Shares."
This prospectus concisely states information about the Fund that you should
know before investing. Please read it and retain it for future
reference.
Additional information about the Fund is contained in a statement of
additional information dated January --, 1996, which has been filed with the
Securities and Exchange Commission and is incorporated by reference into this
prospectus. For a free copy, or for other information about the Fund, write to
the address or call the telephone number listed below.
KEYSTONE INSTITUTIONAL
ADJUSTABLE RATE FUND
200 BERKELEY STREET
BOSTON, MASSACHUSETTS 02116-5034
CALL TOLL FREE 1-800-633-2700
SHARES OF THE FUND ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR
ENDORSED BY, ANY BANK, AND SHARES ARE NOT FEDERALLY INSURED BY THE FEDERAL
DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
<PAGE>
TABLE OF CONTENTS
Page
Fee Table ........................................................... 3
Financial Highlights ................................................ 4
The Fund ............................................................ 6
Investment Objective and Policies ................................... 6
Risk Factors ........................................................ 8
Investment Restrictions ............................................. 10
Pricing Shares ...................................................... 10
Dividends and Taxes ................................................. 11
Fund Management and Expenses ........................................ 12
How to Buy Shares ................................................... 13
Alternative Sales Options ........................................... 14
Distribution Plan ................................................... 15
How to Redeem Shares ................................................ 15
Shareholder Services ................................................ 16
Performance Data .................................................... 16
Fund Shares ......................................................... 17
Additional Information .............................................. 17
Additional Investment Information ................................... (i)
<PAGE>
FEE TABLE
KEYSTONE INSTITUTIONAL ADJUSTABLE RATE FUND
The purpose of this fee table is to assist investors in understanding the
costs and expenses that an investor in each class will bear directly or
indirectly. For a more complete description of the various costs and expenses,
see the "Fund Management and Expenses" section of this prospectus.
<TABLE>
<CAPTION>
ANNUAL FUND OPERATING EXPENSES<F1> CLASS Y CLASS Z<F2>
(as a percentage of average net assets) SHARES SHARES
-------------- --------------
<S> <C> <C>
Management Fees ...................................................................... 0.30% 0.30%
12b-1 Fees ........................................................................... 0.25% 0.00%
Other Expenses ....................................................................... 0.00% 0.00%
---- ----
Total Fund Operating Expenses ........................................................ 0.55% 0.30%
==== ====
<CAPTION>
EXAMPLE<F3> 1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
You would pay the following expenses on a $1,000 investment
in the Fund, assuming (1) 5% annual return and (2)
redemption at the end of each period:
Class Y ................................................. $6 $18 $31 $69
Class Z ................................................. $3 $10 $17 $38
AMOUNTS SHOWN IN THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST
OR FUTURE EXPENSES; ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.
<FN>
- ----------
<F1> Expense ratios are for the Fund's fiscal year ending September 30, 1995.
<F2> Class Z shares are available only to certain investors, as described
previously.
<F3> The Securities and Exchange Commission requires use of a 5% annual return
figure for purposes of this example. Actual return for the Fund may be
greater or less than 5%.
</FN>
</TABLE>
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE INSTITUTIONAL ADJUSTABLE RATE FUND
CLASS Y SHARES
(FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD)
The following table contains important financial information relating to
the Fund and has been audited by KPMG Peat Marwick LLP, the Fund's independent
auditors. The table appears in the Fund's Annual Report and should be read in
conjunction with the Fund's financial statements and related notes, which also
appear, together with the independent auditors' report, in the Fund's Annual
Report. The Fund's financial statements, related notes, and independent
auditors' report are included in the statement of additional information.
Additional information about the Fund's performance is contained in its Annual
Report, which will be made available upon request and without charge.
<TABLE>
<CAPTION>
May 23, 1994 (Date of
Year Ended Initial Public Offering)
September 30, 1995 to September 30, 1994
---------------------- ----------------------------
<S> <C> <C>
NET ASSET VALUE BEGINNING OF PERIOD $9.61 $9.73
----- -----
Income from investment operations:
Net investment income ................. 0.64 0.17
Net realized and unrealized gain
(loss) on investments ............... (0.02) (0.13)
----- -----
Total from investment operations ...... 0.62 0.04
----- -----
Less distributions from:
Net investment income ................. (0.53) (0.16)
In excess of net investment income .... (0.05) 0
----- -----
Total distributions ................... (0.58) (0.16)
----- -----
NET ASSET VALUE END OF PERIOD ......... $9.65 $9.61
===== =====
TOTAL RETURN .......................... 6.60% 0.35%
RATIOS/SUPPLEMENTAL DATA
Ratios to average net assets:
Total expenses ...................... 0.55% 0.43%(a)
Net investment income ............... 6.70% 5.03%(a)
Portfolio turnover rate ............... 56% 63%
----- -----
Net assets end of period (thousands) . $2,871 $ 1
<FN>
- ------------
(a) Annualized.
</FN>
</TABLE>
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE INSTITUTIONAL ADJUSTABLE RATE FUND
CLASS Z SHARES
(FOR A SHARE OUTSTANDING THROUGHOUT THE YEAR)
The following table contains important financial information relating to
the Fund and has been audited by KPMG Peat Marwick LLP, the Fund's independent
auditors. The table appears in the Fund's Annual Report and should be read in
conjunction with the Fund's financial statements and related notes, which also
appear, together with the independent auditors' report, in the Fund's Annual
Report. The Fund's financial statements, related notes, and independent
auditors' report are included in the statement of additional information.
Additional information about the Fund's performance is contained in its Annual
Report, which will be made available upon request and without charge.
<TABLE>
<CAPTION>
Year Ended September 30,
----------------------------------------------------
1995 1994 1993(a) 1992
---- ---- ------- ----
<S> <C> <C> <C> <C>
NET ASSET VALUE BEGINNING OF YEAR ...... $9.61 $9.93 $9.88 $10.00
----- ----- ----- ------
Income from investment operations:
Net investment income .................. 0.63 0.63 0.54 0.67
Net realized and unrealized gain (loss)
on investments ....................... 0.01 (0.49) (0.01) (0.15)
----- ----- ----- -----
Total from investment operations ....... 0.64 0.14 0.53 0.52
----- ----- ----- -----
Less distributions from:
Net investment income .................. (0.55) (0.44) (0.48) (0.64)
In excess of net investment income ..... (0.05) (0.02) 0 0
----- ----- ----- -----
Total distributions .................... (0.60) (0.46) (0.48) (0.64)
----- ----- ----- -----
NET ASSET VALUE END OF YEAR ............ $9.65 $9.61 $9.93 $9.88
===== ===== ===== =====
TOTAL RETURN ........................... 6.87% 1.43% 5.53% 5.46%
RATIOS/SUPPLEMENTAL DATA
Ratios to average net assets:
Total expenses ....................... 0.30% 0.30% 0.30% 0.30%
Net investment income ................ 6.61% 5.15% 5.46% 6.83%
Portfolio turnover rate ................ 56% 63% 81% 88%
------ ------ ------ ------
Net assets end of year (thousands) ..... $23,616 $25,200 $60,035 $51,625
------ ------ ------ ------
<FN>
(a) Per share calculations based on weighted average shares outstanding.
</FN>
</TABLE>
<PAGE>
THE FUND
The Fund was formed as a Massachusetts business trust on June 19, 1991. The
Fund is one of more than thirty funds managed or advised by Keystone, the Fund's
investment adviser.
INVESTMENT OBJECTIVE AND POLICIES
INVESTMENT OBJECTIVE
The Fund seeks a high level of current income consistent with low volatility
of principal. The Fund pursues its investment objective by investing under
ordinary circumstances at least 65% of its assets in mortgage securities or
other securities collateralized by or representing an interest in a pool of
mortgages (collectively, "Mortgage Securities"), which securities have
interest rates that reset at periodic intervals and are issued or guaranteed
by the U.S. government, its agencies or instrumentalities. The Fund does not
attempt to maintain a constant price per share. The Fund follows a strategy
that seeks to minimize changes in its net asset value per share by investing
primarily in adjustable rate securities, the interest rates of which are
periodically reset when market rates change. The average dollar weighted reset
period of adjustable rate securities held by the Fund will not exceed one
year. The Fund seeks to provide a relatively stable net asset value while
providing high current income relative to high-quality, short-term investment
alternatives.
The investment objective of the Fund is fundamental and may not be changed
without approval of the holders of a majority (as defined in the Investment
Company Act of 1940 ("1940 Act"), of the Fund's outstanding shares (which means
the lesser of (1) 67% of the shares represented at a meeting at which more
than 50% of the outstanding shares are represented or (2) more than 50% of
the outstanding shares).
There is no assurance that the Fund will achieve its investment objective
since there is uncertainty in every investment.
INVESTMENT POLICIES AND APPROACH
Keystone believes that by investing primarily in Mortgage Securities with
adjustable rates of interest, the Fund will achieve a less volatile net asset
value per share than is characteristic of mutual funds that invest primarily
in U.S. government securities paying a fixed rate of interest.
Unlike fixed rate mortgages and loans that generally decline in value during
periods of rising interest rates, adjustable rate Mortgage Securities ("ARMS")
allow the Fund to participate in increases in interest rates through periodic
adjustments in the coupons of the underlying mortgages or loans, resulting in
both higher current yields and lower price fluctuations in the Fund's net
asset value per share. The Fund is also affected by decreases in interest
rates through periodic decreases in the coupons of the underlying mortgages or
loans resulting in lower income to the Fund. This downward adjustment results
in lower price fluctuations in the net asset value per share in a decreasing
interest rate environment. As the interest rates on the mortgages or loans
underlying the Fund's investments are reset periodically, coupons of portfolio
securities will gradually align themselves to reflect changes in market rates
and should cause the net asset value per share of the Fund to fluctuate less
dramatically than it would if the Fund invested in more traditional long-term,
fixed rate mortgages.
The portion of the Fund that is not invested in ARMS, if any, is intended to
increase the Fund's total return from changes in market rates while not
materially increasing the volatility of the net asset value per share.
The Fund intends to follow the policies of the Securities and Exchange
Commission as they are adopted from time to time with respect to illiquid
securities, including, at this time, (1) treating as illiquid, securities that
may not be sold or disposed of in the ordinary course of business within seven
days at approximately the value at which the Fund has valued such securities
on its books and (2) limiting its holdings of such securities to 15% of net
assets.
PERMITTED INVESTMENTS
The Fund invests in Mortgage Securities that are issued or guaranteed by the
U.S. government or one of its agencies or instrumentalities, such as the
Government National Mortgage Association ("GNMA"), the Federal National
Mortgage Association ("FNMA") and the Federal Home Loan Mortgage Corporation
("FHLMC"). Securities issued by GNMA, but not those issued by FNMA or FHLMC,
are backed by the full faith and credit of the U.S. government.
The Fund invests in mortgage pass-through securities representing
participation interests in pools of residential mortgage loans originated by
U.S. governmental lenders and guaranteed, to the extent provided in such
securities, by the U.S. government or one of its agencies or
instrumentalities. Such securities, which are ownership interests in the
underlying mortgage loans, differ from conventional debt securities, which
provide for periodic payment of interest in fixed amounts (usually
semiannually) and principal payments at maturity or on specified call dates.
Mortgage pass-through securities provide for monthly payments that are a
"pass-through" of the monthly interest and principal payments (including any
prepayments) made by the individual borrowers on the pooled mortgage loans,
net of any fees paid to the guarantor of such securities and the servicer of
the underlying mortgage loans.
The guaranteed mortgage pass-through securities in which the Fund invests
include those issued or guaranteed by GNMA, FNMA and FHLMC. GNMA certificates
are direct obligations of the U.S. government and, as such, are backed by the
full faith and credit of the U.S. government. FNMA is a federally chartered,
privately owned corporation. FHLMC is a corporate instrumentality of the U.S.
government. FNMA and FHLMC certificates are not backed by the full faith and
credit of the U.S. government and are supported only by the credit of FNMA and
FHLMC, which have the right to borrow to meet their obligations from an
existing line of credit with the U.S. Treasury. Although their close
relationship with the U.S. government is believed to make them high quality
securities with minimal credit risks, the U.S. government is not obligated by
law to support either FNMA or FHLMC. Historically, however, there have been no
defaults in any FNMA or FHLMC issues.
Certificates for Mortgage Securities evidence an interest in a specific pool
of mortgages. These certificates are, in most cases, "modified pass-through"
instruments, wherein the issuing agency guarantees the payment of principal
and interest on mortgages underlying the certificates, whether or not such
amounts are collected by the issuer on the underlying mortgages.
Adjustable rate mortgages are an important form of residential financing.
Generally, adjustable rate mortgages are mortgages that have a specified
maturity date and amortize in a manner similar to that of a fixed rate
mortgage. As a result, in periods of declining interest rates there is a
reasonable likelihood that adjustable rate mortgages will behave like fixed
rate mortgages in that current levels of prepayments of principal on the
underlying mortgages could accelerate. However, one difference between
adjustable rate mortgages and fixed rate mortgages is that for certain types
of adjustable rate mortgages the rate of amortization of principal, as well as
interest payments, can and does change in accordance with movements in a
particular, pre-specified, published interest rate index. The amount of
interest due a holder of an adjustable rate mortgage is calculated by adding a
specified additional amount (margin) to the index, subject to limitations or
"caps" on the maximum and minimum interest rate that is charged to the
mortgagor during the life of the mortgage or to maximum and minimum changes in
that interest rate during a given period. It is these special characteristics,
unique to the adjustable rate mortgages underlying the ARMS in which the Fund
invests, that are believed to make ARMS attractive investments for seeking to
accomplish the Fund's objective. For further information, see "Prepayments" in
the section on "Risk Factors."
OTHER PERMITTED INVESTMENTS
The Fund may invest in collateralized mortgage obligations ("CMOs") issued
or guaranteed by the U.S. government, its agencies, or instrumentalities. The
Fund intends to invest only in CMOs that, in Keystone's opinion, are suitable
in light of the Fund's investment objective and policies. For further
information, see "Additional Investment Information."
In addition, the Fund may enter into repurchase agreements and reverse
repurchase agreements for eligible securities and U.S. government obligations.
For further information, see "Additional Investment Information."
The Fund may also invest up to 35% of its assets under ordinary
circumstances and up to 100% of its assets for temporary defensive purposes in
obligations of the U.S. government, its agencies or instrumentalities, such as
the Federal Home Loan Banks, FNMA, GNMA, FHLMC or the Federal Farm Credit
Banks.
The Fund may assume a temporary defensive position, for example, upon
Keystone's determination that market conditions so warrant. The Fund may not
be pursuing its investment objective when it assumes a temporary defensive
position.
The Fund will not invest in derivative Mortgage Securities other than the
CMOs described in "Additional Investment Information."
RISK FACTORS
Like any investment, your investment in the Fund involves an element of
risk. Before you invest in the Fund, you should carefully evaluate your
ability to assume the risks your investment in the Fund poses.
Certain risks related to the Fund are discussed below. To the extent not
discussed in this section, specific risks attendant to individual securities
or investment practices are discussed in "Additional Investment Information."
Should many shareholders change from this Fund to some other investment at
about the same time, the Fund might have to sell portfolio securities at a
time when it would be disadvantageous to do so and at a lower price than if
such securities were held to maturity.
By itself, the Fund does not constitute a balanced investment program.
Investors should take into account their investment objectives as well as
other investments when considering the purchase of shares of any investment
company.
INTEREST RATE RISK
The values of fixed rate securities fluctuate in response to changes in
interest rates. When interest rates decline, the value of these securities can
be expected to rise. Conversely, when interest rates rise, the value of these
securities can be expected to decline. The corresponding increase or decrease
in the value of fixed rate securities generally becomes more significant for
instruments with longer remaining maturities or longer expected remaining
lives. Moreover, investment yields on relatively short-term investments are
subject to substantial and rapid fluctuation. The market value of such
investments generally will vary inversely to changes in interest rates. If
interest rates increase after a security is purchased, the security, if sold
prior to maturity, may return less than its cost.
PREPAYMENTS
The Mortgage Securities in which the Fund principally invests differ from
conventional bonds in that principal is repaid over the life of the investment
rather than at maturity. As a result, the holder of the investment (i.e., the
Fund) receives monthly scheduled payments of principal and interest and may
receive unscheduled principal payments representing prepayments on the
underlying mortgages or loans. When the holder reinvests the payments and any
unscheduled prepayments of principal it receives, it may receive a rate of
interest that is higher or lower than the rate on the existing investment.
RESETS
The interest rates paid on the securities held in ARMS and adjustable rate
CMOs in which the Fund invests are readjusted at intervals of up to three
years (generally one year or less) to an increment over some predetermined
interest rate index.
There are three main categories of indices: (1) those based on U.S. Treasury
securities; (2) those derived from a calculated measure, such as a cost of
funds index; or (3) a moving average of mortgage rates. Commonly utilized
indices include the one-year, three-year and five-year constant maturity
Treasury rates, the three-month Treasury Bill rate, the 180-day Treasury Bill
rate, rates on longer-term Treasury securities, the 11th District Federal Home
Loan Bank Cost of Funds, the National Median Cost of Funds, the one-month,
three-month, six-month or one-year London Interbank Offered Rate ("LIBOR"),
the prime rate of a specific bank and commercial paper rates. Some indices,
such as the one-year constant maturity Treasury rate, closely mirror changes
in market interest rate levels. Others, such as the 11th District Home Loan
Bank Cost of Funds Index, tend to lag behind changes in market rate levels and
tend to be somewhat less volatile.
The Fund's net asset value per share could vary to the extent that current
interest rates on Mortgage Securities are different than market interest rates
during periods between coupon reset dates. During periods of rising or falling
interest rates, changes in the coupon rate lag behind changes in the market
rate possibly resulting in a net asset value per share that is slightly lower
or higher, as the case may be, until the coupon resets to market rates.
Investors could suffer some principal loss if they sold their shares of the
Fund during periods of rising interest rates before the interest rates on the
underlying mortgages or loans were adjusted to reflect current market rates.
During periods of fluctuations in interest rates, the Fund's net asset value
per share will fluctuate as well.
CAPS AND FLOORS
The underlying loans or mortgages that collateralize the ARMS and CMOs in
which the Fund invests will frequently have "caps" and "floors" that limit the
maximum amount by which the loan rate to the borrower may change up or down per
reset or adjustment interval and over the life of the loan.
The Fund will not benefit from increases in interest rates to the extent
that interest rates rise to the point where they cause the current coupon of
loans or mortgages held as investments to reach their maximum allowable annual
or lifetime reset limits (cap rates). Fluctuation in interest rates above
these levels would cause such mortgages or loans to "cap" out and to behave
more like long-term fixed rate debt securities. Conversely, the Fund will not
benefit from decreases in interest rates to the extent that prepayments
increase. In addition, when interest rates decline, the Fund's income will be
reduced when the interest rates on underlying adjustable rate mortgages are
reduced.
ADDITIONAL FACTORS
It is possible in an environment in which interest rates on short-term, fixed
rate debt securities are rising faster than interest rates on long-term, fixed
rate debt securities that the Fund's investments may not perform as expected
primarily because of the reset risk described above. In this abnormal interest
rate environment, the market value of Mortgage Securities will typically
under-perform other fixed rate debt securities.
ARMS are not as effective a means of "locking in" long-term interest rates
as are fixed rate debt securities. The market value of ARMS will generally
vary inversely with changes in market interest rates, declining when interest
rates rise and rising when interest rates decline. However, ARMS have less
risk of a decline than fixed rate debt securities of comparable maturities
during periods of rapidly rising rates and have less potential than such
investments for capital appreciation due to their adjustable rate features and
the likelihood of increased prepayments of mortgages as interest rates
decline.
To the extent ARMS are purchased at a premium, unscheduled principal
prepayments may result in some loss of the holder's principal investment to
the extent of the premium paid over the face value of the security. On the
other hand, if ARMS are purchased at a discount, both a scheduled payment of
principal and an unscheduled prepayment of principal will increase current and
total returns and will accelerate the recognition of income, which, when
distributed to shareholders, will be taxable as ordinary income.
While the Fund may invest in securities that are issued or guaranteed by the
U.S. government, its agencies or instrumentalities, the market value of such
securities is not guaranteed. In addition, current yield levels should not be
considered representative of yields for any future period of time.
For further information about the types of investments and investment
techniques available to the Fund, including the associated risks, see the
section of this prospectus entitled "Additional Investment Information" and
the statement of additional information.
INVESTMENT RESTRICTIONS
The Fund has adopted the fundamental restrictions summarized below, which may
not be changed without the vote of a majority of the Fund's outstanding shares.
These restrictions and certain other fundamental and non- fundamental
restrictions are set forth in detail in the statement of additional information.
Unless otherwise stated, all references to the Fund's assets are in terms of
current market value.
Generally the Fund may not do the following: (1) with respect to 75% of its
total assets, invest more than 5% of the value of its total assets in the
securities of any one issuer (excepting U.S. government securities); and (2)
borrow money or enter into reverse repurchase agreements, except that the Fund
may enter into reverse repurchase agreements or borrow money from banks for
temporary or emergency purposes in aggregate amounts of up to one-third of the
value of the Fund's net assets.
If a percentage limit is satisfied at the time of investment or borrowing, a
later increase or decrease resulting from a change in asset value is not a
violation of the limit.
PRICING SHARES
The net asset value of a Fund share is computed each day on which the New
York Stock Exchange (the "Exchange") is open as of the close of trading on the
Exchange (currently 4:00 p.m. eastern time for purposes of pricing Fund
shares) except on days when changes in the value of the Fund's portfolio
securities do not affect the current net asset value of its shares. The
Exchange currently is closed on weekends, New Year's Day, Presidents' Day,
Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day. The net asset value per share of the Fund is arrived at by
determining the value of the Fund's assets, subtracting its liabilities and
dividing the result by the number of its shares outstanding.
The Fund values most of its securities at the mean of the bid and asked
price at the time of valuation and values other securities at fair value
according to procedures established by the Board of Trustees, including
valuing certain of its fixed rate Mortgage Securities on the basis of
valuations provided by a pricing service approved by the Fund's Board of
Trustees, which uses information with respect to transactions in Mortgage
Securities, quotations from dealers, market transactions in comparable
securities and various relationships between securities in determining value.
The Fund values securities with maturities of sixty days or less at
amortized cost (original purchase cost as adjusted for amortization of premium
or accretion of discount), which, when combined with accrued interest,
approximates market. Securities with remaining maturities of more than sixty
days for which market quotations are readily available are valued at current
market value. Securities with remaining maturities of more than sixty days
when purchased that are held on the sixtieth day prior to maturity are valued
at amortized cost (market value on the sixtieth day adjusted for amortization
of premium or accretion of discount), which, when combined with accrued
interest, approximates market. All other investments are valued at market
value or, where market quotations are not readily available, at fair value as
determined in good faith in accordance with procedures established by the
Board of Trustees.
DIVIDENDS AND TAXES
The Fund intends to declare dividends from net investment income daily and
distribute to its shareholders such dividends monthly and to declare and
distribute all net realized long-term capital gains annually. All dividends
and distributions are payable in that class of shares upon which the
distribution is based or, at the option of the shareholder (which must be
exercised before the record date for the distribution), in cash. Shareholders
who have not opted to receive cash prior to the payable date for any net
investment income dividend or the record date for any capital gains
distribution will have the number of such shares determined on the basis of
the Fund's net asset value per share computed at the end of that day after
adjustment for the distribution. Net asset value per share is used in
computing the number of shares in both capital gains and income distribution
reinvestments.
Dividends are taxable as ordinary income to shareholders who are subject to
federal income taxes and may also be subject to state and local taxes. The Fund
advises its shareholders annually as to the federal tax status of all
distributions made during the year.
The Fund has qualified, and intends to continue to qualify, as a regulated
investment company under the Internal Revenue Code of 1986, as amended, (the
"Code"). The Fund qualifies if, among other things, it distributes to its
shareholders at least 90% of its net investment income for its fiscal year. The
Fund also intends to make timely distributions, if necessary, sufficient in
amount to avoid the nondeductible 4% excise tax imposed on a regulated
investment company to the extent that it fails to distribute, with respect to
each calendar year, at least 98% of its ordinary income for such calendar year
and 98% of its net capital gains for the one-year period ending on October 31 of
such calendar year. Any such distribution declared in October, November or
December to shareholders of record in such month and paid by the following
January 31 would be includable in the taxable income of shareholders as if paid
on December 31 of the year in which the distribution was declared. If the Fund
qualifies and if it distributes all of its net investment income and net capital
gains, if any, to shareholders, it will be relieved of any federal income tax
liability. Because Class Y shares bear most of the costs of distribution of such
shares through an annual distribution fee, expenses attributable to Class Y
shares will generally be higher than those attributable to Class Z shares, and
income distributions paid by the Fund with respect to Class Z shares will
generally be greater than those paid with respect to Class Y shares.
The Fund intends to distribute its net long-term capital gains as capital
gain dividends; such dividends are treated by shareholders as long-term
capital gains. Such distributions will be designated as long-term capital gain
dividends by a written notice mailed to each shareholder no later than 60 days
after the close of the Fund's fiscal taxable year. If a shareholder receives a
capital gain dividend, then any allowable loss on disposition of Fund shares
will be treated as a long-term capital loss to the extent of such capital gain
dividend, if such shares have been held for six months or less.
Since none of the Fund's income will consist of corporate dividends, no
distributions will qualify for the corporate dividends received deduction.
FUND MANAGEMENT AND EXPENSES
BOARD OF TRUSTEES
Under Massachusetts law, the Fund's Board of Trustees has absolute and
exclusive control over the management and disposition of all assets of the
Fund. Subject to the authority of the Board of Trustees, Keystone serves as
investment adviser to the Fund and is responsible for the overall management
of the Fund's business and affairs.
INVESTMENT ADVISER
Keystone, the Fund's investment adviser, located at 200 Berkeley Street,
Boston, Massachusetts 02116-5034, has provided investment advisory and
management services to investment companies and private accounts since it was
organized in 1932. Keystone is a wholly-owned subsidiary of Keystone
Investments, Inc. (formerly named Keystone Group, Inc.) ("Keystone
Investments"), located at 200 Berkeley Street, Boston, Massachusetts 02116-
5034.
Keystone Investments is a corporation predominantly owned by current and
former members of management and certain employees of Keystone and its
affiliates. The shares of Keystone Investments common stock beneficially owned
by management are held in a number of voting trusts, the trustees of which are
George S. Bissell, Albert H. Elfner, III, Roger T. Wickers, Edward F. Godfrey
and Ralph J. Spuehler, Jr. Keystone Investments provides accounting,
bookkeeping, legal, personnel and general corporate services to Keystone, its
affiliates and the Keystone Investments Family of Funds.
Pursuant to its Investment Advisory and Management Agreement with the Fund
(the "Advisory Agreement"), Keystone provides investment advisory and
management services to the Fund. The Fund pays Keystone a fee for its services
at the annual rate of 0.30% of the average daily net asset value of the shares
of the Fund. A pro-rata portion of the fee is payable in arrears at the end of
each day or calendar month as Keystone may, from time to time, specify to the
Fund.
The Advisory Agreement continues in effect from year to year only so long as
such continuance is specifically approved at least annually by the Board of
Trustees or by vote of a majority of the outstanding shares of the Fund. In
either case, the terms of the Advisory Agreement and continuance thereof must
be approved by the vote of a majority of Independent Trustees in person at a
meeting called for the purpose of voting on such approval. The Advisory
Agreement may be terminated, without penalty, on 60 days' written notice by
the Fund or Keystone, or by a vote of shareholders of the Fund. The Advisory
Agreement will terminate automatically upon its assignment.
The Fund has adopted a Code of Ethics incorporating policies on personal
securities trading as recommended by the Investment Company Institute.
FUND EXPENSES
Pursuant to the Advisory Agreement, Keystone has agreed to pay certain of
the Fund's expenses, including expenses of the Fund's transfer agent,
custodian and auditors; fees payable to government agencies, including
registration and qualification fees of the Fund and its shares under federal
and state securities laws; expenses of preparing, printing and mailing Fund
prospectuses, notices, reports and proxy material; and expenses of
shareholders' and Trustees' meetings. In addition to the investment advisory
and management fee discussed above, the principal expenses that the Fund is
expected to pay, include expenses of its Independent Trustees, brokerage
commissions, interest charges and taxes, legal fees and certain extraordinary
expenses. Each class will pay all of the expenses attributable to it. Such
expenses are currently limited to Distribution Plan expenses.
During the fiscal year ended September 30, 1995, Keystone voluntarily
limited the expenses of the Fund's Class Y and Class Z shares to .55% and
.30%, respectively, of average net class assets annually. Keystone reserves
the right at any time, however, to make a redetermination of whether to
continue these expense limits and, if so, at what rates.
For the fiscal year ended September 30, 1995, the Fund paid or accrued to
Keystone investment management and advisory services fees of $79,819 which
represented 0.30% of the Fund's average net assets. For the fiscal year ended
September 30, 1995, the Fund paid .55% and .30% of the average annual net
assets of the Class Y and Class Z shares, respectively, in expenses.
PORTFOLIO MANAGER
Christopher P. Conkey has been the Fund's portfolio manager since 1991. Mr.
Conkey is a Keystone Senior Vice President and has more than 12 years of
investment experience.
SECURITIES TRANSACTIONS
Under policies established by the Board of Trustees, Keystone selects
broker-dealers to execute transactions subject to the receipt of best
execution. When selecting broker-dealers to execute portfolio transactions for
the Fund, Keystone may follow a policy of considering as a factor the number
of shares of the Fund sold by such broker-dealer. In addition, broker-dealers
executing portfolio transactions from time to time, may be affiliated with the
Fund, Keystone, FICO, the Fund's principal underwriter, (or their affiliates.)
FICO, a wholly-owned subsidiary of Keystone, is located at 200 Berkeley
Street, Boston, Massachusetts 02116-5034.
The Fund may pay higher commissions to broker-dealers that provide research
services. Keystone may use these services in advising the Fund as well as in
advising its other clients.
PORTFOLIO TURNOVER
The Fund's portfolio turnover rates for the fiscal years ended September 30,
1995 and 1994 were 56% and 63%, respectively.
HOW TO BUY SHARES
Shares of the Fund are sold through FICO. FICO acts as the Fund's principal
underwriter and is an affiliate of Keystone. Shares are sold without a sales
charge at the offering price, which equals the net asset value per share next
computed after the Fund receives the purchase order on each day on which the
Exchange is open for business.
Shares are held in "open accounts," i.e., they are credited to the
shareholder's account on the Fund's books. No certificates are issued. All
orders for the purchase of shares are subject to acceptance by the Fund, which
has the right to reject any order.
Shares become entitled to income distributions declared on the first
business day following receipt by the Fund's transfer agent of payment for the
shares.
OPENING AN ACCOUNT
First, telephone Keystone Investor Resource Center, Inc. ("KIRC"), the
Fund's transfer agent and dividend disbursing agent, toll free at 1-800-633-
2700 to open an account and obtain an account or wire identification number.
Second, arrange with your bank to wire federal funds to KIRC's agent at the
following address: (Please include your account number.)
State Street Bank and Trust Company
Boston, Massachusetts
ABA 011000028 Attn: Mutual Fund Division
For incoming wire A/C 0127-654-2
For credit to KIARF
Client Name and/or Account Number:
----------------------------------------------------------------------------
Third, complete and sign the Account Application and mail it to:
Keystone Investor Resource Center, Inc.
P.O. Box 2121
Boston, Massachusetts 02106-2121
If KIRC deems it appropriate, additional documentation or verification of
authority may be required.
Information on how to wire federal funds is available at any national bank
or any state bank that is a member of the Federal Reserve System. The bank may
charge for these services. Presently, there is no fee for receipt by KIRC of
federal funds wired, but the right to charge for this service is reserved.
ALTERNATIVE SALES OPTIONS
The Fund offers two classes of shares.
CLASS Y SHARES
Class Y shares are sold without a sales charge at the time of purchase and
are not subject to a sales charge when they are redeemed. Class Y shares are
available to any investor making a minimum initial purchase aggregating
$1,000,000 or more. There is no minimum amount required for subsequent
purchases.
The Fund has adopted a Distribution Plan with respect to its Class Y shares
("Class Y Distribution Plan"), that provides for payments at an annual rate of
up to 0.35% of the average daily net asset value of Class Y shares, to pay
expenses of the distribution of Class Y shares. Payments are expected to be at
a rate of 0.25% of the average daily net assets of Class Y shares. Amounts
paid by the Fund under the Class Y Distribution Plan are generally used to pay
FICO and others' service fees. The Fund may also make payments to FICO, dealers
and others for activities that are primarily intended to result in sales of
Fund shares, including, but not limited to, mail promotions and advertising,
including the use of member name and address lists of affinity groups,
professional associations, trade groups, industry associations or other
associations (e.g., credit union trade groups), for which use royalty payments
may be made. As a result, income distributions paid by the Fund with respect
to Class Y shares will generally be less than those paid with respect to Class
Z shares. See "Distribution Plan" below.
CLASS Z SHARES
Class Z shares are sold without a sales charge at the time of purchase and
are not subject to a sales charge when they are redeemed. Class Z shares are
available to the following investors making a minimum initial purchase
aggregating $1,000,000 or more: officers, directors or trustees, and employees
of the Fund, Keystone, FICO, or any of their affiliates, and members of the
immediate families of such persons, or any trust, pension, profit-sharing, or
other retirement or benefit plan for the benefit of such persons; present
shareholders of Class Z shares of the Fund; and existing investment advisory
clients of KIC, FICO, or any of their affiliates. There is no minimum amount
required for subsequent purchases.
ARRANGEMENTS WITH BROKER-DEALERS AND OTHERS
FICO may, from time to time, provide promotional incentives to certain
dealers whose representatives have sold or are expected to sell significant
amounts of the Fund. In addition, dealers may, from time to time, receive
additional cash payments. FICO may provide written information to dealers with
whom it has dealer agreements that relates to sales incentive campaigns
conducted by such dealers for their representatives as well as financial
assistance in connection with pre-approved seminars, conferences and
advertising. No such programs or additional compensation will be offered to
the extent they are prohibited by the laws of any state or any self-regulatory
agency, such as the National Association of Securities Dealers ("NASD").
FICO may, at its own expense, pay concessions in addition to those described
above to dealers that satisfy certain criteria established from time to time
by FICO. These conditions relate to increasing sales of shares of the Keystone
funds over specified periods and certain other factors. Such payments may,
depending on the dealer's satisfaction of the required conditions, be periodic
and may be up to 0.25% of the value of shares sold by such dealer.
FICO also may pay a transaction fee up to the level of the payments made
allowable to dealers for the sale of such shares as described above to banks
and other financial services firms that facilitate transactions in shares of
the Fund.
The Glass-Steagall Act currently limits the ability of a depository
institution (such as a commercial bank or a savings and loan association) to
become an underwriter or distributor of securities. In the event the Glass-
Steagall Act is deemed to prohibit depository institutions from accepting
payments under the arrangement described above, or should Congress relax
current restrictions on depository institutions, the Board of Trustees will
consider what action, if any, is appropriate.
In addition, state securities laws on this issue may differ from the
interpretations of federal law expressed herein, and banks and financial
institutions may be required to register as dealers pursuant to state law.
DISTRIBUTION PLAN
As discussed above, the Fund bears some of the costs of selling its Class Y
shares under a Distribution Plan adopted with respect to its Class Y shares
pursuant to Rule 12b-1 under the 1940 Act. Payments under the Class Y
Distribution Plan are limited to up to 0.35% annually of the average daily net
asset value of Class Y shares.
The NASD limits the amount that a fund may pay annually in distribution
costs for the sale of its shares and shareholder service fees. The NASD limits
annual expenditures to 1% of the aggregate average daily net asset value of
its shares, of which 0.75% may be used to pay such distribution costs and
0.25% may be used to pay shareholder service fees. The NASD also limits the
aggregate amount that the Fund may pay for such distribution costs to 6.25% of
gross share sales since the inception of the 12b-1 Distribution Plan, plus
interest at the prime rate plus 1% on such amounts remaining unpaid from time
to time.
The Class Y Distribution Plan may be terminated at any time by vote of the
Independent Trustees or by vote of a majority of the outstanding voting shares
of Class Y.
For the year ended September 30, 1995, the Fund paid or accrued to FICO
$5,470 under its Class Y Distribution Plan.
Payments pursuant to the Class Y Distribution Plan are included in the
operating expenses of that class.
HOW TO REDEEM SHARES
Shares of the Fund may be redeemed at net asset value by mail or by using
the telephone or telecommunication redemption privilege.
MAIL REDEMPTIONS
Shares may be redeemed on each day on which the Exchange is open by mailing
a written request to KIRC at the following address:
Keystone Investor Resource Center, Inc.
P.O. Box 2121
Boston, Massachusetts 02106-2121
The signatures on the written request must be PROPERLY GUARANTEED by a U.S.
stock exchange member, a bank or other persons eligible to guarantee
signatures under the Securities Exchange Act of 1934 and KIRC's policies when
the circumstances of such redemptions indicate that guaranteed signatures are
appropriate, in the judgment of the Fund or KIRC, for the protection of the
Fund, its shareholders and KIRC.
TELEPHONE OR TELECOMMUNICATION REDEMPTIONS
Shares may be redeemed on each day on which the Exchange is open for
business by telephone (toll free 1-800-633-2700), Mailgram, fax or other
request not bearing a signature and a signature guarantee to KIRC.
Shareholders must complete and sign the Account Application, including the
Redemption Authorization Section.
Redemption proceeds will be wired in federal funds only to the commercial
bank (and account number) designated by the shareholder on the Account
Application form. CONSEQUENTLY, SHAREHOLDERS MUST COMPLETE AN ACCOUNT
APPLICATION, INCLUDING THE REDEMPTION AUTHORIZATION. If KIRC deems it
appropriate, additional documentation may be required. Although at present
KIRC pays the wire costs involved, it reserves the right at any time to
require the shareholder to pay such costs.
Except as otherwise noted, neither the Fund, KIRC nor FICO assumes
responsibility for the authenticity of any instructions received by any of
them from a shareholder in writing or by telephone. KIRC will employ
reasonable procedures to confirm that instructions received over the telephone
are genuine. Neither the Fund, KIRC nor FICO will be liable when following
instructions received by telephone that KIRC reasonably believes to be
genuine.
The Fund computes the amount due a shareholder at the close of the Exchange
at the end of the day on which it has received all proper documentation.
Payment will be made promptly and, in any event, within seven days after a
properly completed redemption request is received, subject to suspension of
the right of redemption or extension of the date for payment when (1) the
Exchange is closed, other than customary weekend and holiday closings; (2)
trading on the Exchange is restricted; (3) an emergency exists and the Fund
cannot dispose of its investments or fairly determine their value; or (4) the
Securities and Exchange Commission so orders.
Any change in the bank account designated to receive redemption proceeds
must be made in another Account Application signed by the shareholder (WITH
SIGNATURES PROPERLY GUARANTEED IN THE MANNER DESCRIBED ABOVE) and delivered to
KIRC at the address above.
If a shareholder redeems all the shares in an account, the shareholder will
receive, in addition to the value thereof, all declared but unpaid
distributions thereon.
The Fund has made no arrangements with brokers for the repurchase of shares.
Redemptions placed through brokers, who may charge for their services, must
comply with the redemption procedures and requirements described above.
GENERAL
The Fund reserves the right, at any time, to terminate, suspend or change
the terms of any redemption method described in this prospectus, except
redemption by mail, and to impose or change fees.
SHAREHOLDER SERVICES
Details on all shareholder services may be ob-
tained from KIRC by calling toll free 1-800-633-2700
or from FICO by writing FICO at 200 Berkeley Street, Boston, Massachusetts
02116-5034.
SHAREHOLDER ACCOUNTS
Each investor will automatically have established an account under which he
or she will receive a statement showing details of all transactions, including
the current balance of full and fractional shares in the account.
SUBACCOUNTS
Special processing has been arranged with KIRC for banks and other
institutions that wish to open multiple accounts (a master account and
subaccounts). An investor wishing to avail himself or herself of KIRC's
subaccounting facilities will be required to enter into a separate agreement,
with the charges to be determined on the basis of the level of services to be
rendered. Subaccounts may be opened with the initial investment or at a later
date and may be established by an investor with registration either by name or
by number.
PERFORMANCE DATA
From time to time, the Fund may advertise "total return" and "current
yield." ALL DATA IS BASED ON HISTORICAL EARNINGS AND IS NOT INTENDED TO
INDICATE FUTURE PERFORMANCE. Total return and current yield are computed
separately for each class of shares of the Fund. Total return refers to the
Fund's average annual compounded rates of return over specified periods
determined by comparing the initial amount invested in a particular class to
the ending redeemable value of that amount. The resulting equation assumes
reinvestment of all dividends and distributions and deduction of all recurring
charges, if any, applicable to all shareholder accounts.
Current yield quotations represent the yield on an investment for a stated
30-day period computed by dividing net investment income earned per share
during the base period by the maximum offering price per share on the last
day of the base period.
FUND SHARES
The Fund currently issues two classes of shares, which participate in
dividends and distributions and have equal voting, liquidation and other
rights except that (1) expenses related to the distribution of each class of
shares or other expenses that the Board of Trustees may designate as class
expenses, from time to time, are borne solely by each class; (2) each class
of shares has exclusive voting rights with respect to its Distribution Plan,
if any; and (3) each class has a different designation. When issued and paid
for, the shares will be fully paid and nonassessable by the Fund. Shares will
have no preference, conversion, exchange or preemptive rights. Shares are
transferable, redeemable and freely assignable as collateral. There are no
sinking fund provisions. The Fund is authorized to issue additional classes or
series of shares.
Shareholders of the Fund are entitled to one vote for each full share owned
and fractional votes for fractional shares on all matters subject to Fund
vote. Shares of the Fund vote together except when required by law to vote
separately by series or class. The Fund does not have annual meetings. The
Fund will have special meetings, from time to time, as required under its
Declaration of Trust and under the 1940 Act. As provided in the Declaration of
Trust of the Fund, shareholders have the right to remove Trustees by an
affirmative vote of two-thirds of the outstanding shares. A special meeting of
the shareholders will be held when 10% of the outstanding shares request a
meeting. Shareholders may be eligible for shareholder communications
assistance in connection with the special meeting.
Under Massachusetts law it is possible that a Fund shareholder may be held
personally liable for the Fund's obligations. The Fund's Declaration of Trust
provides, however, that shareholders shall not be subject to any personal
liability for the Fund's obligations and provides indemnification
from Fund assets for any shareholder held personally liable for the Fund's
obligations. Disclaimers of such liability are included in each Fund agreement.
ADDITIONAL INFORMATION
KIRC, located at 101 Main Street, Cambridge, Massachusetts 02142-1519, is a
wholly-owned subsidiary of Keystone. As previously mentioned, KIRC serves as
the Fund's transfer agent and dividend disbursing agent.
Except as otherwise stated in this prospectus or required by law, the Fund
reserves the right to change the terms of the offer stated in this prospectus
without shareholder approval, including the right to impose or change fees for
services provided.
<PAGE>
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ADDITIONAL INVESTMENT INFORMATION
- ------------------------------------------------------------------------------
The Fund may engage in the following investment practices to the extent
described in the prospectus and the statement of additional information.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with member banks of the
Federal Reserve System having at least $1 billion in assets, primary dealers
in U.S. government securities or other financial institutions believed by
Keystone to be creditworthy. Such persons must be registered as U.S.
government securities dealers with an appropriate regulatory organization.
Under such agreements, the bank, primary dealer or other financial institution
agrees upon entering into the contract to repurchase the security at a
mutually agreed upon date and price, thereby determining the yield during the
term of the agreement. This results in a fixed rate of return insulated from
market fluctuations during such period. Under a repurchase agreement, the
seller must maintain the value of the securities subject to the agreement at
not less than the repurchase price, such value being determined on a daily
basis by marking the underlying securities to their market value. Although the
securities subject to the repurchase agreement might bear maturities exceeding
a year, the Fund only intends to enter into repurchase agreements that provide
for settlement within a year and usually within seven days. Securities subject
to repurchase agreements will be held by the Fund's custodian or in the
Federal Reserve book entry system. The Fund does not bear the risk of a
decline in the value of the underlying security unless the seller defaults
under its repurchase obligation. In the event of a bankruptcy or other default
of a seller of a repurchase agreement, the Fund could experience both delays
in liquidating the underlying securities and losses including (1) possible
declines in the value of the underlying securities during the period while the
Fund seeks to enforce its rights thereto; (2) possible subnormal levels of
income and lack of access to income during this period; and (3) expenses of
enforcing its rights. The Board of Trustees of the Fund has established
procedures to evaluate the creditworthiness of each party with whom the Fund
enters into repurchase agreements by setting guidelines and standards of
review for Keystone and monitoring Keystone's actions with regard to
repurchase agreements.
REVERSE REPURCHASE AGREEMENTS
Under a reverse repurchase agreement, the Fund would sell securities and agree
to repurchase them at a mutually agreed upon date and price. The Fund intends to
enter into reverse repurchase agreements to avoid otherwise having to sell
securities during unfavorable market conditions in order to meet redemptions. At
the time the Fund enters into a reverse repurchase agreement, it will establish
a segregated account with the Fund's custodian containing liquid assets such as
U.S. government securities or other high grade debt securities having a value
not less than the repurchase price (including accrued interest) and will
subsequently monitor the account to ensure such value is maintained. Reverse
repurchase agreements involve the risk that the market value of the securities
the Fund is obligated to repurchase may decline below the repurchase price.
Borrowing and reverse repurchase agreements magnify the potential for gain or
loss on the portfolio securities of the Fund and, therefore, increase the
possibility of fluctuation in the Fund's net asset value. Such practices may
constitute leveraging. In the event the buyer of securities under a reverse
repurchase agreement files for bankruptcy or becomes insolvent, such buyer or
its trustee or receiver may receive an extension of time to determine whether to
enforce the Fund's obligation to repurchase the securities, and the Fund's use
of the proceeds of the reverse repurchase agreement may effectively be
restricted pending such determination. The staff of the Securities and Exchange
Commission has taken the position that the 1940 Act treats reverse repurchase
agreements as a form of leverage and, therefore, are included in the percentage
limit on borrowings imposed on a Fund.
COLLATERALIZED MORTGAGE OBLIGATIONS
The Fund will invest only in CMOs issued or guaranteed by the U.S.
government, its agencies or instrumentalities. The Fund intends to invest only
in CMOs that, in Keystone's opinion, are suitable in light of the Fund's
investment objective and policies. The Fund may purchase any class of CMO
other than the residual (final) class or a class whose average life would
extend or is shortened by more than 6 years under modeling scenarios where
mortgage commitment rates immediately rise or fall 300 basis points.
CMOs are debt obligations collateralized by Mortgage Securities and may be
issued by and guaranteed as to principal and interest by the U.S. government,
its agencies or instrumentalities or by private originators of, or investors
in, mortgage loans, including savings and loan associations, mortgage banks,
commercial banks, investment banks and special purpose subsidiaries of the
foregoing. The principal governmental issuer of CMOs is FNMA. In addition,
FHLMC issues a significant number of CMOs. The secondary market for CMOs is
actively traded.
CMOs are structured by redirecting the total payment of principal and
interest on the underlying Mortgage Securities used as collateral to create
classes with different interest rates, maturities and payment schedules.
Instead of interest and principal payments on the underlying Mortgage
Securities being passed through or paid pro-rata to all holders of interests
in the underlying Mortgage Securities, each class of a CMO is paid from and
secured by a separate priority payment of the cash flow generated by the
pledged Mortgage Securities.
Most CMO issues have at least four classes. Classes with earlier maturities
receive priority on payments to assure the early maturity. After the first
class is redeemed, excess cash flow not necessary to pay interest on the
remaining classes is directed to the repayment of the next maturing class
until that class is fully redeemed. This process continues until all classes
of the CMO issue have been paid in full. Among the CMO classes available are
floating (adjustable) rate classes, which have characteristics similar to ARMS
and inverse floating rate classes whose coupons vary inversely with the rate
of some market index.
<PAGE>
KEYSTONE
INSTITUTIONAL
ADJUSTABLE
RATE FUND
PROSPECTUS
[logo] KEYSTONE
INVESTMENTS
[logo]
KIARF-P 1/96
.55M
[recycle logo]
<PAGE>
KEYSTONE INSTITUTIONAL ADJUSTABLE RATE FUND
PART B
STATEMENT OF ADDITIONAL INFORMATION
<PAGE>
KEYSTONE INSTITUTIONAL ADJUSTABLE RATE FUND
STATEMENT OF ADDITIONAL INFORMATION
JANUARY 8, 1996
This statement of additional information is not a prospectus, but relates
to, and should be read in conjunction with, the prospectus of Keystone
Institutional Adjustable Rate Fund (the "Fund") dated January 8, 1996. A copy of
the prospectus may be obtained from Fiduciary Investment Company, Inc. ("FICO"),
the Fund's principal underwriter, 200 Berkeley Street, Boston, Massachusetts
02116-5034.
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TABLE OF CONTENTS
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Page
The Fund 2
Investment Restrictions 2
Dividends and Taxes 4
Valuation of Securities 5
Investment Adviser 6
Trustees and Officers 8
Distribution Plan 12
Distributor 14
Brokerage 15
Declaration of Trust 17
Standardized Total Return and Yield Quotations 19
Additional Information 20
Appendix A-1
Financial Statements F-1
Independent Auditors' Report F-15
#101606a5
<PAGE>
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THE FUND
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The Fund is a diversified, open-end management investment company
commonly known as a mutual fund. The Fund was formed as a Massachusetts business
trust on June 19, 1991. The Fund is one of thirty funds managed or advised by
Keystone Investment Management Company (formerly named Keystone Custodian Funds,
Inc.) ("Keystone"), the Fund's investment adviser.
Certain information about the Fund is contained in its prospectus. This
statement of additional information provides additional information about the
Fund.
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INVESTMENT RESTRICTIONS
- -------------------------------------------------------------------------------
The following restrictions are fundamental and may not be changed
without a vote of the holders of a majority, as defined in the Investment
Company Act of 1940 (the "1940 Act"), of the Fund's outstanding shares.
The Fund shall not do any of the following:
(1) with respect to 75% of its total assets, invest more than 5% of the
value of its total assets in the securities of any one issuer; this limitation
does not apply to investments in securites issued or guaranteed by the U.S.
government, its agencies or instrumentalities;
(2) invest more than 5% of its total assets in securities of any
company having a record, together with its predecessors, of less than three
years of continuous operations;
(3) pledge more than 15% of its net assets to secure indebtedness; the
purchase or sale of securities on a when issued basis is not deemed to be a
pledge of assets;
(4) borrow money or enter into reverse repurchase agreements, except
that the Fund may enter into reverse repurchase agreements or borrow money from
banks for temporary or emergency purposes in aggregate amounts up to one-third
of the value of its net assets; provided that while borrowings from banks (not
including reverse repurchase agreements) exceed 5% of the Fund's net assets, any
such excess borrowings will be repaid before additional investments are made;
(5) make loans, except that the Fund may purchase or hold debt
securities consistent with its investment objective, lend portfolio securities
valued at not more than 15% of its total assets to brokers, dealers and
financial institutions, and enter into repurchase agreements;
(6) make short sales of securities or maintain a short position, unless
at all times when a short position is open it owns an equal amount of such
securities or of securities which, without payment of any further consideration,
are convertible into or exchangeable for securities of the same issue as, and
equal in amount to, the securities sold short;
(7) issue senior securities; the purchase or sale of securities on a
when issued basis is not deemed to be the issuance of a senior security;
(8) purchase securities on margin, except that it may obtain such
short-term credit as may be necessary for the clearance of purchases and sales
of securities;
(9) purchase more than 3% of the total outstanding voting securities of
any one investment company, invest more than 5% of its total assets in any one
investment company or invest more than 10% of its total assets in investment
companies in general, except as part of a merger, consolidation, purchase of
assets or similar transaction;
(10) purchase or sell commodities or commodity contracts or real
estate, except that it may purchase and sell securities secured by real estate
and securities of companies which invest in real estate and may engage in
financial futures contracts and related options transactions; and
(11) underwrite securities of other issuers, except that the Fund may
purchase securities from the issuer or others and dispose of such securities in
a manner consistent with its investment objective.
In order to permit the sale of Fund shares in certain states or foreign
countries, the Fund may make commitments more restrictive than the investment
restrictions described above. Should the Fund determine that any such commitment
is no longer in the best interests of the Fund, it will revoke the commitment by
terminating sales of its shares in the state or country involved.
If a percentage limit is satisfied at the time of investment or
borrowing, a later increase or decrease resulting from a change in asset value
of a security or a decrease in Fund assets is not a violation of the limit.
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DIVIDENDS AND TAXES
- -------------------------------------------------------------------------------
The Fund intends to declare dividends from net investment income daily
and distribute to its shareholders such dividends monthly and to declare and
distribute all net realized long-term capital gains annually. The Fund
distributes such dividends and capital gains in shares or, at the option of the
shareholder, in cash. Distributions are taxable whether paid in cash or in
additional Fund shares. Shareholders who have not opted prior to the payable
date for any income dividend or the record date for any capital gains
distribution to receive cash will have the number of such shares determined on
the basis of the Fund's net asset value per share computed at the end of the day
on the record date after adjustment for the distribution. Net asset value is
used in computing the number of shares in both gains and income distribution
reinvestments. Dividends will be automatically invested in additional shares of
the Fund unless the shareholder elects to receive them in cash. Dividends are
taxable as ordinary income to shareholders who are subject to federal income
taxes and may also be subject to state and local taxes. The Fund advises its
shareholders annually as to the federal tax status of all distributions made
during the year.
It is not expected that the Fund's income dividends will be eligible
for the corporate dividends received deduction. Distributed long-term capital
gains are taxable as such to the shareholder regardless of the period of time
Fund shares have been held by the shareholder. If such shares are held less than
six months and redeemed at a loss, the shareholder will recognize a long-term
capital loss on such shares to the extent of the capital gains distribution
received in connection with such shares. If the net asset value of the Fund's
shares is reduced below a shareholder's cost by a capital gains distribution,
such distribution, to the extent of the reduction, would be a return of
investment, though taxable as stated above. Since distributions of capital gains
depend upon profits actually realized from the sale of securities by the Fund,
they may or may not occur. The foregoing comments relating to the taxation of
dividends and distributions paid on the Fund's shares relate solely to federal
income taxation. Such dividends and distributions may also be subject to state
and local taxes.
When the Fund makes a distribution it intends to distribute only the
Fund's net capital gains and such income as has been predetermined to the best
of the Fund's ability to be taxable as ordinary income. Therefore, net
investment income distributions will not be made on the basis of distributable
income as computed on the books of the Fund, but will be made on a federal
income tax basis.
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VALUATION OF SECURITIES
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Current values for the Fund's portfolio securities are determined in
the following manner:
(1) securities for which market quotations are readily available are
valued at market value, which is deemed to be the mean of the bid and asked
prices at the time of valuation;
(2) (a) instruments having maturities of sixty days or less when
purchased are valued at amortized cost (original purchase cost as adjusted for
amortization of premium or accretion of discount), which, when combined with
accrued interest, approximates market;
(b) instruments maturing in more than sixty days when purchased
that are held on the sixtieth day prior to maturity are valued at amortized cost
(market value on the sixtieth day adjusted for amortization of premium or
accretion of discount), which, when combined with accrued interest, approximates
market; and which in either case reflects fair value as determined in accordance
with procedures established by the Fund's Board of Trustees;
(c) instruments having maturities of more than sixty days, for
which market quotations are readily available, are valued at current market
value; and
(3) securities, including restricted securities, for which market
quotations are not readily available, and other assets are valued at prices
deemed in good faith to be fair under procedures established by the Board of
Trustees.
The Fund believes that reliable market quotations are generally not
readily available for purposes of valuing certain securities. As a result,
depending on the particular securities owned by the Fund, it is likely that most
of the valuations for such obligations will be based upon their fair value
determined under procedures that have been approved by the Board of Trustees.
The Board of Trustees has authorized the use of a pricing service to determine
the fair value of the Fund's fixed rate mortgage securities. Securities for
which market quotations are readily available are valued on a consistent basis
at that price quoted that, in the opinion of the Board of Trustees or the person
designated by the Board of Trustees to make the determination, most nearly
represents the market value of the particular security. Other assets and any
securities for which market quotations are not readily available are valued on a
consistent basis at fair value as determined in good faith using methods
prescribed by the Board of Trustees.
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INVESTMENT ADVISER
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Subject to the general supervision of the Fund's Board of Trustees,
Keystone serves as investment adviser to the Fund and is responsible for the
overall management of the Fund's business and affairs.
Keystone, located at 200 Berkeley Street, Boston, Massachusetts
02116-5034, has provided investment advisory and management services to
investment companies and private accounts since it was organized in 1932.
Keystone is a wholly-owned subsidiary of Keystone Investments, Inc. (formerly
named Keystone Group, Inc.) ("Keystone Investments"), which is located at 200
Berkeley Street, Boston, Massachusetts 02116-5034.
Keystone Investments is a corporation predominantly owned by former and
current members of management and certain employees of Keystone and its
affiliates. The shares of Keystone Investments common stock beneficially owned
by management are held in a number of voting trusts, the trustees of which are
George S. Bissell, Albert H. Elfner, III, Edward F. Godfrey, and Ralph J.
Spuehler, Jr. Keystone Investments provides accounting, bookkeeping, legal,
personnel and general corporate services to Keystone Management, Inc. ("Keystone
Management"), Keystone, their affiliates and the Keystone Investments Family of
Funds.
Pursuant to an Investment Advisory and Management Agreement between the
Fund and Keystone (the "Advisory Agreement") and subject to the supervision of
the Fund's Board of Trustees, Keystone manages and administers the operation of
the Fund and manages the investment and reinvestment of the Fund's assets in
conformity with the Fund's investment objective and restrictions.
The Advisory Agreement stipulates that Keystone shall provide office
space, all necessary office facilities, equipment and personnel in connection
with its services under the Advisory Agreement and pay or reimburse the Fund for
the compensation of officers and Trustees of the Fund who are affiliated with
Keystone as well as pay all expenses of Keystone incurred in connection with the
provision of its services. In addition, Keystone also assumes and pays or
reimburses the Fund for all charges and expenses of any custodian or depository
appointed by the Fund for the safekeeping of its cash, securities and other
property; all charges and expenses for bookkeeping and auditors; all charges and
expenses of any transfer agents and registrars appointed by the Fund; all costs
of certificates representing shares of the Fund; all fees and expenses involved
in registering and maintaining registrations of the Fund and of its shares with
the Securities and Exchange Commission (sometimes referred to herein as the
"Commission") and registering or qualifying its shares under state or other
securities laws, including, without limitation, the preparation and printing of
registration statements, prospectuses and statements of additional information
for filing with the Commission and other authorities; expenses of preparing,
printing and mailing prospectuses and statements of additional information to
shareholders of the Fund; all expenses of shareholders' and Trustees' meetings
and of preparing, printing and mailing notices, reports and proxy materials to
shareholders of the Fund; and all charges and expenses of filing annual and
other reports with the Commission and other authorities.
The Fund assumes and pays all other expenses of the Fund, including,
without limitation, (1) all fees of all Trustees of the Fund who are not
affiliated with Keystone or any of its affiliates, or with any adviser retained
by Keystone; (2) all brokers' fees, expenses and commissions and issue and
transfer taxes chargeable to the Fund in connection with transactions involving
securities and other property to which the Fund is a party; (3) all costs and
expenses of distribution of its Class Y shares incurred pursuant to its Class Y
Distribution Plan adopted pursuant to Rule 12b-1 under the 1940 Act; (4) all
charges and expenses of legal counsel for the Fund and for Trustees of the Fund
in connection with routine legal matters relating to the Fund, including,
without limitation, legal services rendered in connection with the Fund's
existence, business trust and financial structure and relations with its
shareholders, registrations and qualifications of securities under federal,
state and other laws, and issues of securities; (5) all taxes and business trust
fees payable by the Fund to federal, state or other governmental agencies; (6)
all interest costs of the Fund; and (7) all extraordinary expenses and charges
of the Fund, including all charges and expenses of legal counsel to the Fund in
connection with extraordinary matters, including, without limitation, any
litigation involving the Fund, its Trustees, officers, employees or agents. In
the event Keystone provides any of these services or pays any of these expenses,
the Fund will promptly reimburse Keystone therefor.
The Fund pays Keystone a fee for its services to the Fund at the annual
rate of 0.30% of the average daily net asset value of the shares of the Fund. A
pro rata portion of the fee is payable in arrears at the end of each day or
calendar month as Keystone may, from time to time, specify to the Fund.
Currently, annual expenses of the Fund's Class Y shares have been
voluntarily limited by Keystone to no more than 0.55% and 0.30% of Class Y's and
Class Z's average daily net assets, respectively. Keystone reserves the right at
any time, however, to make a redetermination of whether to continue these
expense limits and, if so, at what rates. Keystone will not be required to make
any reimbursement to the extent such reimbursement would result in the Fund's
inability to qualify as a regulated investment company under provisions of the
Internal Revenue Code of 1986, as amended (the "Code").
During the year ended September 30, 1993, the Fund paid or accrued to
Keystone investment management and advisory services fees of $148,915, which
represented 0.30% of the Fund's average net assets on an annualized basis.
During the year ended September 30, 1994, the Fund paid or accrued to
Keystone investment management and advisory services fees of $123,050, which
represented 0.30% of the Fund's average net assets on an annualized basis.
During the year ended September 30, 1995, the Fund paid or accrued to
Keystone investment management and advisory services fees of $79,819, which
represented 0.30% of the Fund's average net assets on an annualized basis.
The Advisory Agreement continues in effect only if approved at least
annually by the Board of Trustees of the Fund or by a vote of a majority of the
outstanding shares of the Fund, and such renewal has been approved by the vote
of a majority of the Trustees who are not interested persons of the Fund as
defined in the 1940 Act (the "Independent Trustees"), cast in person at a
meeting called for the purpose of voting on such approval. The Advisory
Agreement may be terminated, without penalty, on 60 days written notice by the
Fund's Board of Trustees or by a vote of a majority of outstanding shares of the
Fund. The Advisory Agreement will terminate automatically upon its "assignment"
as that term is defined in the 1940 Act.
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TRUSTEES AND OFFICERS
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Trustees and officers of the Fund, their principal occupations and some
of their affiliations over the last five years are as follows:
*ALBERT H. ELFNER, III: President, Chief Executive Officer and Trustee of the
Fund; Chairman of the Board, President and Chief Executive Officer of
Keystone Investments, Keystone, Keystone Management and Keystone Software,
Inc. ("Keystone Software"); President, Chief Executive Officer and Trustee
or Director of all other funds in the Keystone Investments Family of Funds;
Chairman of the Board and Director of Keystone Institutional Company, Inc.
("Keystone Institutional") (formerly named Keystone Investment Management
Corporation) and Keystone Fixed Income Advisors ("KFIA"); Director and
President of Keystone Asset Corporation, Keystone Capital Corporation, and
Keystone Trust Company; KIRC and FICO; Director of Boston Children's
Services Association; Trustee of Anatolia College, Middlesex School, and
Middlebury College; Member, Board of Governors, New England Medical Center;
former Director and President of Hartwell Keystone Advisers, Inc.
("Hartwell Keystone"); former Director and Vice President of Robert Van
Partners, Inc.; and former Trustee of Neworld Bank.
FREDERICK AMLING: Trustee of the Fund; Trustee or Director of all other funds in
the Keystone Investments Family of Funds; Professor, Finance Department,
George Washington University; President, Amling & Company (investment
advice); Member, Board of Advisers, Credito Emilano (banking); and former
Economics and Financial Consultant, Riggs National Bank.
CHARLES A. AUSTIN III: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Family of Funds; Investment Counselor to
Appleton Partners, Inc.; former Managing Director, Seaward Management
Corporation (investment advice) and former Director, Executive Vice
President and Treasurer, State Street Research & Management Company
(investment advice).
*GEORGE S. BISSELL: Chairman of the Board and Trustee of the Fund; Director of
Keystone Investments; Chairman of the Board and Trustee or Director of all
other funds in the Keystone Investments Family of Funds; former Director
and Chairman of the Board of Hartwell Keystone; Chairman of the Board and
Trustee of Anatolia College; Trustee of University Hospital (and Chairman
of its Investment Committee); former Chairman of the Board and Chief
Executive Officer of Keystone Investments; and former Chief Executive
Officer of the Fund.
EDWIN D. CAMPBELL: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Family of Funds; Executive Director,
Coalition of Essential Schools, Brown University; Director and former
Executive Vice President, National Alliance of Business; former Vice
President, Educational Testing Services; and former Dean, School of
Business, Adelphi University.
CHARLES F. CHAPIN: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Family of Funds; former Group Vice
President, Textron Corp.; and former Director, Peoples Bank (Charlotte,
N.C).
LEROY KEITH, JR.: Trustee of the Fund; Trustee or Director of all other funds in
the Keystone Investments Family of Funds; Director of Phoenix Total Return
Fund and Equifax, Inc.; Trustee of Phoenix Series Fund, Phoenix
Multi-Portfolio Fund and The Phoenix Big Edge Series Fund; and former
President, Morehouse College.
K. DUN GIFFORD: Trustee of the Fund; Trustee or Director of all other funds in
the Keystone Investments Family of Funds; Chairman of the Board, Director
and Executive Vice President, The London Harness Company; Managing Partner,
Roscommon Capital Corp.; Trustee, Cambridge College; Chairman Emeritus and
Director, American Institute of Food and Wine; Chief Executive Officer,
Gifford Gifts of Fine Foods; Chairman, Gifford, Drescher & Associates
(environmental consulting); President, Oldways Preservation and Exchange
Trust (education); and former Director, Keystone Investments and Keystone.
F. RAY KEYSER, JR.: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Family of Funds; Of Counsel, Keyser,
Crowley & Meub, P.C.; Member, Governor's (VT) Council of Economic Advisers;
Chairman of the Board and Director, Central Vermont Public Service
Corporation and Hitchcock Clinic; Director, Vermont Yankee Nuclear Power
Corporation, Vermont Electric Power Company, Inc., Grand Trunk Corporation,
Central Vermont Railway, Inc., S.K.I. Ltd., Sherburne Corporation, Union
Mutual Fire Insurance Company, New England Guaranty Insurance Company, Inc.
and the Investment Company Institute; former Governor of Vermont; former
Director and President, Associated Industries of Vermont; former Chairman
and President, Vermont Marble Company; former Director of Keystone; and
former Director and Chairman of the Board, Green Mountain Bank.
DAVID M. RICHARDSON: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Family of Funds; Executive Vice
President, DHR International, Inc. (executive recruitment); former Senior
Vice President, Boyden International Inc. (executive recruitment); and
Director, Commerce and Industry Association of New Jersey, 411
International, Inc. and J & M Cumming Paper Co.
RICHARD J. SHIMA: Trustee of the Fund; Trustee or Director of all other funds in
the Keystone Investments Family of Funds; Chairman, Environmental Warranty,
Inc., and Consultant, Drake Beam Morin, Inc. (executive outplacement);
Director of Connecticut Natural Gas Corporation, Trust Company of
Connecticut, Hartford Hospital, Old State House Association and Enhanced
Financial Services, Inc.; Member, Georgetown College Board of Advisors;
Chairman, Board of Trustees, Hartford Graduate Center; Trustee,
Kingswood-Oxford School and Greater Hartford YMCA; former Director,
Executive Vice President and Vice Chairman of The Travelers Corporation;
and former Managing Director of Russell Miller, Inc.
ANDREW J. SIMONS: Trustee of the Fund; Trustee or Director of all other funds in
the Keystone Investments Family of Funds; Partner, Farrell, Fritz,
Caemmerer, Cleary, Barnosky & Armentano, P.C.; former President, Nassau
County Bar Association; and former Associate Dean and Professor of Law, St.
John's University School of Law.
EDWARD F. GODFREY: Senior Vice President of the Fund; Senior Vice President of
all other funds in the Keystone Investments Family of Funds; Director,
Senior Vice President, Chief Financial Officer and Treasurer of Keystone
Investments, the Principal Underwriter, Keystone Asset Corporation,
Keystone Capital Corporation, Keystone Trust Company; Treasurer of Keystone
Institutional, and FICO; Treasurer and Director of Keystone Management, and
Keystone Software; Vice President and Treasurer of KFIA; and Director of
KIRC; former Treasurer and Director of Hartwell Keystone; and former
Treasurer of Robert Van Partners, Inc.
JAMES R. McCALL: Senior Vice President of the Fund; Senior Vice President of all
other funds in the Keystone Investments Family of Funds; and President of
Keystone.
J. KEVIN KENELY: Treasurer of the Fund; Treasurer of all other funds in the
Keystone Investments Family of Funds; Vice President and Controller of
Keystone Investments, Keystone, the Principal Underwriter, FICO and
Keystone Software; and Controller of Keystone Asset Corporation and
Keystone Capital Corporation.
CHRISTOPHER P. CONKEY: Vice President of the Fund; Vice President certain other
Keystone Investment Funds; and Senior Vice President of Keystone.
ROSEMARY D. VAN ANTWERP: Senior Vice President and Secretary of the Fund; Senior
Vice President and Secretary of all other funds in the Keystone Investments
Family of Funds; Senior Vice President, General Counsel and Secretary of
Keystone, Keystone Investments, Keystone Asset Corporation, Keystone
Capital Corporation and Keystone Trust Company; Senior Vice President,
General Counsel, Secretary and Director of Keystone Management and Keystone
Software; Senior Vice President and General Counsel of Keystone
Institutional; Senior Vice President, General Counsel and Director of FICO
and KIRC; Vice President and Secretary of KFIA; and former Senior Vice
President and Secretary of Hartwell Keystone, and Robert Van Partners, Inc.
* This Trustee may be considered an "interested person" of the Fund within the
meaning of the 1940 Act.
Mr. Elfner and Mr. Bissell are "interested persons" by virtue of their
positions as officers and/or Directors of Keystone Investments and several of
its affiliates including Hartwell Keystone, Keystone Investment Distributors
Company and Keystone Investor Resource Center, Inc. Mr. Elfner and Mr. Bissell
own shares of Keystone Investments . Mr. Elfner is Chairman of the Board, Chief
Executive Officer and a Director of Keystone Investments. Mr. Bissell is a
Director of Keystone Investments.
During the fiscal year ended September 30, 1995, no Trustee affiliated
with Keystone nor any officer received any direct remuneration from the Fund.
During the same period, no non-affiliated Trustee received retainers or fees.
For the year ended December 31, 1995, aggregate compensation received by the
Independent Trustees on a fund complex wide basis was $585,990. On December 31,
1995, the Fund's Trustees, officers and former Advisory Board members as a group
did not beneficially own any of the Fund's outstanding shares.
The address of the Fund's Trustees and officers is 200 Berkeley Street,
Boston, Massachusetts 02116-5034.
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DISTRIBUTION PLAN
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GENERAL
The Fund offers two classes of shares. Class Y shares are offered
without an initial sales charge and are not subject to a sales charge when they
are redeemed. Class Y shares make payments under a distribution plan pursuant to
Rule 12b-1 under the 1940 Act. Class Z shares are also offered without a sales
charge at the time of purchase and are not subject to a sales charge when they
are redeemed. There is no distribution plan in respect of Class Z shares. Class
Z shares are available only to certain investors. The prospectus contains a
general description of how investors may buy shares of the Fund.
Rule 12b-1 under the 1940 Act permits investment companies, such as the
Fund, to use their assets to bear expenses of distributing their shares if they
comply with various conditions, including adoption of a distribution plan
containing certain provisions set forth in Rule 12b-1. On March 16, 1994, the
Fund's Class Y Distribution Plan was approved by the Fund's Board of Trustees,
including a majority of the Independent Trustees and the Trustees who have no
direct or indirect financial interest in the Distribution Plan or any agreement
related thereto (the "Rule 12b-1 Trustees" who are the same as the Independent
Trustees).
The National Association of Securities Dealers, Inc. ("NASD") currently
limits the amount that the Fund may pay annually in distribution costs for sale
of its shares and shareholder service fees. The NASD limits annual expenditures
to 1% of the aggregate average daily net asset value of its shares, of which
0.75% may be used to pay distribution costs and 0.25% may be used to pay
shareholder service fees. The NASD also limits the aggregate amount that the
Fund may pay for such distribution costs to 6.25% of gross share sales since the
inception of the Class Y Distribution Plan, plus interest at the prime rate plus
1% on such amounts.
CLASS Y DISTRIBUTION PLAN
The Class Y Distribution Plan provides that the Fund may expend daily
amounts at an annual rate up to 0.35% of the Fund's average daily net asset
value attributable to Class Y shares to finance any activity that is primarily
intended to result in the sale of Class Y shares, including without limitation,
expenditures consisting of the payment of service fees to a principal
underwriter of the Fund (currently FICO) or others. Such payments are expected
to be at a rate of 0.25% of the average daily net assets of Class Y shares.
Amounts paid by the Fund under the Class Y Distribution Plan are
currently used to pay FICO and others, such as dealers, service fees at an
annual rate of up to 0.25% of the average daily net asset value of Class Y
shares maintained by FICO and such others on the books of the Fund for specified
periods. The Fund may also make payments to FICO, dealers and others for
activities that are primarily intended to result in sales of the Fund's Class Y
shares, including, but not limited to, mail promotions and advertising,
including the use of member name and address lists of affinity groups,
professional associations, trade groups, industry associations, or other
associations, for which use royalty payments may be made.
The Class Y Distribution Plan may be terminated, at any time, by vote
of the Rule 12b-1 Trustees or by vote of a majority of the outstanding voting
shares of the Fund's Class Y shares. Any change in the Class Y Distribution Plan
that would materially increase the distribution expenses of the Fund's Class Y
shares provided for in the Class Y Distribution Plan requires shareholder
approval. Otherwise, the Class Y Distribution Plan may be amended by the
Trustees, including the Rule 12b-1 Trustees.
The total amounts paid by the Fund under the foregoing arrangements may
not exceed the maximum Class Y Distribution Plan limit specified above, and the
amounts and purposes of expenditures under the Class Y Distribution Plan must be
reported to the Rule 12b-1 Trustees quarterly. The Rule 12b-1 Trustees may
require or approve changes in the implementation or operation of the Class Y
Distribution Plan and may also require that total expenditures by the Fund under
the Class Y Distribution Plan be kept within limits lower than the maximum
amount permitted by the Distribution Plan as stated above.
Whether any expenditure under the Class Y Distribution Plan is subject
to a state expense limit will depend upon the nature of the expenditure and the
terms of the state law, regulation or order imposing the limit. A portion of the
Fund's Distribution Plan expenses may be includable in the Fund's total
operating expenses for purposes of determining compliance with state expense
limits.
For the fiscal year ended September 30, 1995, the Fund paid FICO
$5,470 under the Class Y Distribution Plan.
While the Class Y Distribution Plan is in effect, the Fund will be
required to commit the selection and nomination of candidates for Independent
Trustees to the discretion of the Independent Trustees.
The Independent Trustees of the Fund have determined that the sales of
the Fund's Class Y shares resulting from payments under the Class Y Distribution
Plan will benefit the Fund.
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DISTRIBUTOR
- -------------------------------------------------------------------------------
The Fund has entered into a Distribution Agreement with FICO (the
"Distribution Agreement"). FICO is a wholly-owned subsidiary of Keystone.
The Fund has appointed FICO to act as principal underwriter of the
Fund's shares in such states as the Fund may, from time to time, designate. FICO
will act as agent for the Fund and not as principal. FICO will have the right to
obtain subscriptions for and to sell shares as agent of the Fund and, in so
doing, may retain and employ representatives to promote distribution of the
shares and may obtain orders from brokers or dealers or others for sales of
shares to them. No such representative, dealer or broker shall have any
authority to act as agent for the Fund. The Distribution Agreement provides that
FICO will bear the expenses of preparing, printing and distributing advertising
and sales literature and prospectuses used by it. In its capacity as Principal
Underwriter, FICO may receive payments from the Fund pursuant to the Class Y
Distribution Plan.
All subscriptions and sales of shares by FICO are at the offering price
of the shares in accordance with the provisions of the Fund's Declaration of
Trust, By-Laws, current prospectus and statement of additional information. All
orders are subject to acceptance by the Fund, and the Fund reserves the right in
its sole discretion to reject any order received. Under the Distribution
Agreement, the Fund is not liable to anyone for failure to accept any order.
FICO has agreed that it will, in all respects, duly conform with all
state and federal laws applicable to the sale of the shares and will indemnify
and hold harmless the Fund, and each person who has been, is or may be a Trustee
or officer of the Fund, against expenses reasonably incurred by any of them in
connection with any claim or in connection with any action, suit or proceeding
to which any of them may be a party, that arises out of or is alleged to arise
out of any misrepresentation or omission to state a material fact on the part of
FICO or any other person for whose acts FICO is responsible or is alleged to be
responsible, unless such misrepresentation or omission was made in reliance upon
written information furnished by the Fund.
The Distribution Agreement provides that it will remain in
effect for two years and from year to year thereafter as long as its terms and
continuance are approved by a majority of the Fund's Independent Trustees at
least annually at a meeting called for that purpose, and if its continuance is
approved annually by vote of a majority of Trustees, or by vote of a majority of
the outstanding shares of the Fund.
The Distribution Agreement may be terminated, without penalty, on 60
days' written notice by the Fund or on 90 days' written notice by FICO. The
Distribution Agreement will terminate automatically upon its "assignment" as
that term is defined in the 1940 Act.
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BROKERAGE
- -------------------------------------------------------------------------------
It is the policy of the Fund, in effecting transactions in portfolio
securities, to seek best execution of orders at the most favorable prices. The
determination of what may constitute best execution and price in the execution
of a securities transaction by a broker involves a number of considerations
including, without limitation, the overall direct net economic result to the
Fund, involving both price paid or received and any commissions and other costs
paid, the efficiency with which the transaction is effected, the ability to
effect the transaction at all where a large block is involved, the availability
of the broker to stand ready to execute potentially difficult transactions in
the future and the financial strength and stability of the broker. Such
considerations are judgmental and are weighed by management in determining the
overall reasonableness of brokerage commissions paid.
Subject to the foregoing, a factor in the selection of brokers is the
receipt of research services, such as analyses and reports concerning issuers,
industries, securities, economic factors and trends and other statistical and
factual information. Any such research and other statistical and factual
information provided by brokers to the Fund is considered to be in addition to
and not in lieu of services required to be performed by Keystone under the
Advisory Agreement. The cost, value and specific application of such information
are indeterminable and cannot be practically allocated among the Fund and other
clients of Keystone who may indirectly benefit from the availability of such
information. Similarly, the Fund may indirectly benefit from information made
available as a result of transactions effected for such other clients. Under the
Advisory Agreement, Keystone is permitted to pay higher brokerage commissions
for brokerage and research services in accordance with Section 28(e) of the
Securities Exchange Act of 1934. In the event Keystone does follow such a
practice, it will do so on a basis that is fair and equitable to the Fund.
The Fund expects that purchases and sales of its securities and
temporary instruments usually will be principal transactions. Adjustable rate
and fixed rate securities and temporary instruments are normally purchased
directly from the issuer or from an underwriter or market maker for the
securities. There usually will be no brokerage commissions paid by the Fund for
such purchases. Purchases from underwriters will include the underwriting
commission or concession, and purchases from dealers serving as market makers
will include a dealer's mark up or reflect a dealer's mark down. Where
transactions are made in the over-the-counter market, the Fund will deal with
primary market makers unless more favorable prices are otherwise obtainable.
The Fund may participate, if and when practicable, in group bidding for
the direct purchase from an issuer of certain securities for the Fund's
portfolio in order to take advantage of the lower purchase price available to
members of such a group.
Neither Keystone nor the Fund intends to place securities transactions
with any particular broker-dealer or group thereof. The Fund's Board of
Trustees, however, has determined that the Fund may follow a policy of
considering sales of shares as a factor in the selection of broker-dealers to
execute portfolio transactions, subject to the requirements of best execution,
including best price, described above.
The policy of the Fund with respect to brokerage is and will be
reviewed by the Fund's Board of Trustees from time to time. Because of the
possibility of further regulatory developments affecting the securities
exchanges and brokerage practices generally, the foregoing practices may be
changed, modified or eliminated.
Investment decisions for the Fund are made independently by Keystone
from those of the other funds and investment accounts managed by Keystone. It
may frequently develop that the same investment decision is made for more than
one fund. Simultaneous transactions are inevitable when the same security is
suitable for the investment objective of more than one account. When two or more
funds or accounts are engaged in the purchase or sale of the same security, the
transactions are allocated as to amount in accordance with a formula that is
equitable to each fund or account. It is recognized that in some cases this
system could have a detrimental effect on the price or volume of the security as
far as the Fund is concerned. In other cases, however, it is believed that the
ability of the Fund to participate in volume transactions will produce better
executions for the Fund.
In no instance are portfolio securities purchased from or sold to
Keystone, FICO or any of their affiliated persons, as defined in the 1940 Act
and rules and regulations issued thereunder.
For the years ended September 30, 1995, 1994 and 1993, the Fund did not
pay any brokerage commissions.
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DECLARATION OF TRUST
- -------------------------------------------------------------------------------
MASSACHUSETTS BUSINESS TRUST
The Fund is a Massachusetts business trust established under a
Declaration of Trust dated June 19, 1991 (the "Declaration of Trust"). The Fund
is similar in most respects to a business corporation. The principal distinction
between the Fund and a corporation relates to the shareholder liability
described below. A copy of the Declaration of Trust, as amended, has been filed
as an exhibit to the Fund's Registration Statement. This summary is qualified in
its entirety by reference to the Declaration of Trust.
DESCRIPTION OF SHARES
The Declaration of Trust authorizes the issuance of an unlimited number
of shares of beneficial interest of one or more series and/or classes of shares.
Each share of a series or class represents an equal proportionate interest with
each other share of the series or class. Upon liquidation, shares are entitled
to a pro rata share in the net assets of the portfolio of securities underlying
the series or class. Shareholders have no preemptive or conversion rights.
Shares are transferable, redeemable and fully assignable as collateral. There
are no sinking fund provisions. The Fund currently issues two classes of shares
and is authorized to issue additional classes or series of shares.
SHAREHOLDER LIABILITY
Pursuant to court decisions or other theories of law, shareholders of a
Massachusetts business trust may be held personally liable on the obligations of
the trust. The possibility of Fund shareholders incurring financial loss under
such circumstances appears remote because the Fund's Declaration of Trust (1)
contains an express disclaimer of shareholder liability for obligations of the
Fund; (2) requires that notice of such disclaimer be given in each agreement,
obligation or instrument entered into or executed by the Fund or the Trustees;
and (3) provides for indemnification out of Fund property for any shareholder
held personally liable for the obligations of the Fund.
VOTING RIGHTS
Under the terms of the Declaration of Trust, the Fund does not hold
annual meetings. Shares of the Fund are entitled to one vote per share on
matters subject to vote by the Fund, such as investment advisory agreements.
Shares generally vote together as one class. No amendment may be made to the
Declaration of Trust that adversely affects any class of shares without the
approval of a majority of the shares of that class. Each class has exclusive
voting rights with respect to its respective distribution plan, if any. Shares
have non-cumulative voting rights, which means that the holders of more than 50%
of the shares voting for the election of Trustees can elect 100% of the Trustees
to be elected at a meeting. In such event, the holders of the remaining shares
voting will not be able to elect any Trustees.
After the initial meeting electing Trustees, no further meetings of
shareholders for the purpose of electing Trustees will be held, unless required
by law or unless and until such time as less than a majority of the Trustees
holding office have been elected by shareholders, at which time, the Trustees
then in office will call a shareholders' meeting for election of Trustees.
Except as set forth above, the Trustees shall continue to hold office
indefinitely, unless otherwise required by law, and may appoint successor
Trustees. A Trustee may be removed from or cease to hold office (as the case may
be) (1) at any time by two-thirds vote of the remaining Trustees; (2) when such
Trustee becomes mentally or physically incapacitated; or (3) at a special
meeting of shareholders by a two-thirds vote of the outstanding shares. Any
Trustee may voluntarily resign from office.
LIMITATION OF TRUSTEES' LIABILITY
The Declaration of Trust provides that a Trustee shall be liable only
for his own willful defaults and, if reasonable care has been exercised in the
selection of officers, agents, employees or investment advisers, shall not be
liable for any neglect or wrongdoing of any such person; provided, however, that
nothing in the Declaration of Trust shall protect a Trustee against any
liability for his willful misfeasance, bad faith, gross negligence or reckless
disregard of his duties.
The Trustees have absolute and exclusive control over the management
and disposition of all assets of the Fund and may perform such acts as in their
sole judgment and discretion are necessary and proper for conducting the
business and affairs of the Fund or promoting the interests of the Fund and the
shareholders.
- -------------------------------------------------------------------------------
STANDARDIZED TOTAL RETURN AND YIELD QUOTATIONS
- -------------------------------------------------------------------------------
Total return quotations for a class of shares of the Fund as they may
appear from time to time in advertisements are calculated by finding the average
annual compounded rates of return over one, five and ten year periods, or the
time periods for which such class of shares has been effective, whichever is
relevant, on a hypothetical $1,000 investment that would equate the initial
amount invested to the ending redeemable value. To the initial investment all
dividends and distributions are added, and all recurring fees charged to all
shareholder accounts are deducted. The ending redeemable value assumes a
complete redemption at the end of the relevant periods.
Average annual total return for Class Y shares for the fiscal year
ended September 30, 1995 was 6.60%. Average annual total return for Class Y
shares for the period May 23, 1994 (commencement of operations) through the
fiscal period ended September 30, 1995 was 5.16%. The average annual total
return for Class Z for the fiscal year ended September 30, 1995 was 6.87%. The
average annual total return for Class Z for the period of October 1, 1991
(commencement of operations) through September 30, 1995 was 4.78%.
Current yield quotations as they may appear, from time to time, in
advertisements will consist of a quotation based on a 30-day period ended on the
date of the most recent balance sheet of the Fund, computed by dividing the net
investment income per share earned during the period by the maximum offering
price per share on the last day of the base period. The current yields for Class
Y and Class Z for the 30-day period ended September 30, 1995 were 6.49% and
6.71%, respectively.
Any given yield or total return quotation should not be considered
representative of the Fund's yield or total return for any future period.
- -------------------------------------------------------------------------------
ADDITIONAL INFORMATION
- -------------------------------------------------------------------------------
SMALL ACCOUNTS
The Fund reserves the right to redeem shares in any account in which
the value of shares is less than $1,000. The redemption proceeds will be
promptly paid to the shareholder. Shareholders will be notified if their
accounts are less than such amount and given 60 days to bring the account up to
such amount before the redemption is made.
REDEMPTIONS IN KIND
If conditions arise that would make it undesirable for the Fund to pay
for all redemptions in cash, the Fund may authorize payment to be made in
portfolio securities or other property. The Fund has obligated itself under the
1940 Act, however, to redeem for cash all shares presented for redemption by any
one shareholder in any 90-day period up to the lesser of $250,000 or 1% of the
Fund's net assets. Securities delivered in payment of redemptions would be
valued at the same value assigned to them in computing the net asset value per
share and would, to the extent permitted by law, be readily marketable.
Shareholders receiving such securities would incur brokerage costs when these
securities are sold.
OTHER INFORMATION
State Street Bank and Trust Company,located at 225 Franklin Street,
Boston, Massachusetts 02110, is custodian of all securities and cash of the Fund
(the "Custodian"). The Custodian performs no investment management functions for
the Fund, but, in addition to its custodial services, is responsible for
accounting and related recordkeeping on behalf of the Fund.
KPMG Peat Marwick LLP, 99 High Street, Boston, Massachusetts 02110,
Certified Public Accountants, are the independent auditors for the Fund.
Keystone Investor Resource Center, Inc., 101 Main Street, Cambridge,
Massachusetts 02142, is a wholly-owned subsidiary of Keystone and acts as
transfer agent and dividend disbursing agent for the Fund.
Except as otherwise stated in its prospectus or required by law, the
Fund reserves the right to change the terms of the offer stated in its
prospectus without shareholder approval, including the right to impose or change
fees for services provided.
No dealer, salesman or other person is authorized to give any
information or to make any representation not contained in the Fund's
prospectus, statement of additional information or in supplemental sales
literature issued by the Fund or FICO, and no person is entitled to rely on any
information or representation not contained therein.
As of December 31, 1995, the following accounts owned of record 5% or
more of the Fund's Class Y shares:
PERCENTAGE
RECORD OWNER OF CLASS OWNED
------------ --------------
William H. Morgan Jr. 33.888%
906 Weightman
Greenwood, MS 38930-2438
M & M Farms 29.610%
906 Weightman
Greenwood, MS 38930-2438
James Alexander 19.714%
P.O. Box 1265
Meridian, MS 39302
Oklahoma Farms Inc. 13.628%
906 Weightman
Greenwood, MS 38930-2438
As of December 31, 1995, the following accounts owned of record 5% or
more of the outstanding shares of the Fund's Class Z shares:
PERCENTAGE
RECORD OWNER OF CLASS OWNED
------------ --------------
Ampex Retirement Master Trust 69.660%
P.O. BoX 1992
Boston, MA 02105-1992
Keystone Investment Distributors Company 21.551%
ATTN: Mgr. Financial Accounting
200 Berkeley Street
Boston, MA 02116-5022
Buffalo Color Corp Master Trust 8.636%
P.O. Box 1992
Boston, MA 02105-1992
The Fund's prospectus and statement of additional information omit
certain information contained in its registration statement filed with the
Commission, which may be obtained from the Commission's principal office in
Washington, D.C. upon payment of the fee prescribed by the rules and regulations
promulgated by the Commission.
<PAGE>
- -------------------------------------------------------------------------------
APPENDIX
- -------------------------------------------------------------------------------
U.S. GOVERNMENT SECURITIES
Securities issued or guaranteed by the U.S. government include a
variety of Treasury securities that differ only in their interest rates,
maturities and dates of issuance and securities issued by the Government
National Mortgage Association ("GNMA"). Treasury bills have maturities of one
year or less. Treasury bills have maturities of one year or less. Treasury notes
have maturities of one to ten years and Treasury bonds generally have maturities
of greater than ten years at the date of issuance. GNMA securities include GNMA
mortgage pass-through certificates. Such securities are supported by the full
faith and credit of the U.S.
Securities issued or guaranteed by U.S. government agencies or
instrumentalities include securities issued or guaranteed by the Federal Housing
Administration, Farmers Home Administration, Export-Import Bank of the U.S.,
Small Business Administration, General Services Administration, Central Bank for
Cooperatives, Federal Home Loan Banks, Federal Loan Mortgage Corporation,
Federal Intermediate Credit Banks, Federal Land Banks, Maritime Administration,
The Tennessee Valley Authority, District of Columbia Armory Board and Federal
National Mortgage Association.
Some obligations of U.S. government agencies and instrumentalities,
such as securities of Federal Home Loan Banks, are supported by the right of the
issuer to borrow from the Treasury. Others, such as bonds issued by the Federal
National Mortgage Association, a private corporation, are supported only by the
credit of the instrumentality. Because the U.S. government is not obligated by
law to provide support to an instrumentality it sponsors, the Fund will invest
in securities issued by such an instrumentality only when Keystone determines
under standards established by the Board of Trustees that the credit risk with
respect to the instrumentality does not make its securities unsuitable
instruments. U.S. government securities do not include international agencies or
instrumentalities in which the U.S. government, its agencies or
instrumentalities participate, such as the World Bank, Asian Development Bank or
the Inter-American Development Bank, or issues insured by the Federal Deposit
Insurance Corporation.
CORPORATE BOND RATINGS
S&P CORPORATE BOND RATINGS
A Standard & Poor's Corporation ("S&P") corporate bond rating is a
current assessment of the creditworthiness of an obligor, including obligors
outside the U.S., with respect to a specific obligation. This assessment may
take into consideration obligors such as guarantors, insurers, or lessees.
Ratings of foreign obligors do not take into account currency exchange and
related uncertainties. The ratings are based on current information furnished by
the issuer or obtained by S&P from other sources it considers reliable.
The ratings are based, in varying degrees, on the following
considerations:
1. Likelihood of default - capacity and willingness of the obligor as
to the timely payment of interest and repayment of principal in accordance with
the terms of the obligation;
2. Nature of and provisions of the obligation; and
3. Protection afforded by and relative position of the obligation in
the event of bankruptcy, reorganization or other arrangement under the laws of
bankruptcy and other laws affecting creditors' rights.
PLUS (+) OR MINUS (-): To provide more detailed indications of credit
quality, ratings from AA to A may be modified by the addition of a plus or minus
sign to show relative standing within the major rating categories.
Bond ratings are as follows:
1. AAA - Debt rated AAA has the highest rating assigned by S&P.
Capacity to pay interest and repay principal is extremely strong.
2. AA - Debt rated AA has a very strong capacity to pay interest and
repay principal and differs from the higher rated issues only in small degree.
MOODY'S CORPORATE BOND RATINGS
Ratings of Moody's Investors Service, Inc. ("Moody's") are as follows:
1. Aaa - Bonds that are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt-edge". Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair fundamentally strong position of such issues.
2. Aa - Bonds that are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long term risks appear somewhat larger than in Aaa securities.
Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating
classification from Aa through B in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
ADJUSTABLE RATE SECURITIES RATINGS
S&P RATINGS
A S&P rating of an issue secured by a pool of mortgages is a measure of
the likelihood that cash flow from the mortgages is sufficient for timely
payment of interest and principal on the rated security. Each rating category
generally defines an adverse economic climate that is likely to impact the
performance of the mortgages in the pool over time. The rating process for
commercial mortgages, like all asset-backed financings, involves a credit, legal
structure and cash flow analysis.
The credit analysis involves an analysis of the originator and an
evaluation of the credit quality of the loans and their risk characteristics,
such as property types, geographic locations, loan maturity dates, loan-to-value
ratios, lien status and loan seasoning.
The legal structure analysis involves a review of legal documents to
determine the documents accurately reflect the specifics of the financing and a
review of flow of funds and investment restrictions of any reserve fund or
credit enhancement.
The cash flow analysis involves identification of the type of security
created out of the cash flow from the pool of commercial mortgages and the
payment terms of the security. Once these items are identified, the individual
loan and pool analysis are applied to determine cash flow scenarios for the
pool.
Eligible ratings are as follows:
1. AAA - Securities rated AAA have the highest rating assigned by S&P
and reflect certainty that the issuer at all times will have pledged collateral
such that scheduled cash flow and assumed reinvestment income thereon will be
sufficient to pay annual interest on the securities and redeem principal at
maturity.
2. AA - Securities rated AA reflect certainty that amounts available
from distributions on the mortgage loans and from reserves will be sufficient to
pay monthly interest and return principal.
MOODY'S RATINGS
Moody's rating provides a system of gradation by which the relative
credit risks of investments in adjustable rate securities can be judged. Moody's
factors into its ratings the frequency, severity and timing of defaults in order
to provide an assessment of the appropriate risk premium for taking on credit
risk. In rating adjustable rate securities, Moody's uses the same letter system
as that for corporate bonds. In assessing risk, on average the risks associated
with Aaa and Aa rated Moody's corporate bonds would apply to adjustable
securities rated Aaa or Aa by Moody's. See the description of Moody's corporate
bond ratings set forth above.
MONEY MARKET INSTRUMENTS
Money market securities are instruments with remaining maturities of
one year or less such as bank certificates of deposit, bankers' acceptances,
commercial paper (including master demand notes) and obligations issued or
guaranteed by the U.S. government, its agencies or instrumentalities, some of
which may be subject to repurchase agreements.
COMMERCIAL PAPER
Commercial paper will consist of issues rated at the time of purchase
A-1 by S&P, PRIME-1 by Moody's, or F-1 by Fitch Investors Service, Inc.
("Fitch's"); or, if not rated, will be issued by companies that have an
outstanding debt issue rated at the time of purchase Aaa, Aa or A by Moody's, or
AAA, AA or A by S&P, or will be determined by Keystone to be of comparable
quality.
A. S&P RATINGS
An S&P commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. Ratings are graded into four categories, ranging from "A" for the
highest quality obligations to "D" for the lowest. The top category is as
follows:
1. A: Issues assigned this highest rating are regarded as having the
greatest capacity for timely payment. Issues in this category are delineated
with the numbers 1, 2 and 3 to indicate the relative degree of safety.
2. A-1: This designation indicates that the degree of safety regarding
timely payment is either overwhelming or very strong. Those issues determined to
possess overwhelming safety characteristics are denoted with a plus (+) sign
designation.
B. MOODY'S RATINGS
The term "commercial paper" as used by Moody's means promissory
obligations not having an original maturity in excess of nine months. Moody's
commercial paper ratings are opinions of the ability of issuers to repay
punctually promissory obligations not having an original maturity in excess of
nine months. Moody's employs the following designation, judged to be investment
grade, to indicate the relative repayment capacity of rated issuers.
The rating PRIME-1 is the highest commercial paper rating assigned by
Moody's. Issuers rated PRIME-1 (or related supporting institutions) are deemed
to have a superior capacity for repayment of short term promissory obligations.
Repayment capacity of PRIME-1 issuers is normally evidenced by the following
characteristics:
1. leading market positions in well-established industries;
2. high rates of return on funds employed;
3. conservative capitalization structures with moderate reliance on
debt and ample asset protection;
4. broad margins in earnings coverage of fixed financial charges and
high internal cash generation; and
5. well established access to a range of financial markets and assured
sources of alternate liquidity.
In assigning ratings to issuers whose commercial paper obligations are
supported by the credit of another entity or entities, Moody's evaluates the
financial strength of the affiliated corporations, commercial banks, insurance
companies, foreign governments or other entities, but only as one factor in the
total rating assessment.
CERTIFICATES OF DEPOSIT
Certificates of deposit are receipts issued by a bank in exchange for
the deposit of funds. The issuer agrees to pay the amount deposited plus
interest to the bearer of the receipt on the date specified on the certificate.
The certificate usually can be traded in the secondary market prior to maturity.
Certificates of deposit will be limited to U.S. dollar denominated
certificates of United States banks, including their branches abroad, and of
U.S. branches of foreign banks, which are members of the Federal Reserve System
or the Federal Deposit Insurance Corporation and have at least $1 billion in
assets as of the date of their most recently published financial statements.
The Fund will not acquire time deposits or obligations issued by the
International Bank for Reconstruction and Development, the Asian Development
Bank or the Inter-American Development Bank. Additionally, the Fund does not
intend to purchase such foreign securities (except to the extent that
certificates of deposit of foreign branches of U.S. banks may be deemed foreign
securities) or purchase certificates of deposit, bankers' acceptances or other
similar obligations issued by foreign banks.
BANKERS' ACCEPTANCES
Bankers' acceptances typically arise from short term credit
arrangements designed to enable businesses to obtain funds to finance commercial
transactions. Generally, an acceptance is a time draft drawn on a bank by an
exporter or an importer to obtain a stated amount of funds to pay for specific
merchandise. The draft is then "accepted" by the bank that, in effect,
unconditionally guarantees to pay the face value of the instrument on its
maturity date. The acceptance may then be held by the accepting bank as an
earning asset or it may be sold in the secondary market at the going rate of
discount for a specific maturity. Although maturities for acceptances can be as
long as 270 days, most acceptances have maturities of six months or less.
Bankers' acceptances acquired by the Fund must have been accepted by U.S.
commercial banks, including foreign branches of U.S. commercial banks, having
total assets at the time of purchase in excess of $1 billion and must be payable
in U.S. dollars.
<PAGE>
KEYSTONE INSTITUTIONAL ADJUSTABLE RATE FUND
SCHEDULE OF INVESTMENTS -- September 30, 1995
<TABLE>
<CAPTION>
Interest Maturity Par Market
Rate Date Value Value
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
ADJUSTABLE RATE MORTGAGE SECURITIES (91.8%)
FHLMC (35.8%)
FHLMC Pool #605386, Cap 12.890%, Margin 2.114% + CMT, Resets Annually 7.736% 09/01/17 $1,122,269 $1,152,952
FHLMC Pool #605343, Cap 13.604%, Margin 2.125% + CMT, Resets Annually 7.782 03/01/19 1,459,873 1,500,019
FHLMC Pool #606541, Cap 13.539%, Margin 2.037% + CMT, Resets Annually 7.735 03/01/21 989,905 1,015,890
FHLMC Pool #845039, Cap 12.463%, Margin 2.080% + CMT, Resets Annually 7.612 10/01/21 1,598,826 1,640,795
FHLMC Pool #606679, Cap 12.052%, Margin 2.159% + CMT, Resets Annually 7.566 10/01/21 1,287,306 1,321,497
FHLMC Pool #845049, Cap 12.678%, Margin 2.183% + CMT, Resets Annually 7.767 11/01/21 248,526 255,827
FHLMC Pool #845063, Cap 12.050%, Margin 2.174% + CMT, Resets Annually 7.750 11/01/21 904,612 931,185
FHLMC Pool #845082, Cap 12.350%, Margin 1.997% + CMT, Resets Annually 7.687 03/01/22 1,628,783 1,667,466
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL FHLMC 9,485,631
- ---------------------------------------------------------------------------------------------------------------------------------
FNMA (56.0%)
FNMA Pool #070119, Cap 12.021%, Margin 2.000% + CMT, Resets Annually 7.802 11/01/17 3,137,088 3,237,083
FNMA Pool #090678, Cap 13.136%, Margin 2.177% + CMT, Resets Annually 7.747 09/01/18 1,536,260 1,587,632
FNMA Pool #124015, Cap 13.307%, Margin 1.817% + CMT, Resets Annually 7.580 11/01/18 544,703 555,341
FNMA Pool #095405, Cap 13.738%, Margin 2.068% + CMT, Resets Annually 7.853 12/01/19 1,110,152 1,142,763
FNMA Pool #124289, Cap 13.425%, Margin 2.005% + CMT, Resets Annually 7.696 09/01/21 2,758,355 2,831,617
FNMA Pool #142963, Cap 10.960%, Margin 1.950% + CMT, Resets Annually 7.453 01/01/22 1,800,851 1,836,022
FNMA Pool #238847, Cap 13.334%, Margin 2.317% + CMT, Resets Annually 8.023 06/01/31 3,524,124 3,647,469
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL FNMA 14,837,927
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL ADJUSTABLE RATE MORTGAGE SECURITIES (Cost - $24,395,519) 24,323,558
- ---------------------------------------------------------------------------------------------------------------------------------
FIXED RATE MORTGAGE SECURITIES (2.8%)
FHLMC (0.4%)
FHLMC Pool #277831 7.250 11/01/08 107,107 106,673
- ---------------------------------------------------------------------------------------------------------------------------------
FNMA (2.4%)
FNMA Pool #004534 10.750 10/01/12 572,721 627,616
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED RATE MORTGAGE SECURITIES (Cost - $716,287) 734,289
- ---------------------------------------------------------------------------------------------------------------------------------
UNITED STATES TREASURY ISSUES (1.9%)
U.S. Treasury Notes (Cost $501,016) 6.000 08/31/97 500,000 501,250
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Schedule of Investments
<PAGE>
KEYSTONE INSTITUTIONAL ADJUSTABLE RATE FUND
SCHEDULE OF INVESTMENTS -- September 30, 1995
<TABLE>
<CAPTION>
Interest Maturity Par Market
Rate Date Value Value
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
SHORT-TERM INVESTMENT (2.3%)
Keystone Joint Repurchase Agreement (Investments in repurchase agreements,
in a joint trading account, purchased 9/30/95) (Cost -- $618,000)(a) 6.391% 10/02/95 $618,329 $618,000
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS (Cost - $26,230,822)(b) 26,177,097
- ---------------------------------------------------------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES -- NET (1.2%) 309,618
- ---------------------------------------------------------------------------------------------------------------------------------
NET ASSETS -- (100.0%) $26,486,715
<FN>
NOTES TO SCHEDULE OF INVESTMENTS:
(a) The repurchase agreements are fully collateralized by U.S. government and/or agency obligations based
on market prices at September 30, 1995.
(b) The cost of investments for federal income tax purposes is $26,239,168. Gross unrealized appreciation and
depreciation of investments, based on identified tax cost at September 30, 1995 are as follows:
Gross unrealized appreciation $80,048
Gross unrealized depreciation -142,119
-------
Net unrealized depreciation -$62,071
=======
</TABLE>
Legend of Portfolio Abbreviations:
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>
Keystone Institutional Adjustable Rate Fund
FINANCIAL HIGHLIGHTS - CLASS Y SHARES
(For a share outstanding throughout the period)
<TABLE>
<CAPTION>
May 23, 1994 (Date of
Year Ended September 30, Initial Public Offering)
1995 to September 30, 1994
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
NET ASSET VALUE BEGINNING OF PERIOD $9.61 $9.73
Income from investment operations:
Net investment income 0.64 0.17
Net realized and unrealized gain (loss) on investments (0.02) (0.13)
- ---------------------------------------------------------------------------------------------------------------------------------
Total from investment operations 0.62 0.04
- ---------------------------------------------------------------------------------------------------------------------------------
Less distributions from:
Net investment income (0.53) (0.16)
In excess of net investment income (0.05) 0
Total distributions (0.58) (0.16)
- ---------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE END OF PERIOD $9.65 $9.61
=================================================================================================================================
TOTAL RETURN 6.60% 0.35%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses 0.55% 0.43%(a)
Net investment income 6.70% 5.03%(a)
Portfolio turnover rate 56% 63%
- ---------------------------------------------------------------------------------------------------------------------------------
NET ASSETS END OF PERIOD (THOUSANDS) $2,871 $ 1
=================================================================================================================================
<FN>
(a) Annualized
</TABLE>
See Notes to Financial Statements
<PAGE>
Keystone Institutional Adjustable Rate Fund
FINANCIAL HIGHLIGHTS - CLASS Z SHARES
(For a share outstanding throughout the year)
<TABLE>
<CAPTION>
Year Ended September 30,
--------------------------------------------------------
1995 1994 1993(a) 1992
<S> <C> <C> <C> <C>
NET ASSET VALUE BEGINNING OF YEAR $9.61 $9.93 $9.88 $10.00
- ---------------------------------------------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income 0.63 0.63 0.54 0.67
Net realized and unrealized gain (loss) on investments 0.01 (0.49) (0.01) (0.15)
- ---------------------------------------------------------------------------------------------------------------------------------
Total from investment operations 0.64 0.14 0.53 0.52
- ---------------------------------------------------------------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
Net investment income (0.55) (0.44) (0.48) (0.64)
In excess of net investment income (0.05) (0.02) 0 0
Total distributions (0.60) (0.46) (0.48) (0.64)
- ---------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE END OF YEAR $9.65 $9.61 $9.93 $9.88
=================================================================================================================================
TOTAL RETURN 6.87% 1.43% 5.53% 5.46%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses 0.30% 0.30% 0.30% 0.30%
Net investment income 6.61% 5.15% 5.46% 6.83%
Portfolio turnover rate 56% 63% 81% 88%
- ---------------------------------------------------------------------------------------------------------------------------------
NET ASSETS END OF YEAR (THOUSANDS) $23,616 $25,200 $60,035 $51,625
=================================================================================================================================
<FN>
(a) Per share calculations based on weighted average shares outstanding.
</TABLE>
See Notes to Financial Statements
<PAGE>
Keystone Institutional Adjustable Rate Fund
STATEMENT OF ASSETS AND LIABILITIES
September 30, 1995
ASSETS:
Investments at market value ( identified cost
-- $26,230,822)(Note 1) $26,177,097
Cash 58
Receivable for:
Principal paydown 234,775
Interest 227,690
Receivable from investment adviser (Note 4) 76
- ------------------------------------------------------------------------------
Total assets 26,639,696
LIABILITIES:
Payable for income distribution 152,915
Accrued expenses 66
- ------------------------------------------------------------------------------
Total liabilities 152,981
- ------------------------------------------------------------------------------
NET ASSETS $26,486,715
==============================================================================
NET ASSETS REPRESENTED BY (NOTE 1):
Paid-in capital 27,795,222
Accumulated distributions in excess of net investment income (130,905)
Accumulated net realized gain (loss) on investments (1,123,877)
Net unrealized appreciation (depreciation) on investments (53,725)
- ------------------------------------------------------------------------------
Total net assets $26,486,715
==============================================================================
NET ASSET VALUE AND REDEMPTION PRICE PER SHARE (NOTE 1):
Class Y Shares
Net assets of $2,870,585/297,431 shares outstanding $9.65
Class Z Shares
Net assets of $23,616,130/2,447,003 shares outstanding 9.65
==============================================================================
See Notes to Financial Statements
<PAGE>
Keystone Institutional Adjustable Rate Fund
STATEMENT OF OPERATIONS
Year Ended September 30, 1995
- ------------------------------------------------------------------------------
INVESTMENT INCOME (NOTE 1):
Interest $1,852,307
- ------------------------------------------------------------------------------
EXPENSES (NOTES 2 AND 4):
Management fees 79,819
Distribution Plan expenses 5,470
- ------------------------------------------------------------------------------
Total expenses 85,289
Less: Reimbursement from investment advisor (Note 4) (76)
- ------------------------------------------------------------------------------
Net expenses 85,213
- ------------------------------------------------------------------------------
Net investment income 1,767,094
- ------------------------------------------------------------------------------
NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS (NOTES 1 AND 3) :
Net realized gain (loss) on investments (233,646)
- ------------------------------------------------------------------------------
Net change in unrealized appreciation (depreciation)
on investments 278,275
- ------------------------------------------------------------------------------
Net realized and unrealized gain (loss) on investments 44,629
- ------------------------------------------------------------------------------
Net increase (decrease) in net assets resulting
from operations $1,811,723
==============================================================================
See Notes to Financial Statements
<PAGE>
Keystone Institutional Adjustable Rate Fund
STATEMENTS OF CHANGES IN NET ASSETS
Year Ended September 30,
-------------------------------
1995 1994
- ------------------------------------------------------------------------------
Operations:
Net investment income $1,767,094 $2,054,680
Net realized gain (loss) on investments (233,646) (490,115)
Net change in unrealized appreciation
(depreciation) on investments 278,275 (829,592)
- ------------------------------------------------------------------------------
Net increase (decrease) in net assets
resulting from operations 1,811,723 734,973
- ------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM (NOTE 1):
Net investment income - Class Y Shares (125,619) (17)
Net investment income - Class Z Shares (1,407,521) (1,803,281)
In excess of net investment income
- Class Y Shares (10,726) -0-
In excess of net investment income
- Class Z Shares (120,179) (87,216)
- ------------------------------------------------------------------------------
Total distributions to shareholders (1,664,045) (1,890,514)
- ------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 2):
Proceeds from shares sold - Class Y Shares 5,084,803 1,000
Proceeds from shares sold - Class Z Shares 219,375 8,811,967
Payments for shares redeemed - Class Y Shares (2,362,055) -0-
Payments for shares redeemed - Class Z Shares (3,056,070) (43,893,431)
Net asset value of shares issued in
reinvestment of dividends and distributions
from:
Class Y Shares 118,357 -0-
Class Z Shares 1,133,577 1,402,449
- ------------------------------------------------------------------------------
Net increase (decrease) in net assets
resulting from capital share transactions 1,137,987 (33,678,015)
- ------------------------------------------------------------------------------
Total increase (decrease) in net assets 1,285,665 (34,833,556)
- ------------------------------------------------------------------------------
NET ASSETS:
Beginning of year 25,201,050 60,034,606
- ------------------------------------------------------------------------------
End of year [Including undistributed net
investment income (distributions in excess
of net investment income) as follows:
1995-($130,905) and 1994-($87,216)](Note 1) $26,486,715 $25,201,050
==============================================================================
See Notes to Financial Statements
<PAGE>
KEYSTONE INSTITUTIONAL ADJUSTABLE RATE FUND
NOTES TO FINANCIAL STATEMENTS
(1.) SIGNIFICANT ACCOUNTING POLICIES
Keystone Institutional Adjustable Rate Fund (the "Fund") is a Massachusetts
business trust for which Keystone Investment Management Company ("Keystone")
(formerly known as Keystone Custodian Funds, Inc.) is the Investment Adviser and
Manager. The Fund was organized on June 19, 1991, and had no operations prior to
October 1, 1991. 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 currently offers Class Y shares and Class Z shares. Both classes are
offered without an initial sales charge and are not subject to a sales charge
when they are redeemed. Class Y shares make payments under a Distribution Plan
pursuant to Rule 12b-1 under the 1940 Act.
Keystone is a wholly-owned subsidiary of Keystone Investments, Inc. ("KII")
(formerly Keystone Group, Inc.), a Delaware corporation. KII is privately owned
by an investor group consisting of current and former members of management of
Keystone and its affiliates. Keystone Investor Resource Center, Inc. ("KIRC"), a
wholly-owned subsidiary of Keystone, is the Fund's transfer agent.
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.
A. U.S. Government agency securities and certificates are traded in the
over-the-counter market and are valued at the mean of bid and asked prices at
the time of valuation. Short-term investments which are purchased with
maturities of sixty days or less are valued at amortized cost (original purchase
cost as adjusted for amortization of premium or accretion of discount) which
when combined with accrued interest approximates market. Short-term investments
maturing in more than sixty days for which market quotations are readily
available are valued at current market value. Short-term investments maturing in
more than sixty days when purchased which are held on the sixtieth day prior to
maturity are valued at amortized cost (market value on the sixtieth day adjusted
for amortization of premium or accretion of discount) which when combined with
accrued interest approximates market. All other securities for which market
quotations are readily available are valued at current market value. Management
values the following securities at prices it deems in good faith to be fair: (a)
securities (including restricted securities) for which complete quotations are
not readily available and (b) listed securities if, in the opinion of
management, the last sales price does not reflect a current value, or if no sale
occurred.
B. 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. All premiums and
discounts are amortized/accreted for both financial reporting and federal income
tax purposes.
C. 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
("Internal Revenue Code"). Thus, the Fund expects to be 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 intends to
avoid any excise tax liability by making the required distributions under the
Internal Revenue Code.
D. When the Fund enters into a repurchase agreement (a purchase of securities
whereby the seller agrees to repurchase the securities at a mutually agreed upon
date and price) the repurchase price of the securities will generally equal the
amount paid by the Fund plus a negotiated interest amount. The seller under the
repurchase agreement will be required to provide securities ("collateral") to
the Fund whose value will be maintained at an amount not less than the
repurchase price, and which generally will be maintained at 101% of the
repurchase price. The Fund monitors the value of collateral on a daily basis,
and if the value of collateral falls below required levels, the Fund intends to
seek additional collateral from the seller or terminate the repurchase
agreement. If the seller defaults, the Fund would suffer a loss to the extent
that the proceeds from the sale of the underlying securities were less than the
repurchase price. Any such loss would be increased by any cost incurred on
disposing of such securities. If bankruptcy proceedings are commenced against
the seller under the repurchase agreement, the realization on the collateral may
be delayed or limited. Repurchase agreements entered into by the Fund will be
limited to transactions with dealers or domestic banks believed to present
minimal credit risks, and the Fund will take constructive receipt of all
securities underlying repurchase agreements until such agreements expire.
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 collateralized by U.S.
Treasury and/or Federal Agency obligations.
E. The Fund distributes net investment income monthly and net capital gains, if
any, annually. Distributions are determined in accordance with income tax
regulations. Distributions from taxable net investment income and net capital
gains can exceed book basis net investment income and net capital gains.
The significant differences between financial statement amounts
available for distribution and distributions made in accordance with income tax
regulations are due to the deferral of losses for income tax purposes and
differences in the treatment of paydown gains and losses.
(2) CAPITAL SHARE TRANSACTIONS
The Trust Agreement authorizes the issuance of an unlimited number of shares of
beneficial interest without par value. Transactions in shares of the Fund were
as follows:
Class Y Shares
----------------------------------------------
May 23, 1994 (Date of
Year Ended Initial Public Offering)
September 30, 1995 to September 30, 1994
- ----------------------------------------------------------------------------
Shares sold 529,838 103
Shares redeemed (244,779) 0
Shares issued in
reinvestment of dividends
and distributions 12,269 0
- ----------------------------------------------------------------------------
Net increase (decrease) 297,328 103
============================================================================
Class Z Shares
----------------------------------------------
Year Ended September 30,
1995 1994
- ----------------------------------------------------------------------------
Shares sold 22,876 899,739
Shares redeemed (317,154) (4,465,425)
Shares issued in
reinvestment of dividends
and distributions 117,999 142,717
- ----------------------------------------------------------------------------
Net increase (decrease) (176,279) (3,422,969)
============================================================================
The Fund bears some of the costs of selling its shares under a Distribution Plan
adopted with respect to its Class Y shares pursuant to Rule 12b-1 under the 1940
Act.
The Class Y Distribution Plan provides for payments which are currently limited
to 0.25% annually of the average daily net assets of Class Y shares to pay
expenses of the distribution of Class Y shares.
Amounts paid by the Fund under the Class Y Distribution Plan are currently used
to pay service fees to the Fund's principal underwriter, Fiduciary Investment
Company Inc.("FICO") and others. The Fund may also make payments to FICO,
dealers and others for activities primarily intended to result in sales of Class
Y Shares.
The Class Y Distribution Plan may be terminated at any time by vote of the
Independent Trustees or by vote of a majority of the outstanding voting shares
of Class Y. However, after termination of the Class Y Distribution Plan, at the
discretion of the Independent trustees, payments to FICO may continue as
compensation for its services which had been earned while the Distribution Plan
was in effect.
Presently, the Fund's class-specific expenses are limited to Distribution Plan
expenses incurred by Class Y shares. During the year ended September 30, 1995,
the Fund paid or accrued to FICO $5,470 under its Class Y Distribution Plan.
This amount represents 0.25% of the average net asset value of Class Y for the
year ended September 30, 1995.
(3.) SECURITIES TRANSACTIONS
As of September 30, 1995 the Fund had capital loss carryovers of approximately
$1,072,000 which expire as follows: $305,000 in 2000, $486,000 in 2001 and
$281,000 in 2003.
Purchases and sales of investment securities (including proceeds received at
maturity) for the year ended September 30, 1995 were as follows:
Cost of Proceeds
Purchases From Sales
- ---------------------------------------------------------------------------
Portfolio securities $ 15,583,485 $ 14,203,463
Short-term investments 262,057,726 262,207,726
- ---------------------------------------------------------------------------
$277,641,211 $276,411,189
============================================================================
(4.) INVESTMENT MANAGEMENT AND OTHER TRANSACTIONS
Under the terms of the Investment Advisory and Management Agreement between
Keystone and the Fund dated September 19, 1991, Keystone provides investment
advisory and management services to the Fund. The Fund pays Keystone a fee for
its services at the annual rate of 0.30% of the average daily net assets of the
Fund.
During the year ended September 30, 1995, Keystone voluntarily limited expenses
including the management fee of Class Y to 0.55% annually and Class Z to 0.30%
annually of the respective average daily net assets of each class. However,
Keystone will not be required to make any reimbursement to an extent which would
result in the Fund's inability to qualify as a regulated investment company
under provisions of the Internal Revenue Code. In accordance with these
voluntary expense limitations, Keystone reimbursed the Fund during the year
ended September 30, 1995 $76 for Class Y shares. Keystone does not intend to
seek repayment of this amount.
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.
<PAGE>
KEYSTONE INSTITUTIONAL ADJUSTABLE RATE FUND
INDEPENDENT AUDITORS' REPORT
The Trustees and Shareholders
Keystone Institutional Adjustable Rate Fund
We have audited the accompanying statement of assets and liabilities of Keystone
Institutional Adjustable Rate Fund, including the schedule of investments, as of
September 30, 1995, 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, 1995 and the period from May 23, 1994 (date of initial public
offering) to September 30, 1994 for Class Y shares and for each of the years in
the four-year period then ended for Class Z 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, 1995 by correspondence with the custodian. 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 Institutional Adjustable Rate Fund as of September 30, 1995, 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 years or periods specified in the first paragraph
above in conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Boston, Massachusetts
October 27, 1995
