SMITH BREEDEN INTERMEDIATE DURATION SERIES ANNUAL REPORT
PERFORMANCE REVIEW
The Smith Breeden Intermediate Duration U.S. Government Series
("Series") provided a total return of 6.10% for the year ended
March 31, 1995. The Series' return was in excess of that of its
benchmark, the Salomon Brothers Mortgage Index (the "SBMI"), by .09%.
Since the Series' inception, its return has exceeded that of its benchmark
by 3.19%, and on an annualized basis by .91%. The graph below plots the
Series' return versus its benchmark, which as noted in the title of the
graph, changed effective January 1, 1994.
The year ended March 31, 1995, was a tumultuous one for the fixed income
markets. The Federal Reserve Board raised the discount rate, the rate at
which banks borrow from the Federal Reserve to meet reserve requirements
and temporary liquidity needs, four times. The rate on March 31, 1994
was 3%, but rose to 5.25% by March 1995. These increases, and the market's
anticipation of the Federal Reserve's actions over the course of the year,
boosted short and intermediate-term yields and increased interest rate
volatility. From March 31, 1994 to March 31, 1995, short-term U.S. Treasury
yields rose over 200 basis points (100 basis points equals one percent),
intermediate-term U.S. Treasury yields rose 85 to 160 basis points, and
long-term yields rose less than 50 basis points. Over the course of the
fiscal year, intermediate and long-term interest rates had actually peaked
at much higher levels: for example, in early January 1995, the five year
U.S. Treasury Note yield was 80 basis points over its closing yield
on March 31, 1995.
IN ACCORDANCE WITH REG. 232.304 OF REGULATION S-T, THE FOLLOWING IS
A DESCRIPTION OF THE GRAPH PRESENTED HERE IN THE TEXT IN COMPLIANCE WITH
ITEM 5a. OF FORM N-1A:
The graph presented compares the change for the period from March 31, 1992
through March 31, 1995 of a $10,000 investment in the Series versus its
benchmark. For the period from the Series' inception, March 31, 1992,
through March 31, 1995, the Series' benchmark was the Five Year US Treasury, as
tracked by Salomon Brothers, Inc. After December 31, 1993, upon approval of a
majority of the shareholders, the Series' benchmark was changed to the Salomon
Brothers Mortgage Index. The Series average annual return for the one year
period was 6.10% and 8.28% for the three year period. The dollar value of a
$10,000 invested in the Series and benchmark, at the end of the three year
period, were $12,699 and $12,380, respectively.
Rising interest rates, volatility and extending durations hurt mortgage
security returns during the first part of the Series' fiscal year. In its
first three quarters, the Intermediate Series returned only .38%.
Performance turned around in the last quarter, however, primarily due to
two reasons. Intermediate-term rates declined in January of 1995
(five-year U.S. Treasury Note yields fell 0.32%), and the Intermediate
Series returned 2.51%, .27% in excess of its benchmark, the SBMI. The
January SBMI return was the best single monthly return for this index since
May of 1990. In February, the Intermediate Series continued to benefit from
declining rates, and returned 2.5%. In March, the Series returned only .38%,
reflecting the stability of market rates and mortgage yield spreads.
The fine performance of the Intermediate Series and SBMI in the first
quarter of 1995 reflects the fact that not only did rates decline, but
mortgages also performed extremely well versus U.S. Treasury securities. In
the first quarter, the five-year U.S. Treasury returned only 4.95% versus
5.39% for the Series. Adjustable-rate mortgages ("ARMS") underperformed
generic fixed-rate mortgages during most of 1994, so the Series took
advantage of the opportunity by increasing its position in ARMS issued by
GNMA. In the first quarter of 1995, investors realized that ARMS had been
considerably undervalued and bid up prices of ARMS relative to the mortgage
securities market in general. During this time, fixed-rate mortgages also
performed well.
The Series' approach to investment in the mortgage markets is to hold
relatively liquid, easy to price, government mortgage securities in a portfolio
with minimal interest-rate risk relative to its benchmark. With only small
exposures to credit and liquidity risk, the Intermediate Series seeks
actively to take advantage of changes in relative value among liquid
mortgage securities markets. This portfolio management style is reflected
in the Series' 557% portfolio turnover rate for the year ended
March 31, 1995. The markets in which the Series executes most of its
transactions are so liquid that transaction costs are relatively small,
especially in relation to the return advantage gained from these transactions.
SMITH BREEDEN INTERMEDIATE DURATION
U.S. GOVERNMENT SERIES
SCHEDULE OF INVESTMENTS MARCH 31, 1995
Market
Face Amount Security Value
U.S. GOVERNMENT & AGENCY OBLIGATIONS - 99.86%
FEDERAL HOME LOAN MORTGAGE CORPORATION - 8.47% *
FHLMC:
$2,955,733 8.00%, due 08/01/09-09/01/24....................... $2,945,358
TOTAL FEDERAL NATIONAL MORTGAGE ASSOCIATION
(Cost $2,917,339)................................... 2,945,358
FEDERAL NATIONAL MORTGAGE ASSOCIATION - 45.44% *
FNMA:
3,673,326 7.00%, due 08/01/23-06/01/24........................ 3,461,890
9,950,191 8.50%, due 09/14/24-02/01/25........................ 10,052,158
2,000,000 9.50%, due (a)...................................... 2,083,750
FNMA ARM:
211,869 6.92%, due 06/01/20................................. 215,907
TOTAL FEDERAL NATIONAL MORTGAGE ASSOCIATION
(Cost $15,455,743).................................. 15,813,705
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION - 45.78% *
GNMA:
7,813,813 7.00%, due 12/15/23-03/15/24........................ 7,315,089
1,944,841 8.00%, due 11/15/06-04/15/09........................ 1,962,845
GNMA ARM:
939,767 5.50%, due 05/20/23................................. 913,115
1,972,848 6.00%, due 08/20/22................................. 1,948,582
2,625,493 6.125%, due 11/20/22................................ 2,584,272
1,200,000 7.00%, due (a)...................................... 1,208,250
TOTAL GOVERNMENT NATIONAL MORTGAGE ASSOCIATION
(Cost $15,823,677).................................. 15,932,153
UNITED STATES TREASURY BILLS - 0.17% **
50,000 5.66% due 06/29/95.................................. 49,301
10,000 5.69% due 06/29/95.................................. 9,859
TOTAL UNITED STATES TREASURY BILLS (Cost $59,160)... 59,160
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(Cost $34,255,920).................................. 34,750,376
TOTAL INVESTMENTS (Cost $34,255,920) - 99.86%....... 34,750,376
CASH AND OTHER ASSETS LESS LIABILITIES - 0.14%...... 47,120
NET ASSETS - 100.00%................................$34,797,496
* Mortgage-backed obligations are subject to principal paydowns as a result
of prepayments or refinancings of the underlying securities instruments. As a
result, the average life may be substantially less than the original maturity.
The interest rate shown is the rate in effect at March 31, 1995. ARM's have
coupon rates which adjust periodically. The adjusted rate is determined by
adding a spread to a specified index.
** The interest rate shown is the discount rate paid at the time of purchase
by the Fund.
(a) To be announced
Portfolio Abbreviations:
ARM - Adjustable-Rate Mortgage
FHLMC - Federal Home Loan Mortgage Corporation
FNMA - Federal National Mortgage Association
GNMA - Government National Mortgage Association
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN INTERMEDIATE DURATION
U.S. GOVERNMENT SERIES
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 1995
ASSETS:
Investments at market value
(identified cost $34,255,920)(Note 1)............... $34,750,376
Cash and cash equivalents.............................. 3,197,511
Interest receivable.................................... 213,911
Prepaid expenses....................................... 21,528
Deferred organization expenses (Note 1)................ 19,587
Due from adviser (Note 3).............................. 17,137
TOTAL ASSETS...................................... 38,220,050
LIABILITIES:
Variation margin on futures contracts.................. 3,625
Accrued expenses....................................... 41,821
Securities purchased payable........................... 3,229,302
Distributions payable.................................. 147,806
TOTAL LIABILITIES................................. 3,422,554
NET ASSETS:
(Applicable to outstanding shares of 3,538,283;
unlimited number of shares of beneficial
interest authorized; no stated par)................. $34,797,496
Net asset value, offering price and redemption
price per share ($34,797,496 / 3,538,283)........... $ 9.83
SOURCE OF NET ASSETS:
Paid in capital........................................ $35,250,723
Overdistributed net investment income.................. (109,925)
Accumulated net realized loss on investments........... (831,188)
Net unrealized appreciation (depreciation) of investments
and futures contract............................... 487,886
NET ASSETS............................................. $34,797,496
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN INTERMEDIATE DURATION
U.S. GOVERNMENT SERIES
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1995
INVESTMENT INCOME:
Interest and discount earned, net of premium
amortization....................................... $1,516,801
EXPENSES:
Advisory fees (Note 3)................................ 132,174
Accounting and pricing services fees.................. 26,079
Distribution fees (Note 3)............................ 7,074
Custodian fees....................................... 16,614
Audit & tax preparation fees......................... 18,395
Legal fees........................................... 20,663
Amortization of organization expenses (Note 1)....... 9,248
Transfer agent fees.................................. 30,431
Registration fees.................................... 20,558
Trustees fees........................................ 4,701
Insurance............................................ 3,459
Other................................................ 3,956
TOTAL EXPENSES BEFORE REIMBURSEMENT.............. 293,352
Expenses reimbursed by Adviser (Note 3).......... (123,390)
NET EXPENSES..................................... 169,962
NET INVESTMENT INCOME ........................... 1,346,839
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized loss on investments..................... (248,302)
Change in unrealized appreciation (depreciation) of
investments and futures contracts................. 778,903
Net realized and unrealized gain on inestments....... 530,601
Net increase in net assets resulting from operations. $1,877,440
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN INTERMEDIATE DURATION
U.S. GOVERNMENT SERIES
STATEMENTS OF CHANGES IN NET ASSETS
Year Ended Year Ended
OPERATIONS: March 31, 1995 March 31, 1994
Net investment income......................... $1,346,839 $598,297
Net realized gain (loss) on investments....... (248,302) 37,266
Change in unrealized appreciation (depreciation)
of investments and futures contracts........ 778,903 (361,010)
Net increase in net assets resulting from
operations.................................. 1,877,440 274,553
DISTRIBUTIONS TO SHAREHOLDERS:
Dividends from net investment income.......... (1,346,839) (594,276)
Dividends in excess of net investment income.. (140,634) -
Distributions from net realized capital gains. - (5,416)
Distributions in excess of net realized capital
gains....................................... (28,444) -
Total distributions........................... (1,515,917) (599,692)
CAPITAL SHARE TRANSACTIONS:
Shares sold.................................. 31,506,439 9,608,109
Shares issued on reinvestment of
distributions............................. 669,611 569,108
Shares redeemed.............................. (4,519,742) (5,996,326)
Increase in net assets resulting from capital
share transactions (a).................... 27,656,308 4,180,891
TOTAL INCREASE IN NET ASSETS.............. 28,017,831 3,855,752
NET ASSETS:
Beginning of period ......................... 6,779,665 2,923,913
End of period................................ $34,797,496 $6,779,665
(a) Transactions in capital shares were as follows:
Shares sold.............................. 3,257,497 902,154
Shares issued on reinvestment of
distributions......................... 68,948 53,947
Shares redeemed.......................... (465,316) (554,342)
Net increase............................. 2,861,129 401,759
Beginning balance ....................... 677,154 275,395
Ending balance........................... 3,538,283 677,154
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN INTERMEDIATE DURATION
U.S. GOVERNMENT SERIES
FINANCIAL HIGHLIGHTS
The following average per share data, ratios and supplemental information
have been derived from information provided in the financial statements.
Year Ended Year Ended Period Ended
March 31, 1995 March 31, 1994 March 31, 1993 (3)
Net Asset Value, Beginning
of Period......... $10.01 $10.62 $10.00
Income From Investment
Operations
Net investment
income.......... 0.664 1.050 0.826
Net loss on securities
(both realized and
unrealized)...... (0.049) (0.601) 0.621
Total from investment
operations....... 0.615 0.449 1.447
Less Distributions
Dividends from net
investment
income.......... (0.664) (1.044) (0.826)
Dividends in excess of
net investment
income........... (0.108) - -
Distributions from net
realized gains on
investments...... - (0.015) -
Distributions in excess of
net realized gains on
investments...... (0.022) - -
Total distributions.. (0.794) (1.059) (0.826)
Net Asset Value,
End of Period...... $9.83 $10.01 $10.62
Total Return......... 6.10% 4.11% 14.93%
Ratios/Supplemental Data
Net assets, end of
period........... $34,797,496 6,779,666 $2,923,913
Ratio of expenses to
average net assets (1). 0.78% 0.00% 0.31%
Ratio of net investment
income to average
net assets (2)... 6.20% 7.74% 8.18%
Portfolio turnover
rate............. 557% 84% 42%
______________________
1 The annualized ratio of expenses to average net assets prior to
reimbursement of expenses by the Advisor was 1.35%, 1.30% and 14.80%
for the years ended March 31, 1995 and March 31, 1994 and for the
period ended March 31, 1993, respectively.
2 The annualized ratio of net investment income to average net assets
prior to reimbursement of expenses by the Adviser was 5.64%, 6.43%
and (6.31)% for the years ended March 31, 1995 and March 31, 1994 and
for the period ended March 31, 1993, respectively.
3 The Intermediate Duration U.S. Government Series commenced operations
on March 31, 1992.
The accompanying notes are an integral part of these financial statements.
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
Smith Breeden Series Fund (the "Fund") is an open-end, diversified management
investment company registered under the Investment Company Act of 1940, as
amended. The Fund offers shares in two series: Smith Breeden Short Duration
U.S. Government Series and the Smith Breeden Intermediate Duration U.S.
Government Series ("Intermediate Series" or "Series"). The following is a
summary of significant accounting policies consistently followed by the
Intermediate Series.
A. Security Valuation: Portfolio securities are valued at current market
value provided by a pricing service or by a bank or broker/dealer experienced
in such matters, when over-the-counter market quotations are readily available.
Securities and other assets for which market prices are not readily available
are valued at fair market value as determined in accordance with procedures
approved by the Board of Trustees. All money market instruments and debt
securities originally purchased with remaining maturities of 60 days or less
shall be valued at their amortized cost.
B. Distributions and Taxes: The Intermediate Series intends to continue to
qualify for and elect the special tax treatment afforded regulated investment
companies under Subchapter M of the Internal Revenue Code, thereby relieving
the Series of Federal income taxes. To so qualify, the Series intends to
distribute substantially all of its net investment income and net realized
capital gains, if any, less any available capital loss carry forward. As of
March 31, 1995, the Series had a capital loss carry forward of $659,858 of
which $484,264 expires March 31, 2002, and $175,594 expires March 31, 2003.
C. Repurchase Agreements: The Intermediate Series may enter into
repurchase agreements with member banks of the Federal Reserve System having
total assets in excess of $500 million and securities dealers, provided that
such banks or dealers meet the credit guidelines of the Series' Board of
Trustees. In a repurchase agreement, the Series acquires securities from a
third party with the commitment that they will be repurchased by the seller
at a fixed price on an agreed upon date. The Intermediate Series' custodian
maintains control or custody of these securities collateralizing the
repurchase agreements until maturity of the repurchase agreements. The
value of the collateral is monitored daily, and if necessary, additional
collateral is received to ensure that the market value of the underlying
assets remains sufficient to protect the Series in the event of the seller's
default. However, in the event of default or bankruptcy of the seller,
the Series' right to the collateral may be subject to legal proceedings.
D. Reverse Repurchase Agreements: A reverse repurchase agreement involves
the sale by the Intermediate Series of portfolio assets concurrently with an
agreement by the Series to repurchase the same assets at a later date at a
fixed price. The Series will maintain a segregated account with its
custodian, which will be marked to market daily, consisting of cash, U.S.
Government securities or other liquid high-grade debt obligations equal in
value to its obligations under reverse repurchase agreements. In the event
the buyer of securities under a reverse repurchase agreement files for
bankruptcy or becomes insolvent, the Series' use of the proceeds of the
agreement may be restricted pending a determination by the other party,
or its trustee or receiver whether to enforce the Series' obligation to
repurchase the securities.
E. Dollar Roll Agreements: The Intermediate Series may enter into dollar
rolls in which the Series sells securities for delivery in the current month
and simultaneously contracts to repurchase substantially similar (same type
and coupon) securities on a specified future date. During the roll period,
the Series foregoes principal and interest paid on these securities. The
Series is compensated by the difference between the current sales price and
the forward price for the future purchase (often referred to as the "drop")
as well as by the interest earned on the cash proceeds of the initial sale.
F. Determination Of Gains Or Losses On Sales Of Securities: Gains or
losses on the sale of securities are calculated for accounting and tax
purposes on the identified cost basis.
G. Deferred Organizational Expenses: Deferred organizational expenses are
being amortized on a straight-line basis over five years.
H. Securities Transactions and Investment Income: Interest income is
accrued daily on both long-term bonds and short-term investments. Interest
income also includes net amortization from the purchase of fixed-income
securities. Transactions are recorded on the first business day following
the trade date. Realized gains and losses from security transactions
are determined and accounted for on the basis of identified cost.
2. FINANCIAL INSTRUMENTS
A. Derivative Financial Instruments Held or Issued for Purposes other
than Trading: The Intermediate Series uses interest rate futures contracts
for risk management purposes in order to reduce fluctuation of the Series'
net asset value relative to its targeted option-adjusted duration.
Upon entering into a futures contract, the Series is required to deposit
either cash or securities in an amount (initial margin) equal to a certain
percentage of the contract value. Subsequent payments (variation margin)
are made or received by the Series each day. The variation margin
payments are equal to the daily changes in the contract value and are
recorded as unrealized gains or losses. The Series recognizes a realized
gain or loss when the contract is closed or expires equal to the difference
between the value of the contract at the time it was opened and the value
at the time it was closed.
The Intermediate Series had the following open futures contracts as of
March 31, 1995:
Principal Expiration Unrealized
Type Amount Position Month Gain/(Loss)
10 year $2,000,000 Long June 1995 $80,535
Treasury
3 month
Eurodollar $22,000,000 Short March 1998 (36,856)
3 month
Eurodollar $6,000,000 Short March 1999 (13,377)
3 month
Eurodollar $16,000,000 Short March 2000 (36,872)
($ 6,570)
Futures transactions involve costs and may result in losses. The effective
use of futures strategies depends on the Series' ability to terminate futures
positions at times when the Series' investment adviser deems it desirable to
do so. The use of futures also involves the risk of imperfect correlation
among movements in the values of the securities underlying the futures
purchased and sold by the Series, of the futures contract itself, and of the
securities which are the subject of a hedge.
The aggregate market value of investments pledged to cover margin requirements
for the open positions at March 31, 1995 was $59,175.
3. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH
AFFILIATES
Smith Breeden Associates, Inc. (the "Adviser"), a registered investment
adviser, provides the Series with investment management services. As
compensation for these services, the Intermediate Series pays the Adviser
a fee computed daily and payable monthly, at an annual rate equal to 0.70%
of the Series' average daily net asset value.
The Adviser has voluntarily agreed to reduce or otherwise limit other
expenses of the Intermediate Series (excluding advisory fees and litigation,
indemnification and other extraordinary expenses) to 0.90% of the Series'
average daily net assets. This voluntary agreement may be terminated or
modified at any time by the Adviser in its sole discretion. The Adviser has
agreed to reduce the fees payable (to the extent of such fees) by the amount
the Series' expenses would, absent the fee reduction, exceed the applicable
expense limitations imposed by state securities administrators. For the
year ended March 31, 1995, the Adviser received fees of $132,174 and
reimbursed the Series $123,391.
Pursuant to Rule 12b-1 under the Investment Company Act of 1940, the
Intermediate Series adopted a distribution plan pursuant to which Fund/Plan
Broker Services, Inc., the Series' principal underwriter (the "Principal
Underwriter") received a fee, accrued daily and paid monthly, at an annual
rate of 0.25% of the Series' average daily net assets, regardless of the
amount of expenses incurred by the Principal Underwriter, to compensate the
Principal Underwriter for services provided in connection with sales of
shares of the Series, including bearing the cost of printing of prospectuses
used for sales, advertising expenses, and marketing allowances, promotional
incentives and other compensation paid to its employees or other dealers
that sell shares of the Series. For the four months ended July 31, 1994,
the Series paid the Principal Underwriter $7,074 for such fees. This plan
terminated August 1, 1994, at which point the Series adopted a different
distribution and services plan (the "Plan") pursuant to Rule 12b-1 under
the 1940 Act.
The purpose of the Plan is to permit the Adviser to compensate investment
dealers and other persons involved in servicing shareholder accounts for
services provided and expenses incurred in promoting the sale of shares of
the Series, reducing redemptions, or otherwise maintaining or improving
services provided to shareholders by such dealers or other persons.
The Plan provides for payments by the Adviser, out of its advisory fee, to
dealers and other persons at the annual rate of up to 0.25% of the
Intermediate Series' average net assets subject to the authority of the
Trustees of the Series to reduce the amount of payments permitted under the
Plan or to suspend the Plan for such periods as they may determine. Subject
to these limitations, the amount of such payments and the purposes for which
they are made shall be determined by the Adviser.
Certain officers and trustees of the Series are also officers and directors
of the Adviser.
4. INVESTMENT TRANSACTIONS
During the year ended March 31, 1995, purchases and proceeds from sales of
securities, other than short-term investments, aggregated $158,263,181 and
$131,617,023, respectively. The purchases and proceeds shown above do not
include dollar roll agreements which are considered borrowings by the
Intermediate Series. The cost of securities for federal income tax purposes
is $34,255,920. Net unrealized appreciation of investments and futures
contracts consists of:
Gross unrealized appreciation...... $700,358
Gross unrealized depreciation...... (212,472)
Net unrealized appreciation........ $487,886
5. LIQUIDATION OF THE INSTITUTIONAL INTERMEDIATE FUND
Pursuant to a plan of liquidation adopted by the Trustees of the Smith Breeden
Institutional Intermediate U.S. Government Fund (the "Institutional Fund"),
on August 1, 1994, the Intermediate Series redeemed in-kind its shares in the
Smith Breeden Institutional Fund. The value of the securities and cash
received by the Intermediate Series totalled $8,563,933.
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders,
Smith Breeden Intermediate Duration U.S. Government Series
of the Smith Breeden Series Fund:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of the Smith Breeden Intermediate
Duration U.S. Government Series of the Smith Breeden Series Fund as of
March 31, 1995, and the related statements of operations for the year
ended and changes in net assets for each of the years in the two-year
period then ended and financial highlights for each of the years in the
two-year period then ended and the period March 31, 1992 (commencement
of operations) to March 31, 1993. 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 at March 31, 1995 by correspondence with the custodian
and brokers. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of the Smith
Breeden Intermediate Duration U.S. Government Series of the Smith Breeden
Series Fund as of March 31, 1995, the results of its operations, the
changes in net assets, and financial highlights for the respective stated
periods in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
May 12, 1995
ANNUAL REPORT SMITH BREEDEN SHORT DURATION U.S GOVERNMENT SERIES
PERFORMANCE REVIEW
The Smith Breeden Short Duration U.S. Government Series (the "Series")
provided a total return of 6.58% for the year ended March 31, 1995. The
Series' return exceeded its benchmark, the six-month U.S. Treasury Bill,
by a significant margin, 1.16%. Since the Series' inception, its return
has exceeded that of its benchmark by 3.60%, and on an annualized basis
by 1.09%. The graph below plots the Series' return versus its benchmark.
The Series had invested all of its assets in the Short Duration U.S.
Government Fund (the "Portfolio") through March 31, 1995. At the close
of business on March 31, 1995, the Portfolio liquidated its assets by a
distribution in kind to its shareholders. The Series received mortgage
securities and other assets with a market value of $218,431,665.
The year ended March 31, 1995, was a tumultuous one for the fixed
income markets. The Federal Reserve Board raised the discount rate, the
rate at which banks borrow from the Federal Reserve to meet reserve
requirements and temporary liquidity needs, four times. The rate on
March 31, 1994 was 3%, but rose to 5.25% by March 1995. These increases,
and the market's anticipation of the Federal Reserve's actions over the
course of the year, boosted short-term and intermediate-term yields and
increased interest-rate volatility. From March 31, 1994 to March 31, 1995,
short-term U.S. Treasury yields rose over 200 basis points (100 basis
points equals one percent), intermediate-term U.S. Treasury yields rose
85 to 160 basis points, and long-term yields rose less than 50 basis
points. Over the course of the fiscal year, intermediate and long-term
interest rates had actually peaked at much higher levels: for example,
in early January 1995, the five-year U.S. Treasury Note yield was 80
basis points over its closing yield on March 31,1995.
THE LINE GRAPH DETAILING PERFORMANCE VERSUS THE SERIES' INDEX
ACCORDING TO ITEM 5a. OF FORM N1-A IS LOCATED HERE IN THE TEXT AND IS
DESCRIBED BELOW IN ACCORDANCE WITH REG. 232.304 OF REGULATION S-T:
THE GRAPH DEPICTS THE CHANGE IN VALUE OF A $10,000 INVESTMENT IN THE
SHORT SERIES VERSUS THAT OF ITS BENCHMARK, THE SIX MONTH US TREASURY
BILL. FROM INCEPTION OF MARCH 31, 1992 THROUGH MARCH 31, 1995, AN
INVESTMENT OF $10,000 IN THE SERIES WOULD HAVE GROWN TO $11,676, VERSUS
$11,317, IF INVESTED IN THE SIX MONTH US TREASURY BILL. THE RETURN IN
THE SERIES IS NET OF FEES AND SALES CHARGES; THE RETURN OF THE
SIX MONTH US TREASURY DOES NOT REFLECT FEES OR TRANSACTION COSTS.
THE ANNUALIZED ONE YEAR RETURN FOR THE SERIES IS 6.58%, AND 5.30%
ANNUALIZED SINCE INCEPTION.
As interest rates rose, the effective maturities (durations) of
mortgage securities lengthened. This happened for two predictable
reasons. First, homeowners were less likely to prepay their mortgages
(primarily due to refinancing or moving). This lengthened the expected
time to receipt of a mortgage investor's principal payments and made a
mortgage security investment longer-term in nature. Second, as
variable-rate mortgage coupons began to reset upward (indexed, as they
are, to short-term rates), they began to be subject to caps on their
periodic adjustments, and their rates moved closer to their contractual
lifetime maximum rates. This made adjustable-rate mortgages (ARMs) more
fixed-rate and less adjustable-rate in nature, extending their durations
and making them more sensitive to subsequent changes in interest rates.
Although the "extension" of mortgage securities in 1994's rising rate
environment was predictable (and well prepared for by the Series, by virtue
of its investment in the Portfolio), investors in general appeared to be
surprised, or at least disappointed, as many left the market. ARM mutual
funds shrank dramatically during the year as many funds failed to deliver
on promises or expectations of price stability. Government mortgage mutual
funds also experienced very substantial outflows during the year; and banks
curtailed their purchases of ARMs as the market depreciation of their
existing holdings was deducted from their reported capital.
Rising volatility and extending durations hurt mortgage security returns
during the first part of the Series' fiscal year. Through November 1994,
the Series had outperformed its benchmark by only 17 basis points.
Adjustable-rate mortgages underperformed generic fixed-rate mortgages during
most of 1994, so the Portfolio, and the Series, by virtue of its investment
in the Portfolio, took advantage of the opportunity by increasing its position
in ARMs issued by GNMA. In December 1994 and January 1995, investors realized
that ARMs had become considerably undervalued and bid up the prices of ARMs
relative to the mortgage securities market in general. During this time,
fixed-rate mortgages also performed well. In these two months, the Series
earned 110 basis points over its six-month U.S. Treasury Bill benchmark.
In February and March 1995 the mortgage markets were "treading water" as
rates declined and spreads held relatively firm. The Portfolio took advantage
of the strength of the earlier mortgage performance to reduce ARM holdings
in the first months of 1995 and to increase the its cash position for future
opportunities.
The Series' and Portfolio's approach to investment in the mortgage
markets is to hold relatively liquid, easy to price, government mortgage
securities in a portfolio with minimal interest rate risk relative to its
benchmark. With only small exposures to credit risk, interest-rate risk
and liquidity risk, the Series seeks actively to take advantage of changes
in relative value among liquid mortgage securities markets. This portfolio
management style is reflected in the Portfolio's 438% portfolio turnover
for the year ended March 31, 1995. The markets in which the Series executes
most of its transactions are so liquid that transactions costs are
relatively small, especially in relation to the return advantage gained
from these transactions.
The Series' and Portfolio's strong risk management discipline stood it
in good stead during the fiscal year. Because the Series' risk is always
targeted to a six-month duration, we proactively prepare for the change in
the portfolio's effective maturity that we expect will occur should interest
rates either rise or fall. We therefore had in place hedge instruments
which counteracted the effects of rising interest rates during the fiscal
year. Gains on the Portfolio's hedge instruments significantly offset
depreciation of the core investments, enabling the Series and Portfolio to
deliver the low risk profile specified in the Prospectus and to outperform
the benchmark at the same time.
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT SERIES
SCHEDULE OF INVESTMENTS March 31, 1995
Market
Face amount Security Value
U.S. GOVERNMENT & AGENCY OBLIGATIONS - 102.55%
FEDERAL HOME LOAN MORTGAGE CORP. - 33.11% *
FHLMC GOLD:
$24,933,273 7.50%, due 06/01/24-07/01/24............... $24,143,753
20,989,707 8.00%, due 09/01/24 to (a)................. 20,786,732
20,000,000 8.50%, due (a)............................. 20,218,750
FHLMC FLOATING-RATE REMIC:
7,308,287 6.83%, due 03/15/24 (b).................... 7,158,124
TOTAL FEDERAL HOME LOAN MORTGAGE CORP.
(Cost $72,466,365) 72,307,359
FEDERAL NATIONAL MORTGAGE ASSOCIATION - 16.62% *
FNMA:
20,383,132 8.50%, due 01/01/25 ....................... 20,592,011
FNMA ARM & FLOATING-RATE REMIC:
11,962,925 6.78%, due 02/25/24 (b)................. 11,710,114
468,440 6.89%, due 12/01/15........................ 471,392
847,476 6.99%, due 06/01/20........................ 863,629
239,776 7.08%, due 12/01/26 ....................... 246,864
1,065,438 7.45%, due 01/01/16 ....................... 1,100,566
555,568 7.50%, due 01/01/18 ....................... 565,379
FNMA INTEREST ONLY **:
2,338,485 9.00%, due 07/25/21........................ 752,693
TOTAL FEDERAL NATIONAL MORTGAGE ASSOCIATION
(Cost $35,548,396 36,302,648
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION - 52.55% *
GNMA:
28,722,855 7.00%, due 11/15/22-03/15/24............... 26,889,586
2,059,451 9.50%, due 07/15/09 to 09/15/21............ 2,165,604
GNMA ARM:
3,052,322 6.13%, due 11/20/22......................... 2,997,014
82,150,000 7.00%, due (a).............................. 82,714,781
TOTAL GOVERNMENT NATIONAL MORTGAGE ASSOCIATION 114,766,985
UNITED STATES TREASURY BILLS - 0.27%
UNITED STATES TREASURY BILL ***
20,000 5.71%, due 06/29/95 ........................ 19,725
50,000 5.69%, due 06/29/95 ........................ 49,312
20,000 5.68%, due 06/29/95 ........................ 19,725
500,000 5.65%, due 06/29/95 ....................... 493,125
TOTAL UNITED STATES TREASURY BILLS
(Cost $581,743) 581,887
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(Cost $223,617,515) 223,958,879
Notional Amount INTEREST RATE SWAP CONTRACTS - 1.88%
$20,000,000 Contract dated 06/22/93 with Prudential Global Funding,
Expires 06/22/98.................................. 938,753
20,000,000 Contract dated 08/31/93 with Salomon Swapco,
Expires 08/31/00.................................1,740,853
20,000,000 Contract dated 12/02/93 with Morgan Guaranty,
Expires 12/02/00.................................1,432,554
TOTAL INTEREST RATE SWAP CONTRACTS............ 4,112,160
Market
Notional amount Security Value
THREE MONTH LIBOR INTEREST RATE CAP CONTRACTS - 3.84
$50,000,000 Contract with Credit Suisse Financial Products, expi
Strike rate 7.00%................................$1,685,000
75,000,000 Contract with Credit Suisse Financial Products, expi
Strike rate 9.00%...................................997,500
40,000,000 Contract with Morgan Guaranty, expires 10/15/98,
Strike rate 5.00%.................................2,655,600
40,000,000 Contract with Salomon SwapCo, expires 11/01/96,
Strike rate 5.00%.................................1,098,360
40,000,000 Contract with Salomon SwapCo, expires 11/15/97,
Strike rate 5.00%.................................1,960,240
TOTAL THREE-MO. LIBOR INTEREST RATE CAP CONTRACTS
(Cost $5,328,180) 8,396,700
Contracts TEN YEAR NOTE PUT OPTION CONTRACTS - 0.02%
50 Expires 6/95, Strike Price $98....................... 1,563
50 Expires 6/95, Strike Price $103......................32,813
TOTAL TEN YEAR NOTE PUT OPTION CONTRACTS
(Cost $75,450 34,376
TOTAL INVESTMENTS (Cost $229,021,146).......... 236,502,115
Face Amount REPURCHASE AGREEMENTS- 48.03%
$59,000,000 Morgan Stanley, 6.10%, due 04/04/95 dated 03/28/95
Collateralized by $60,189,173 FNMA ARM, 6.25%,
5.56%, 5.37% due 12/01/18-05/01/19 with
a market value of $60,179,105 59,000,000
45,900,000 Nomura, 6.15%, due 04/07/95 dated 03/31/95
Collateralized by $47,492,878 FNMA FRM, 6.0%, 8.0%,
due 06/01/08-11/01/21 with a market value of
$46,997,288 45,900,000
TOTAL REPURCHASE AGREEMENTS (Cost $104,900,000)..104,900,000
TOTAL INVESTMENTS AND REPURCHASE AGREEMENTS
(Cost $333,921,146) - 156.32%................341,402,115
OTHER LIABILITIES LESS CASH AND OTHER ASSETS
-(56.32%) (122,970,450)
NET ASSETS - 100.00% $218,431,665
* Mortgage-backed obligations are subject to principal paydowns as a result
of prepayments or refinancings of the underlying mortgage instruments. As a
result,the average life may be substantially less than the original maturity.
The interest rate shown is the rate in effect at March 31, 1995.
ARM's have coupon rates which adjust periodically.
The adjusted rate is determined by adding a spread to a specified index.
** Represents an interest only stripped mortgage-backed security.
*** The interest rate shown is the discount rate paid at the time of purchase
by the Fund.
(a) To be announced.
(b) Real Estate Mortgage Investment Conduit
Portfolio Abbreviations
ARM- Adjustable-rate mortgage
FHLMC- Federal Home Loan Mortgage Corporation
FNMA- Federal National Mortgage Association
GNMA- Government National Mortgage Association
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT SERIES
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 1995
ASSETS:
Investments at market value
(identified cost $229,021,146)(Note 1)............ $236,502,115
Repurchase agreements (cost $104,900,000)(Note 1).. 104,900,000
Cash .............................................. 72,897
Receivables:
Interest........................................ 1,364,434
Miscellaneous................................... 15,028
Securities sold................................. 219,933
Prepaid expenses................................... 45,539
Deferred organization expenses..................... 19,177
TOTAL ASSETS.................................. 343,139,123
LIABILITIES:
Variation margin on futures contracts (Note 1)..... 21,998
Accrued expenses................................... 100,968
Payables:
Securities purchased............................. 121,598,606
Payable for shares redeemed..................... 2,910,348
Due to adviser (Note 3)......................... 75,538
TOTAL LIABILITIES............................. 124,707,458
NET ASSETS:
(Applicable to outstanding shares of 22,050,739
unlimited number of shares of beneficial
interest authorized; no stated par)............. $218,431,665
Net asset value, offering price and redemption
price per share ($218,431,665 / 22,050,739)..... $9.90
SOURCE OF NET ASSETS:
Paid in capital.................................... $222,111,273
Accumulated net realized loss on investments....... (10,954,167)
Net unrealized appreciation(depreciation) of
investments, interest rate swap and
futures contracts.................................. 7,274,559
NET ASSETS.................................... $218,431,665
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT SERIES
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1995
INVESTMENT INCOME:
Dividends...................................... $13,729,868
EXPENSES:
Distribution fees (Note 3)..................... 188,180
Registration fees.............................. 20,118
Transfer agent fees............................ 28,093
Custodian fees................................. 4,712
Legal fees..................................... 31,305
Accounting and pricing......................... 26,336
Amortization of organization expenses (Note 1). 9,603
Trustees fees and expenses..................... 43,414
Insurance...................................... 15,191
Other.......................................... 4,904
TOTAL EXPENSES BEFORE REIMBURSEMENT........ 371,856
Expenses reimbursed by Adviser (Note 3).... (146,256)
NET EXPENSES............................... 225,600
NET INVESTMENT INCOME ..................... 13,504,268
REALIZED AND UNREALIZED LOSS ON INVESTMENTS:
Net realized loss on investments............... (1,414,168)
Change in unrealized appreciation(depreciation)
of investments............................... 1,365,349
Net realized and unrealized loss on
investments.................................. (48,819)
Net increase in net assets resulting from
operations................................... $13,455,449
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT SERIES
STATEMENTS OF CHANGES IN NET ASSETS
Year Ended Year Ended
March 31, 1995 March 31, 1994
OPERATIONS:
Net investment income.............. $13,504,268 $4,653,713
Net realized loss on investments... (1,414,168) (382,998)
Change in unrealized appreciation
(depreciation) of investments... 1,365,349 (1,572,884)
Net increase in net assets
resulting from operations...... 13,455,449 2,697,831
DISTRIBUTIONS TO SHAREHOLDERS:
Dividends from net investment
income......................... (13,504,268) (4,702,281)
Dividends in excess of net
investment income.............. (90) -
Total distributions................ (13,504,358) (4,702,281)
CAPITAL SHARE TRANSACTIONS:
Shares sold........................ 94,549,923 292,685,905
Shares issued on reinvestment of
distributions................... 4,346,125 2,411,081
Shares redeemed.................... (98,582,965) (123,456,251)
Increase in net assets resulting
from capital share
transactions (a)................ 313,083 171,640,735
TOTAL INCREASE IN NET ASSETS... 264,174 169,636,285
NET ASSETS:
Beginning of period ............... 218,167,491 48,531,206
End of period...................... $218,431,665 $218,167,491
(a) Transactions in capital shares
were as follows:
Shares sold................... 9,582,171 29,296,974
Shares issued on reinvestment
of distributions............ 441,809 241,234
Shares redeemed............... (10,018,137) (12,346,115)
Net increase.................. 5,843 17,192,093
Beginning balance ............ 2,044,896 4,852,803
Ending balance................ 22,050,739 22,044,896
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT SERIES
FINANCIAL HIGHLIGHTS
The following average per share data, ratios and supplemental
information have been derived from information
provided in the financial statements.
Year Year For the Period
Ended Ended March 31, 1992 to
March 31, 1995 March 31, 1994 March 31, 1993(1)
Net Asset Value,
Beginning of Period....... $9.90 $10.00 $10.00
Income From Investment Operations
Net investment income..... 0.628 0.432 0.552
Net realized and unrealized
gain (loss)
on investments.......... - (0.070) 0.002
Total from investment
operations............ 0.628 0.362 0.554
Less Distributions
Dividends from net investment
income.................. (0.628) (0.462) (0.554)
Total distributions... (0.628) (0.462) (0.554)
Net Asset Value,
End of Period............... $9.90 $9.90 $10.00
Total Return ............... 6.58% 3.67% 5.67%
Ratios/Supplemental Data
Net assets, end of period. $218,431,665 $218,167,491 $48,531,206
Ratio of expenses to
average net assets (2).. 0.11% 0.29% 0.27%
Ratio of net investment
income to average
net assets (3)........... 6.33% 4.17% 4.53%
Portfolio turnover rate.... 47% 112% 3%
______________________
(1) Commencement of operations.
(2) The annualized operating expense ratios prior to reimbursment of
expenses by the Adviser were 0.17%, 0.45% and 1.63% for the Short
Duration U.S. Government Series for the years ended
March 31, 1995, March 31, 1994, and period ended March 31, 1993,
respectively.
(3) The annualized net investment income ratios prior to reimbursment
of expenses by the Adviser were 6.26%, 3.72%, and 3.17% for the
Short Duration U.S. Government Series for the years ended
March 31, 1995, March 31, 1994, and period ended March 31, 1993,
respectively.
The accompanying notes are an integral part of these financial statements.
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
Smith Breeden Series Fund (the "Fund") is an open-end, diversified
management investment company registered under the Investment Company
Act of 1940, as amended. The Fund offers shares in two series:
Smith Breeden Short Duration U.S. Government Series (the "Short Series"
or "Series") and Smith Breeden Intermediate Duration U.S. Government
Series ("Intermediate Duration Series"). For the year ended March 31,
1995, the Short Series sought to achieve its investment objective by
investing all of its assets in Smith Breeden Short Duration U.S.
Government Fund (the "Short Fund"), an open-end, diversified management
investment company having the same investment objective as the Series.
However, at the close of business on March 31, 1995, pursuant to a plan
of liquidation adopted March 1, 1995 by the Board of Trustees of the
Short Fund, and approved by the Board of Trustees of the Short Series,
the Short Series redeemed in-kind its shares of the Short Fund. The
assets of the Short Fund were transferred in proportion to the Short
Series' ownership of the Short Fund in cancellation of its shares.
Accordingly, the Schedule of Investments for the Short Series, which is
included in this report, reflects the transfer of the assets from the
Short Fund to the Short Series at the close of business on March 31, 1995
and the cancellation of the Short Series' shares. The following is a
summary of significant accounting policies consistently followed by
either the Short Fund or Short Series (the "Funds").
A. Security Valuation: Securities are valued at current market value
provided by a pricing service or by a bank or broker/dealer experienced
in such matters, when over-the-counter market quotations are readily
available. Securities and other assets for which market prices are not
readily available are valued at fair market value as determined in
accordance with the procedures approved by the Board of Trustees. All
money market instruments and debt securities originally purchased with
remaining maturities of 60 days or less shall be valued at their amortized
cost.
B. Repurchase Agreements: Repurchase agreements may be entered into
with member banks of the Federal Reserve System having total assets in
excess of $500 million and securities dealers, provided that such banks
or dealers meet the credit guidelines of the Funds' Board of Trustees. In
a repurchase agreement, securities are acquired from a third party with the
commitment that they will be repurchased by the seller at a fixed price on
an agreed upon date. The custodian maintains control or custody of
securities collateralizing repurchase agreements until maturity of the
repurchase agreements. The value of the collateral will be monitored
daily, and if necessary, additional collateral is received to ensure that
the market value of the underlying assets remains sufficient to protect the
Series in the event of the seller's default. However, in the event of
default or bankruptcy of the seller, the right to the collateral may be
subject to legal proceedings.
C. Reverse Repurchase Agreements: A reverse repurchase agreement involves
the sale of portfolio assets concurrently with an agreement to repurchase
the same assets at a later date at a fixed price. Assets will be
maintained in a segregated account with the custodian, which will be
marked to market daily, consisting of cash, U.S. Government securities or
other liquid high-grade debt obligations equal in value to the obligations
under the reverse repurchase agreements. In the event the buyer of
securities under a reverse repurchase agreement files for bankruptcy or
becomes insolvent, the use of the proceeds under the agreement may be
restricted pending a determination by the other party, or its trustee or
receiver whether to enforce the obligation to repurchase the securities.
D. Dollar Roll Agreements: A dollar roll is an agreement to sell
securities for delivery in the current month and simultaneously contract
to repurchase substantially similar (same type and coupon) securities on
a specified future date. During the roll period, principal and interest
paid on these securities are not received. Compensation under the dollar
roll agreement is represented by the difference between the current sales
price and the forward price for the future purchase (often referred to as
the "drop") as well as by the interest earned on the cash proceeds of the
initial sale.
E. Investment Income: The Short Series earned income, net of expenses,
on its investment in the Short Fund.
F. Distributions and Taxes: The Short Series intends to continue to
qualify for and elect the special tax treatment afforded regulated
investment companies under Subchapter M of the Internal Revenue Code,
thereby relieving the Series of Federal income taxes. To so qualify,
the Series intends to distribute substantially all of its net investment
income and net realized capital gains, if any, less any available
capital loss carry forward. As of March 31, 1995, the Series had a
net capital loss carry forward of $981,362 with $589 expiring
on March 31, 2001 and $75,461 expiring on March 31, 2002 and $905,312
expiring on March 31, 2003.
G. Determination of Gains or Losses on Sales of Securities: Gains or
losses on the sale of securities are calculated for accounting and tax
purposes on the identified cost basis.
H. Deferred Organization Expenses: Deferred organization expenses are
being amortized on a straight-line basis over five years.
I. Securities Transactions and Investment Income: Interest income is
accrued daily on both long-term bonds and short-term investments.
Interest income also includes net amortization from the purchase of
fixed-income securities. Transactions are recorded on the first business
day following the trade date. Realized gains and losses from security
transactions are determined and accounted for on the basis of identified
cost.
2. FINANCIAL INSTRUMENTS
Derivative Financial Instruments Held or Issued for Purposes other than
Trading: Interest rate futures, swaps, caps and options contracts are
used for risk management purposes in order to reduce fluctuations in
net asset value relative to the targeted option-adjusted duration.
A. Futures Contracts: Upon entering into a futures contract, either
cash or securities in an amount (initial margin) equal to a certain
percentage of the contract value is required to be deposited in a
segregated account. Subsequent payments (variation margin) are made
or received each day. The variation margin payments are equal to the
daily changes in the contract value and are recorded as unrealized
gains or losses. A realized gain or loss is recognized when the
contract is closed or expires equal to the difference between the
value of the contract at the time it was opened and the value at the
time it was closed.
The following open futures contracts had been assigned by the Short Fund
to the Short Series as of the close of business on March 31, 1995:
Principal Expiration Unrealized
Type Amount Position Month Gain/(Loss)
5 year Treasury $ 29,900,000 Long June, 1995 $ ( 44,455)
10 year Treasury $ 8,500,000 Short June, 1995 1,071
6 month Treasury $ 100,000,000 Long June, 1995 3,301
3 month Eurodollar $ 350,000,000 Long March, 1995 255,964
3 month Eurodollar $ 47,000,000 Short March, 1996 9,088
3 month Eurodollar $ 47,000,000 Short March, 1997 17,588
3 month Eurodollar $ 107,000,000 Short March, 1998 3,618
3 month Eurodollar $ 161,000,000 Short March, 1999 ( 41,819)
3 month Eurodollar $ 182,000,000 Short March, 2000 ( 66,370)
3 month Eurodollar $ 208,000,000 Short March, 2001 (109,456)
3 month Eurodollar $ 65,000,000 Short March, 2002 ( 46,990)
3 month Eurodollar $100,000,000 Short March, 2003 (187,950)
$ (206,410)
Futures transactions involve costs and may result in losses. The effective
use of futures strategies depends on the Series' ability to terminate
futures positions at times when the Series' investment adviser deems it
desirable to do so. The use of futures also involves the risk of imperfect
correlation among movements in the values of the securities underlying the
futures purchased and sold by the Series, of the futures contract itself,
and of the securities which are the subject of a hedge.
The aggregate market value of instruments pledged to cover margin
requirements for the open position at March 31, 1995 was $581,452.
B. Interest Rate Swap Contracts: Interest rate swaps involve the exchange
by one party with another party of their respective commitments to pay or
receive interest. The interest rate swap contracts assigned by the Short
Fund to the Short Series had been entered into on a net basis, i.e., the
two payment streams are netted out, with the Short Series receiving or
paying, as the case may be, only the net amount of the two payments. As
of March 31, 1995, the Short Series had been assigned by the Short Fund
three interest rate swap contracts. In each of the contracts, the Short
Fund had agreed to pay a fixed rate and receive a floating rate. The
floating rate on the three contracts resets quarterly and is the three
month London Interbank Offered Rate ("LIBOR"). Interest rate swap
contracts will not be entered into unless the unsecured commercial paper,
unsecured senior debt or the claims-paying ability of the other party
thereto is rated either AA or A-1 or better by Standard & Poor's
Corporation or Aa or P-1 or better by Moody's Investors Service, Inc.
(or is otherwise acceptable to either agency) at the time of entering into
such transaction. If there is a default by the other party to the swap
transaction, the Short Series will be limited to contractual remedies
pursuant to the agreements related to the transaction. There is no
assurance that interest rate swap contract counterparties will be able to
meet their obligations pursuant to the swap contracts or that, in the
event of default, the Short Series will succeed in pursuing contractual
remedies. The Short Series thus assumes the risk that it may be delayed
in, or prevented from, obtaining payments owed to it pursuant to the swap
contracts.
The Short Series' interest receivable on the interest rate swap contracts
was $27,967. No collateral is required to be maintained on these contracts.
C. Interest Rate Cap Contracts: The purchase of an interest rate cap
entitles the purchaser, to the extent that a specified index exceeds a
predetermined interest rate, to receive payments of interest on a notional
principal amount from the party selling such interest rate caps. The Short
Series' interest receivable on the interest rate cap contracts at
March 31, 1995 was $254,445.
3. TRANSACTIONS WITH AFFILIATES
The Short Fund and the Series each paid their respective expenses in the year
ended March 31, 1995 and the Series will continue to do so. Smith Breeden
Associates, Inc. (the "Adviser"), a registered investment adviser, provided
the Short Fund with investment management services. As all of the Fund's
assets were invested in the Short Fund for the year ended March 31, 1995, the
Series did not directly pay advisory fees. Fees of the Adviser were paid by
the Short Fund. However, as of the close of business on March 31, 1995, the
Adviser will provide investment management services to the Short Series, and
the Series will the pay the Adviser directly.
The Adviser voluntarily agreed to reimburse normal business expenses of the
Short Series through March 31, 1995 so that total direct and indirect operating
expenses would not exceed 0.78% of its average net assets. This voluntary
agreement may be terminated at any time by the Adviser in its sole discretion
after March 31, 1995. The Adviser has also agreed to reduce its fees payable
(to the extent of such fees) by the amount the Series' direct and indirect
expenses would, absent the fee reduction, exceed the applicable expenses
limitations imposed by state securities administrators. For the year ended
March 31, 1995, the Adviser received no fees and reimbursed the Short Series
$146,256.
Certain officers and trustees of the Fund are also officers and directors of
the Adviser.
Pursuant to Rule 12b-1 under the Investment Company Act of 1940 ("1940 Act"),
the Series adopted a distribution plan pursuant to which Fund/Plan Broker
Services, Inc., the Series' principal underwriter (the "Principal
Underwriter") would receive a fee, accrued daily and paid monthly, at an
annual rate of 0.25% of the Short Series' average daily net assets, regardless
of the amount of expenses incurred by the Principal Underwriter, to
compensate the Principal Underwriter for services provided in connection with
sales of shares of the Series, including bearing the cost of printing of
prospectuses used for sales, advertising expenses, and marketing allowances,
promotional incentives and other compensation paid to its employees or other
dealers that sell shares of the Series. For the four months ended
July 31, 1994, the Series paid the Principal Underwriter $188,180 for such
fees.
This plan terminated August 1, 1994, at which point the Series adopted a
different Distribution and Services Plan ( the "Plan") pursuant to Rule 12b-1
under the 1940 Act. The Short Fund had also adopted an identical Plan.
The purpose of the Plan is to permit the Adviser to compensate investment
dealers and other persons involved in servicing shareholder accounts for
services provided and expenses incurred in promoting the sale of shares of
the Short Fund or Series, as the case may be, reducing redemptions, or
otherwise maintaining or improving services provided to shareholders by
such dealers or other persons. The Plan provides for payments by the
Adviser, out of the advisory fee paid to it by the Short Fund or Series,
as the case may be, to dealers and other persons at the annual rate of up
to 0.25% of the Short Fund's or Series' average net assets, as the case
may be, subject to the authority the Trustees of the Short Fund or Series,
as the case may be, to reduce the amount of payments permitted under the
Plan or to suspend the Plan for such periods as they may determine.
Subject to these limitations, the amount of such payments and the purposes
for which they are made shall be determined by the Adviser.
4. INVESTMENT TRANSACTIONS
During the year ended March 31, 1995, purchases and proceeds from sales of
securities, other than short-term investments, aggregated $99,328,403 and
$100,371,923 respectively for the Series. The cost of securities assigned
by the Short Fund to the Short Series for federal income tax purposes at
March 31, 1995, is $333,921,145. Net unrealized appreciation consists of:
Gross unrealized appreciation $ 9,448,111
Gross unrealized depreciation (2,173,552)
Net unrealized appreciation . $ 7,274,559
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders,
Smith Breeden Short Duration U.S. Government Series
of the Smith Breeden Series Fund:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of the Smith Breeden Short Duration
U.S. Government Series of the Smith Breeden Series Fund as of March 31, 1995,
and the related statements of operations for the year ended and changes in
net assets for each of the years in the two- year period then ended and
financial highlights for each of the years in the two-year period then ended
and the period March 31, 1992 (commencement of operations) to March 31, 1993.
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 at March 31, 1995 by correspondence with the custodian and
brokers. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of the Smith
Breeden Short Duration U.S. Government Series of the Smith Breeden Series
Fund as of March 31, 1995, the results of its operations, the changes
in net assets, and financial highlights for the respective stated periods
in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
May 12, 1995
