SMITH BREEDEN SHORT DURATION
U.S. GOVERNMENT SERIES
ANNUAL REPORT
PERFORMANCE REVIEW
The Smith Breeden Short Duration U.S. Government Series provided a
total return of 4.95% in the year ended March 31, 1996, while the
return on the Series' benchmark, the six month U.S. Treasury Bill,
was 5.96%. The Series' annualized return from inception on March
31, 1992 through March 31, 1996 was 5.20%, while the benchmark six
month Treasury Bill's annualized return over the same period was
4.58%.
The Series underperformed its benchmark by 1.01% in the year ending
March 31, 1996. The Series invests in mortgage securities, and its
performance relative to its benchmark is adversely affected when
the price of mortgage securities appreciates by less than the price
of Treasury securities in a falling interest rate environment.
This is what occurred during 1995. The yield on the ten year U.S.
Treasury Note fell from 7.19% in March 1995 to 5.58% in December
1995, or 1.61% in total. Over the same period the yield on par
coupon FNMA thirty year fixed-rate mortgages (that is, mortgage
securities which are priced at 100 or par) fell 1.46% from 8.26% to
6.80%. Mortgage securities underperformed U.S. Treasury securities
due to investors' concerns about prepayment risk. Prepayment risk
is the risk that homeowners will take advantage of lower interest
rates to prepay their mortgages. The mortgage investor is at a
disadvantage since the funds from these payments can be reinvested
only at a lower yield.
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, 1996, AN INVESTMENT
OF $10,000 IN THE SERIES WOULD HAVE GROWN TO $12,254, VERSUS $11,964, 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 4.95%, THE ANNUALIZED THREE YEAR RETURN IS
5.06%, AND THE ANNUALIZED RETURN SINCE INCEPTION IS 5.20%.
During the first quarter of 1996 the yield on the ten year U.S.
Treasury Note began to climb, rising to 6.32% on March 31, 1996.
The Series' performance for the quarter was in line with its benchmark,
providing a return of 1.26% as compared with the U.S. Treasury Bill
return of 1.20%. Prepayment concerns dissipated somewhat with the
increase in interest rates, but yields on mortgages remained at
relatively high levels when compared with U.S. Treasury securities,
which precluded the Series' outperforming the benchmark by a large
margin. The short duration of the Series provided superior performance
in the quarter relative to the universe of bonds, however, as rising
interest rates produced losses for investors holding U.S. Treasury
securities with maturities of three years or more.
The portfolio turnover rate for the Series was 225% for the year.
This measure, which is calculated by dividing the lesser of
portfolio purchases and sales for the year by average net assets,
provides an indication of how much active trading is conducted in
a portfolio. In order to meet the Series' objective of providing
a return exceeding that of the Series' benchmark, while maintaining
the same approximate interest rate risk as the benchmark, the
Series aims to own at any given time those mortgage securities
offering a superior risk-adjusted yield. Hence, short term
opportunities to exchange mortgage securities with a lower
risk-adjusted yield for those with a higher risk-adjusted yield are
exploited whenever it is economical and prudent to do so. Equally,
when the mortgage securities sector as a whole offers a superior
yield to U.S. Treasury securities, the Series will increase its
holdings of mortgages as a percentage of net assets. Accordingly,
the Series took advantage of rising yield spreads to increase its
holdings of mortgages, and the Series' holdings of mortgages as a
percent of net assets rose from 107% in March 1995 to 122% in March
1996. The weight of GNMA adjustable-rate securities in the
portfolio also increased as the yields offered on these securities
relative to estimated prepayment risk increased.
As actively as the Series may trade in the mortgage market, the
securities purchased and sold are of the highest credit quality,
can be priced using reliable sources. Transaction costs are
therefore relatively small, especially in relation to the yield
advantage. In addition, whenever a trade is executed, and on a
daily basis, the hedges in the portfolio are evaluated to ensure
that the Series continues to maintain its interest rate risk target
at a level approximating that of the six month U.S. Treasury Bill.
In the next fiscal year, the Series will continue to maintain this
strategy, which has resulted in a positive return over all calendar
quarters since the Series' inception.
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT SERIES
SCHEDULE OF INVESTMENTS MARCH 31, 1996
Market
Face Amount Security Value
U.S. GOVERNMENT & AGENCY OBLIGATIONS - 120.94%
FEDERAL HOME LOAN MORTGAGE CORP. - 24.92% *
FHLMC GOLD:
$44,000,000 6.50%, due (a) ............................ $41,896,250
7,000,000 7.00%, due (a) ............................ 6,833,750
3,909,482 7.50%, due 6/1/24 to 10/1/25 .............. 3,906,185
1,142,037 8.00%, due 9/1/24 to 5/1/25 ............... 1,163,917
1,470,825 8.50% Balloon Mortgages,
due 4/1/96 to 11/1/96 .............. 1,471,228
TOTAL FEDERAL HOME LOAN MORTGAGE CORP.
(Cost $56,327,564)........................ 55,271,330
FEDERAL NATIONAL MORTGAGE ASSOCIATION - 14.96% *
FNMA:
30,808,916 7.50%, due 8/01/25 to 9/1/25 .............. 30,763,387
FNMA ARM:
410,630 7.136%, due 12/1/15 ....................... 416,551
546,625 7.571%, due 1/1/18 ........................ 558,693
634,882 7.692%, due 6/20/20 ....................... 654,061
200,693 7.839%, due 12/1/26 ....................... 208,135
FNMA INTEREST ONLY **:
1,988,264 9.00%, due 7/25/21 ........................ 590,476
TOTAL FEDERAL NATIONAL MORTGAGE ASSOCIATION
(Cost $32,977,247)........................ 33,191,303
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION - 81.06% *
GNMA:
27,238,097 7.00%, due 11/15/22 to 3/15/24 ............ 26,560,093
1,689,664 9.50%, due 7/15/09 to 4/15/25 ............. 1,832,898
GNMA ARM:
98,681,809 5.50%, due 10/20/25 to 3/20/26 ............ 97,726,368
33,917,962 6.00%, due 7/20/25 to 9/20/25 ............. 34,109,528
19,212,423 7.00%, due 5/20/25 ........................ 19,589,106
TOTAL GOVERNMENT NATIONAL MORTGAGE ASSOCIATION
(Cost $180,387,686)....................... 179,817,993
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(Cost $269,692,497)....................... 268,280,626
Notional
Amount INTEREST RATE SWAP CONTRACTS - 0.24%
$20,000,000 Contract dated 6/22/93 with Prudential
Global Funding,Expires 6/22/98 ............ 197,553
20,000,000 Contract dated 8/31/93 with Salomon Swapco,
Expires 8/31/00 ........................... 725,807
20,000,000 Contract dated 12/2/93 with Morgan Guaranty,
Expires 12/2/00 ........................... 387,516
40,000,000 Contract dated 5/15/95 with Salomon Swapco,
Expires 5/15/05 ........................... (786,983)
TOTAL INTEREST RATE SWAP CONTRACTS ........ 523,893
THREE MONTH LIBOR INTEREST RATE CAP CONTRACTS - 0.76
$40,000,000 Contract with Salomon SwapCo, expires 11/1/96,
Strike rate 5.00% ......................... 113,600
40,000,000 Contract with Salomon SwapCo, expires 11/15/97,
Strike rate 5.00% ......................... 504,360
40,000,000 Contract with Morgan Guaranty, expires 10/15/98,
Strike rate 5.00% ......................... 1,060,800
TOTAL THREE-MO. LIBOR INTEREST RATE CAP CONTRACTS
(Cost $1,875,834)......................... 1,678,760
Contracts FUTURES OPTION CONTRACTS - 0.35%
50 Call on 10 Year UST Note futures,
expires 6/96, strike price $116............ 781
50 Call on 10 Year UST Note futures,
expires 6/96, strike price $117............ 781
100 Put on 10 Year UST Note futures,
expires 6/96, strike price $109............ 117,187
100 Put on 10 Year UST Note futures,
expires 6/96, strike price $110............ 173,438
50 Put on 10 Year UST Note futures,
expires 6/96, strike price $111............ 121,094
100 Put on 10 Year UST Note futures,
expires 6/96, strike price $112............ 325,000
50 Put on 30 Year UST Bond futures,
expires 6/96, strike price $108............ 28,125
TOTAL FUTURES OPTION CONTRACTS
(Cost $249,908) .......................... 766,406
TOTAL INVESTMENTS (Cost $271,818,239) ..... 271,249,685
Face Amount REVERSE REPURCHASE AGREEMENTS- (0.45%):
($1,000,000) FHLMC, 5.51%, due 4/4/96 dated 3/29/96 .... (1,000,000)
TOTAL REVERSE REPURCHASE AGREEMENTS ....... (1,000,000)
OTHER LIABILITIES LESS CASH AND OTHER ASSETS -
(21.84%).................................. (48,424,549)
NET ASSETS - 100.00% $221,825,136
* 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, 1996. ARMs 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.
(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 SHORT DURATION U.S. GOVERNMENT SERIES
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 1996
ASSETS:
Investments at market value (identified
cost $271,818,239)(Note 1)...................... $271,249,685
Cash............................................... 514,603
Receivables:
Variation margin on futures contracts (Note 1).. 58,000
Interest........................................ 1,352,131
Deferred organization expenses (Note 1)............ 9,548
TOTAL ASSETS.................................. 273,183,967
LIABILITIES:
Reverse repurchase agreement (Note 1).............. 1,000,000
Payables:
Securities purchased............................ 50,014,306
Swap interest................................... 92,380
Due to adviser (Note 3)......................... 113,212
Accrued expenses................................... 138,933
TOTAL LIABILITIES............................. 51,358,831
NET ASSETS:
(Applicable to outstanding shares of 22,769,456
unlimited number of shares of beneficial
interest authorized; no stated par)............. $221,825,136
Net asset value, offering price and redemption
price per share ($221,825,136 / 22,769,456)..... $9.74
SOURCE OF NET ASSETS:
Paid in capital.................................... $229,328,831
Accumulated net realized loss on investments....... (6,435,945)
Net unrealized depreciation of investments......... (1,067,750)
NET ASSETS.................................... $221,825,136
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, 1996
INVESTMENT INCOME:
Interest and discount earned, net of premium
amortization and interest expense (Note 1) .... $17,326,843
EXPENSES:
Advisory fees (Note 3)......................... 1,717,748
Accounting and pricing services fees........... 73,827
Custodian fees................................. 76,145
Audit and tax preparation fees................. 92,199
Legal fees..................................... 80,126
Amortization of organization expenses (Note 1). 9,629
Transfer agent fees............................ 33,767
Registration fees.............................. 24,996
Trustees fees and expenses..................... 103,888
Insurance...................................... 31,961
Other.......................................... 34,641
TOTAL EXPENSES BEFORE REIMBURSEMENT........ 2,278,927
Expenses reimbursed by Adviser (Note 3).... (364,865)
NET EXPENSES............................... 1,914,062
NET INVESTMENT INCOME ..................... 15,412,781
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized gain on investments............... 4,639,312
Change in unrealized appreciation of
investments.................................. (8,342,309)
Net realized and unrealized loss on
investments.................................. (3,702,997)
Net increase in net assets resulting
from operations.............................. $11,709,784
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
FOR THE YEARS ENDED MARCH 31, 1996 AND 1995
Year Ended Year Ended
March 31, 1996 March 31, 1995
OPERATIONS:
Net investment income............. $15,412,781 $13,504,268
Net realized gain (loss)
on investments.................... 4,639,312 (1,414,168)
Change in unrealized appreciation
(depreciation) of investments..... (8,342,309) 1,365,349
Net increase in net assets
resulting from operations......... 11,709,784 13,455,449
DISTRIBUTIONS TO SHAREHOLDERS:
Dividends from net investment
income............................ (15,412,781) (13,504,268)
Dividends in excess of net
investment income................. (269,331) (90)
Total distributions............... (15,682,112) (13,504,358)
CAPITAL SHARE TRANSACTIONS:
Shares sold....................... 93,214,276 94,549,923
Shares issued on reinvestment of
distributions..................... 3,773,450 4,346,125
Shares redeemed................... (89,621,927) (98,582,965)
Increase in net assets resulting
from capital share
transactions (a).................. 7,365,799 313,083
TOTAL INCREASE IN NET ASSETS............... 3,393,471 264,174
NET ASSETS:
Beginning of year................. 218,431,665 218,167,491
End of year....................... $221,825,136 $218,431,665
(a) Transactions in capital shares were as follows:
Shares sold....................... 9,500,348 9,582,171
Shares issued on reinvestment
of distributions.................. 386,101 441,809
Shares redeemed................... (9,167,732) (10,018,137)
Net increase...................... 718,717 5,843
Beginning balance ................ 22,050,739 22,044,896
Ending balance.................... 22,769,456 22,050,739
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN SHORT DURATION US GOVERNMENT SERIES
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED MARCH 31, 1996
Year Ended
March 31, 1996
Cash flows from operating activities:
Net increase in net assets resulting from operations.... $11,709,784
Net realized and unrealized loss on investments......... 3,702,997
Net investment income................................. 15,412,781
Adjustments to reconcile net investment income
to net cash provided by operating activities:
Interest rate cap and interest-only strip amortization.. 643,641
Paydown gains and losses................................ (15,635)
Increase in interest receivable......................... (430,707)
Decrease in other assets................................ 74,098
Increase in other liabilities........................... 168,021
Net cash provided by operating activities............. 15,852,199
Cash flows from investing activities:
Payments for futures variations......................... (2,465,409)
Proceeds from sales of long-term investments............ 291,400,731
Proceeds from sales of short-term investments........... 2,807,926
Proceeds from maturities of short-term investments...... 1,539,970,000
Proceeds from paydowns of long-term investments......... 19,239,211
Purchases of long-term investments...................... (423,241,572)
Purchases of short-term investments.....................(1,435,805,067)
Net cash used in investing activities................. (8,094,180)
Cash flows from financing activities:
Increase in collateralized borrowings................... 1,000,000
Purchase of shares tendered............................. 3,592,349
Dividends from net investment income.................... (11,908,662)
Net cash used in financing activities................. (7,316,313)
Net increase in cash.................................. 441,706
Cash at beginning of year.................................. 72,897
Cash at end of year........................................ $514,603
Noncash financing activities:
Market value of shares issued to stockholders
through reinvestment of dividends..................... $3,773,450
Supplemental disclosure:
Interest paid........................................... $373,480
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 Year For the Period
Ended Ended Ended March 31, 1992 (1)
March 31, 1996 March 31, 1995 March 31, 1994 to March 31, 1993
Net Asset Value,
Beginning of
Period....... $9.90 $9.90 $10.00 $10.00
Income From
Investment Operations
Net investment
income..... 0.621 0.628 0.432 0.552
Net realized
and unrealized
gain (loss) on
investments. (0.148) - (0.070) 0.002
Total from
investment
operations. 0.473 0.628 0.362 0.554
Less Distributions
Dividends from
net investment
income....... (0.621) (0.628) (0.462) (0.554)
Dividends in
excess of
investment
income....... (0.012) - - -
Total
distributions (0.633) (0.628) (0.462) (0.554)
Net Asset Value,
End of Period.. $9.74 $9.90 $9.90 $10.00
Total Return .. 4.95% 6.58% 3.67% 5.67%
Ratios/Supplemental Data
Net assets, end
of period..... $221,825,136 $218,431,665 $218,167,491 $48,531,206
Ratio of expenses
to average
net assets (2) 0.78% 0.78% 0.78% 0.78%
Ratio of net
investment
income to average
net assets (3) 6.29% 6.33% 4.17% 4.53%
Portfolio turnover
rate.......... 225% 47% 112% 3%
______________________
(1) Commencement of operations.
(2) The annualized operating expense ratios prior to reimbursement of
expenses by the Adviser were 0.93%, 0.92%, 1.00%, and 2.58% for the
Short Duration U.S. Government Series for the years ended March 31,
1996, March 31, 1995, March 31, 1994 and the period ended March 31,
1993, respectively. Expense ratios include both the direct expenses
of the Short Duration U.S.Government Series, and the indirect expenses
incurred through the Series' investment in the Short Duration U.S.
Government Fund (Note 1).
(3) The annualized net investment income ratios prior to reimbursement of
both direct and indirect expenses by the Adviser were 6.13%, 6.18%,
3.95%, and 2.73% for the Short Duration U.S. Government Series for the
years ended March 31, 1996, March 31, 1995, March 31, 1994, and the
period ended March 31, 1993, respectively.
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT SERIES
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The 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: the Smith Breeden Short Duration U.S. Government
Series (the "Short Series" or "Series") and the Smith Breeden
Intermediate Duration U.S. Government Series ("Intermediate
Duration Series"). Prior to April 1, 1995, the Short Series sought
to achieve its investment objective by investing all of its assets
in the 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.
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.
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. 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 carryforward. As of March 31,
1996, the Series had a net capital loss carryforward of $2,340,576,
with $589 expiring on March 31, 2001, $75,461 expiring on March 31,
2002, $905,312 expiring on March 31, 2003, and $1,359,214 expiring
on March 31, 2004.
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 Organization Expenses: Deferred organization
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
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 Short Series had the following open futures contracts as of
March 31, 1996:
Notional Expiration Unrealized
Type Amount Position Month Gain/(Loss)
10 year Treasury $ 4,000,000 Short June, 1996 $ 9,820
3 month Treasury 70,000,000 Long June, 1996 (87,815)
3 month Eurodollar 77,000,000 Long June, 1996 (76,021)
3 month Eurodollar 75,000,000 Long September, 1996 (99,712)
3 month Eurodollar 52,000,000 Short March, 1997 (28,584)
3 month Eurodollar 6,000,000 Short March, 1998 3,573
3 month Eurodollar 34,000,000 Short March, 1999 20,247
3 month Eurodollar 77,000,000 Short March, 2000 (199,897)
3 month Eurodollar 28,000,000 Short March, 2001 (57,526)
3 month Eurodollar 32,000,000 Short March, 2002 (36,394)
3 month Eurodollar 30,000,000 Short March, 2003 53,115
$ (499,194)
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.
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,
1996, the Short Series had open 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 payable on the interest rate swap
contracts was $92,380, and swap contract interest receivable was
$478. 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, 1996 was $91,632.
3. TRANSACTIONS WITH AFFILIATES
Smith Breeden Associates, Inc. (the "Adviser"), a registered
investment adviser, provides the Short Series with investment
management services.
The Adviser voluntarily agreed to reimburse normal business
expenses of the Short Series through March 31, 1996 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,
1996. 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, 1996, the Adviser
received $1,717,748 in fees and reimbursed the Short Series $364,865.
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, effective August 1, 1994, a
Distribution and Services Plan (the "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 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 the advisory fee paid to it by the Short Series, to
dealers and other persons at the annual rate of up to 0.25% of the
Short Series' average net assets, subject to the authority the
Trustees of the Short 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.
4. INVESTMENT TRANSACTIONS
During the year ended March 31, 1996, purchases and proceeds from
sales of securities, other than short-term investments, aggregated
$690,002,566 and $690,050,141 respectively for the Series. The
cost of the Short Series' securities for federal income tax
purposes at March 31, 1996, is $271,818,239. Net unrealized
depreciation of investments and futures contracts consists of:
Gross unrealized appreciation $ 2,957,098
Gross unrealized depreciation (4,024,848)
Net unrealized depreciation $ (1,067,750)
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, 1996, and the related statements of operations and cash
flows 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 each of the years in the three-year period then ended and
the period March 31, 1992 (commencement of operations) to March 31, 1993.
These financial statements and the financial highlights are the
responsibility of the Fund's management. Our responsibility is to express
an opinion on these financial statements and the 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 the
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, 1996 by correspondence with the custodian
and brokers. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide
a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position
of the Smith Breeden Short Duration U.S. Government Series of the Smith
Breeden Series Fund as of March 31, 1996, the results of its operations
and its cash flows, the changes in its net assets, and the financial
highlights for the respective stated periods in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
May 10, 1996
SMITH BREEDEN INTERMEDIATE DURATION
U.S. GOVERNMENT SERIES
ANNUAL REPORT
PERFORMANCE REVIEW
The Smith Breeden Intermediate Duration U.S. Government Series
provided a total return of 9.69% in the year ended March 31,
1996, while the return on the Series' benchmark, the Salomon
Brothers Mortgage Index, was 10.51%.
The period from March 1995 to December 1995 saw a strong rally
in bonds, as inflation fears lessened and the Federal Reserve
lowered its target rate for Federal Funds from 6.0% in March to
5.5% in December. The Series return from March through December
1995 was 10.39%. The return on the five year U.S. Treasury
Note, which has roughly the same duration as the Series, was
11.66%. The return on the Salomon Brothers Mortgage Index over
the same period was 10.91%.
During the nine month period ended December 31, 1995, mortgage
securities underperformed U.S. Treasury Notes of comparable
duration because of investors' concerns about prepayment risk.
Prepayment risk is the risk that homeowners will take advantage
of lower interest rates to prepay their mortgages. The mortgage
investor is at a disadvantage since the funds from these
payments can be invested only at a lower yield.
The advantage enjoyed by U.S. Treasury securities in 1995 was
reversed in the first quarter of 1996. The five year U.S.
Treasury Note yield rose 0.69% from 5.39% to 6.08% as a series
of strong employment statistics reawakened fears of inflation
among investors.
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 N1-A:
THE GRAPH PRESENTED COMPARES THE CHANGE FOR THE PERIOD FROM
MARCH 31, 1992 THROUGH MARCH 31, 1996 OF A $10,000 INVESTMENT IN
THE SERIES VERSUS ITS BENCHMARK. FOR THE PERIOD FROM THE SERIES'
INCEPTION, MARCH 31, 1992, THROUGH MARCH 31, 1996, 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 SHAREHOLDERS, THE SERIES' BENCHMARK WAS CHANGED TO THE SALOMON
BROTHERS MORTGAGE INDEX. THE SERIES AVERAGE ANNUAL RETURN WAS 9.69%
FOR THE ONE YEAR PERIOD, 6.61% FOR THE THREE YEAR PERIOD, AND 8.62%
FOR THE PERIOD SINCE INCEPTION. FROM INCEPTION OF MARCH 31, 1992
THROUGH MARCH 31, 1996, AN INVESTMENT OF $10,000 IN THE SERIES WOULD
HAVE GROWN TO $13,927, VERSUS $13,686, IF INVESTED IN THE BENCHMARK.
Interestingly, the Federal Reserve Board didn't
seem to share those inflation fears, and it actually cut the
target rate for Federal Funds to 5.25% in January 1996. The five
year U.S. Treasury Note posted a loss of 1.54% in the first
quarter, while the Intermediate Series posted a loss of 0.63%,
and the Salomon Brothers Mortgage Index loss was 0.37%. Mortgage
securities outperformed U.S. Treasury securities in the first
quarter as investor's fears about prepayment risk lessened.
The portfolio turnover rate for the Series was 193% for the
year. This measure, which is calculated by dividing the lesser
of portfolio purchases and sales for the year by average net
assets, provides an indication of how much active trading is
conducted in a portfolio. In order to meet the Series'
objective of providing a return exceeding that of the Series'
benchmark, while also covering the 0.90% annual fund expense
ratio, and maintaining the same approximate interest rate risk
as the benchmark, the Series aims to own at any given time those
mortgage securities offering a superior risk-adjusted yield.
Hence, short term opportunities to exchange mortgage securities
with a lower risk-adjusted yield for those with a higher risk-
adjusted yield are exploited whenever it is economical and
prudent to do so. Equally, when the mortgage securities sector
as a whole offers an attractive risk-adjusted yield advantage
over U.S. Treasury securities the Series will increase its
holdings of mortgages as a percentage of net assets.
Accordingly, the Series took advantage of rising yield spreads
of mortgages to U.S. Treasury securities to increase its
holdings of mortgages as a percent of net assets, which rose
from 100% in March 1995 to 134% in March 1996. The weighting of
GNMA adjustable-rate securities in the portfolio was also
increased from 19% of net assets in March 1995 to 36% in March
1996, as the risk-adjusted yields offered on these securities
increased relative to U.S. Treasury securities. Although
adjustable-rate mortgages are not included in the Salomon
Brothers Mortgage Index, the Series will hold adjustable-rate
mortgages in its portfolio when they offer a risk-adjusted yield
advantage over fixed-rate mortgages.
As actively as the Series may trade in the mortgage market, the
securities purchased and sold are of the highest credit quality,
and can be priced using reliable sources. Transaction costs are
therefore relatively small, especially in relation to the yield
advantage. In addition, whenever a trade is executed, and on a
daily basis, the hedges in the portfolio are evaluated to ensure
that the Series continues to maintain its interest rate risk at
approximately the same level as that of the Salomon Brothers
Mortgage Index. In the next fiscal year, the Series will
continue its strategy of purchasing securities in the mortgage
sector which offer superior risk-adjusted yields. This strategy
has enabled the Series to provide an annualized total return
from inception of 8.62%, comfortably exceeding the return of
8.15% on its benchmark, while maintaining a similar level of
interest rate risk.
SMITH BREEDEN INTERMEDIATE DURATION
U.S. GOVERNMENT SERIES
SCHEDULE OF INVESTMENTS MARCH 31, 1996
Market
Face Amount Security Value
U.S. GOVERNMENT & AGENCY OBLIGATIONS - 134.39%
FEDERAL HOME LOAN MORTGAGE CORP. - 41.74% *
FHLMC GOLD:
$7,000,000 6.50, due (a) ......................... $6,719,063
6,000,000 7.00%, due (a) ........................ 5,857,500
2,578,648 8.00%, due 9/1/24 to 10/19/24.......... 2,635,324
TOTAL FEDERAL HOME LOAN MORTGAGE CORP.
(Cost $15,456,817)..................... 15,211,887
FEDERAL NATIONAL MORTGAGE ASSOC. - 32.09% *
FNMA ARM:
1,369,074 5.98%, due 9/1/25 ..................... 1,403,379
158,720 7.692%, due 8/25/22 ................... 163,515
FNMA:
3,491,642 7.00%, due 8/1/23 to 6/1/24 ........... 3,406,702
3,631,118 7.50%, due 8/1/25 ..................... 3,625,752
1,277,596 8.50%, due 9/14/24 to 2/1/25 .......... 1,322,721
1,643,028 9.50%, due 7/1/16 to 5/1/22 ........... 1,773,567
TOTAL FEDERAL NATIONAL MORTGAGE ASSOC.
(Cost $11,368,709)..................... 11,695,636
GOVERNMENT NATIONAL MORTGAGE ASSOC. - 60.13% *
GNMA ARM:
7,472,926 5.50%, due 10/20/25 to 1/20/26 ........ 7,400,934
5,726,103 6.00%, due 9/20/25 .................... 5,758,443
GNMA:
7,189,552 7.00%, due 11/21/14 to 3/15/24 ........ 7,010,593
1,686,432 8.00%, due 12/15/06 to 4/15/09 ........ 1,747,195
TOTAL GOVERNMENT NATIONAL MORTGAGE ASSOC.
(Cost $21,694,608)..................... 21,917,165
UNITED STATES TREASURY BILLS - 0.43% **
140,000 5.02 due 6/27/96 ...................... 138,309
20,000 4.96 due 6/27/96 ...................... 19,760
TOTAL UNITED STATES TREASURY BILLS
(Cost $158,062) ....................... 158,069
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(Cost $48,678,196)..................... 48,982,757
Contracts FUTURES OPTION CONTRACTS- 0.01%
50 Call on 10 Year UST Note futures,
expires 6/96, strike price $115........ 1,562
30 Call on 10 Year UST Note futures,
expires 6/96, strike price $116........ 469
TOTAL FUTURES OPTION CONTRACTS
(Cost $69,423) ........................ 2,031
TOTAL INVESTMENTS (Cost $48,747,619) -
134.40% ............................... 48,984,788
CASH AND OTHER ASSETS LESS LIABILITIES -
(34.40%) .............................. (12,537,848)
NET ASSETS - 100.00% .................... $36,446,940
* 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, 1996. ARMs 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, 1996
ASSETS:
Investments at market value
(identified cost $48,747,619)(Note 1)............... $48,984,788
Cash................................................ 312,247
Receivables:
Variation margin on futures contracts............ 25,950
Interest......................................... 232,324
Prepaid expenses.................................... 6,057
Deferred organization expenses (Note 1)............. 10,159
TOTAL ASSETS................................... 49,571,525
LIABILITIES:
Payables:
Securities purchased............................. 12,938,923
Distributions payable............................ 135,382
Due to advisor (Note 3).......................... 15,102
Accrued expenses.................................... 35,178
TOTAL LIABILITIES.............................. 13,124,585
NET ASSETS:
(Applicable to outstanding shares of 3,639,328;
unlimited number of shares of beneficial
interest authorized; no stated par).............. $36,446,940
Net asset value, offering price and redemption
price per share ($36,446,940 /3,639,328)........ $10.01
SOURCE OF NET ASSETS:
Paid in capital..................................... $36,286,422
Overdistributed net investment income............... (98,690)
Accumulated net realized gain on investments........ 28,769
Net unrealized appreciation of investments.......... 230,439
NET ASSETS..................................... $36,446,940
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, 1996
INVESTMENT INCOME:
Interest and discount earned, net of premium
amortization and interest expense (Note 1) ......... $2,698,898
EXPENSES:
Advisory fees (Note 3) ............................. 256,075
Accounting and pricing services fees ............... 38,954
Custodian fees ..................................... 22,593
Audit & tax preparation fees ....................... 11,452
Legal fees ......................................... 8,987
Amortization of organization expenses (Note 1) ..... 9,428
Transfer agent fees ................................ 28,915
Registration fees .................................. 20,004
Trustees fees and expenses ......................... 11,365
Insurance .......................................... 3,576
Other .............................................. 3,242
TOTAL EXPENSES BEFORE REIMBURSEMENT ............ 414,591
Expenses reimbursed by Adviser (Note 3) ........ (85,364)
NET EXPENSES ................................... 329,227
NET INVESTMENT INCOME .......................... 2,369,671
REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gain on investments ................... 1,227,064
Change in unrealized appreciation of investments.... (257,447)
Net realized and unrealized gain on investments .... 969,617
Net increase in net assets resulting from operations $3,339,288
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
FOR THE YEARS ENDED MARCH 31, 1996 AND 1995
Year Ended Year Ended
March 31, 1996 March 31, 1995
OPERATIONS:
Net investment income............... $2,369,671 $1,346,839
Net realized gain (loss) on investments 1,227,064 (248,302)
Change in unrealized appreciation
(depreciation) of investments....... (257,447) 778,903
Net increase in net assets resulting
from operations..................... 3,339,288 1,877,440
DISTRIBUTIONS TO SHAREHOLDERS:
Dividends from net investment income. (2,358,436) (1,346,839)
Dividends in excess of net investment
income.............................. - (140,634)
Distributions from net realized
capital gains....................... (367,107) -
Distributions in excess of net
realized capital gains.............. - (28,444)
Total distributions................. (2,725,543) (1,515,917)
CAPITAL SHARE TRANSACTIONS:
Shares sold......................... 1,030,079 31,506,439
Shares issued on reinvestment of
distributions....................... 702,855 669,611
Shares redeemed..................... (697,235) (4,519,742)
Increase in net assets resulting
from capital share transactions (a) 1,035,699 27,656,308
TOTAL INCREASE IN NET ASSETS.... 1,649,444 28,017,831
NET ASSETS:
Beginning of year................... 34,797,496 6,779,665
End of year......................... $36,446,940 $34,797,496
(a) Transactions in capital shares
were as follows:
Shares sold.................... 100,992 3,257,497
Shares issued on
reinvestment of distributions.. 69,235 68,948
Shares redeemed................ (69,182) (465,316)
Net increase................... 101,045 2,861,129
Beginning balance ............. 3,538,283 677,154
Ending balance................. 3,639,328 3,538,283
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN INTERMEDIATE DURATION US GOVERNMENT SERIES
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED MARCH 31, 1996
Year Ended
March 31, 1996
Cash flows from operating activities:
Net increase in net assets resulting from
operations....................................... $3,339,288
Net realized and unrealized gain on investments.. (969,617)
Net investment income.......................... 2,369,671
Adjustments to reconcile net investment income
to net cash provided by operating activities:
Net paydown gains and losses..................... (40,951)
Increase in interest receivable.................. (36,556)
Decrease in other assets......................... 3,025
Increase in other liabilities.................... 25,598
Net cash provided by operating activities...... 2,320,787
Cash flows from investing activities:
Proceeds from futures variations................. 157,418
Proceeds from sales of long-term investments..... 55,165,384
Proceeds from sales of short-term investments.... 20,254
Proceeds from maturities of short-term
investments...................................... 81,940,000
Proceeds from paydowns of long-term investments.. 3,311,979
Purchases of long-term investments............... (61,937,619)
Purchases of short-term investments.............. (82,161,200)
Net cash used in investing activities.......... (3,503,784)
Cash flows from financing activities:
Purchase of shares tendered...................... 332,844
Dividends from net investment income and
realized capital gains........................... (2,035,111)
Net cash used in financing activities........ (1,702,267)
Net decrease in cash......................... (2,885,264)
Cash at beginning of year.......................... 3,197,511
Cash at end of year................................ $312,247
Noncash financing activities:
Market value of shares issued to stockholders
through reinvestment of dividends.............. $702,855
Supplemental disclosure:
Interest paid.................................... $191,436
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 Year Year Period
Ended Ended Ended Ended
March 31, 1996 March 31, 1995 March 31, 1994 March 31, 1993*
Net Asset Value,
Beginning
of Period..... $9.83 $10.01 $10.62 $10.00
Income From
Investment
Operations
Net investment
income....... 0.660 0.664 1.050 0.826
Net gain (loss)
on securities
(both realized
and unrealized) 0.227 (0.049) (0.601) 0.621
Total from
investment
operations.. 0.937 0.615 0.449 1.447
Less Distributions
Dividends from
net investment
income........ (0.656) (0.664) (1.044) (0.826)
Dividends in
excess of net
investment
income........ - (0.108) - -
Distributions
from net realized
gains on
investments... (0.101) - (0.015) -
Distributions in
excess of net
realized gains on
investments... - (0.022) - -
Total
distributions (0.757) (0.794) (1.059) (0.826)
Net Asset Value,
End of Period.. $10.01 $9.83 $10.01 $10.62
Total Return... 9.69% 6.10% 4.11% 14.93%
Ratios/Supplemental Data
Net assets, end
of period.... $36,446,940 $34,797,496 $6,779,666 $2,923,913
Ratio of expenses
to average net
assets (1)... 0.90% 0.90% 0.90% 0.82%
Ratio of net
investment income
to average net
assets (2)... 6.49% 6.20% 7.74% 8.18%
Portfolio
turnover rate 193% 557% 84% 42%
______________________
(1) The annualized ratio of expenses to average net assets prior to
reimbursement of expenses by the Adviser was 2.28%, 2.33%, 2.34%,
and 17.52% for the years ended March 31, 1996, March 31, 1995 and
March 31, 1994, and for the period ended March 31, 1993, respectively.
Expense ratios include both the direct expenses of the Intermediate
Duration U.S. Government Series, and the indirect expenses incurred
through the Series' investment in the Institutional Intermediate
Duration U.S. Government Fund (Note 5).
(2) The annualized ratio of net investment income to average net assets
prior to reimbursement of both direct and indirect expenses by the
Adviser was 6.26%, 4.77%, 6.30% and (8.52)% for the years ended
March 31, 1996, March 31, 1995 and March 31, 1994, and for the period
ended March 31, 1993, respectively.
* The Intermediate Duration U.S. Government Series commenced operations
on March 31, 1992.
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT SERIES
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The 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: the 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.
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
carryforward. As of March 31, 1996, the Series had no capital loss
carryforward.
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
periods.
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, 1996:
Notional Expiration Unrealized
Type Amount Position Month Gain/(Loss)
10 Year
Treasury $ 7,200,000 Long June, 1996 $ 184,176
3 Month
Eurodollar 22,000,000 Short March, 1998 (94,607)
3 month
Eurodollar 6,000,000 Short March, 1999 (27,027)
3 month
Eurodollar 16,000,000 Short March, 2000 (69,272)
$ (6,730)
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, 1996 was $158,069.
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, 1996, the Adviser received fees of
$256,075 and reimbursed the Series $85,364.
Effective August 1, 1994, the Series adopted a 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, 1996, purchases and proceeds from
sales of securities, other than short-term investments, aggregated
$87,639,428 and $87,338,696, 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 $48,747,619. Net
unrealized appreciation of investments and futures contracts
consists of:
Gross unrealized appreciation .................. $773,535
Gross unrealized depreciation .................. (543,096)
Net unrealized appreciation .................... $230,439
5. LIQUIDATION OF THE INSTITUTIONAL INTERMEDIATE FUND
From its inception until August 1, 1994, the Intermediate
Series sought to achieve its investment obective by investing
all of its assets in the Smith Breeden Institutional
Intermediate Duration U.S. Government Fund (the "Institutional
Fund"), an open-end, diversified management investment company
having the same investment objective as the Series. However,
at the close of business on August 1, 1994, pursuant to a plan
of liquidation adopted by the Trustees of the Institutional
Fund, and approved by the Trustees of the Intermediate Series,
the Intermediate Series redeemed in-kind its shares of the
Institutional Fund. The assets of the Institutional Fund were
transferred in proportion to the Intermediate Series' ownership
of the Institutional Fund in cancellation of its shares.
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, 1996, and the related
statements of operations and cash flows 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
each of the years in the three-year period then ended and the
period March 31, 1992 (commencement of operations) to March 31,
1993. These financial statements and the financial highlights
are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial
statements and the 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 the 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, 1996 by correspondence with the
custodian and brokers. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial
highlights referred to above present fairly, in all material
respects, the financial position of the Smith Breeden
Intermediate Duration U.S. Government Series of the Smith
Breeden Series Fund as of March 31, 1996, the results of its
operations and its cash flows, the changes in its net assets,
and the financial highlights for the respective stated periods
in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
May 10, 1996
