- --------------------------------------------------------------------------------
PROSPECTUS/JUNE 15, 1998
(logo)
SMITH BREEDEN
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MUTUAL FUNDS
- Equity Market Plus Fund
- Financial Services Fund
- Short Duration U.S. Government Fund
- Intermediate Duration U.S. Government Fund
"We are pleased to announce the introduction of our newest fund -- the Smith
Breeden Financial Services Fund. This fund, like our others, aims to deliver
professional investment strategies that focus on performance and risk
control."
<TABLE>
<S> <C>
/s/ Douglas T. Breeden /s/ Michael J. Giarla
Douglas T. Breeden Michael J. Giarla
Chairman President
</TABLE>
<PAGE>
(LOGO)
NOT PART OF THE PROSPECTUS
Dear Investor,
Thank you for selecting Smith Breeden No-Load Mutual Funds. Enclosed
is the information you requested.
How Your Fund is Managed -- Please read the enclosed prospectus
booklet carefully to learn about the potential rewards and risks of
each fund before you invest or send money. Please call us at
800-221-3138 if you have questions.
How To Invest -- To invest, simply complete the separate account
application. Please return the application with a check payable to
Smith Breeden Mutual Funds ($1000 initial minimum for each fund,
$250 minimum for Uniform Gifts to Minors and Retirement accounts,
$50 subsequent minimum purchase) using the enclosed postage paid
envelope. Shares may also be purchased by bank wire transfer or
through leading computerized fund trading systems.
We Will Keep You Informed -- You will receive an account statement
each time you buy or sell shares, and whenever your fund pays or
reinvests a dividend. The share prices of most Smith Breeden funds
are published daily in the mutual fund section of major newspapers
or simply call us at 800-221-3138 for prices and dividend
information.
Again, thank you for selecting Smith Breeden Mutual Funds.
Sincerely,
<TABLE>
<S> <C>
/s/ Douglas T. Breeden /s/ Michael J. Giarla
Douglas T. Breeden Michael J. Giarla
Chairman President
</TABLE>
<PAGE>
(LOGO)
NOT PART OF THE PROSPECTUS
Fund Spotlight:
Short Duration US Govt Fund
Intermediate Duration US Govt Fund
Fund Managers:
(PICTURE OF TIMOTHY D. ROWE
APPEARS HERE)
(PICTURE OF DANIEL C. DEKTAR Timothy D. Rowe
APPEARS HERE)
Daniel C. Dektar
Smith Breeden's goal is to design funds that target the risk profile of
specific asset classes and not deviate from those risk targets. Our focus is on
risk target stability, as well as delivering returns that exceed relevant
benchmarks.
The Short Duration Fund is positioned to be a step up from money market
funds. Our goal is to maintain a very low risk profile -- about the same as a
6-month Treasury Bill.
Our Intermediate Duration Fund also has a specific risk target: the Salomon
Brothers Mortgage Index, whose risk should be similar to a 3-5 year maturity
Treasury Note. Of course while Treasury Bills and Notes are U.S. Government
insured and offer a fixed rate of return, the U.S. Government does not
guarantee mutual fund performance. All bond funds experience some fluctuation
in principal and yield.
Smith Breeden's expertise is in finding undervalued securities in the
mortgage-backed securities market. We've been successful in creating total
returns in the mortgage market that are above what you'd expect for the risks
we have taken. We call these "excess returns."
Mortgage-backed securities can be prepaid by homeowners. That possibility
generally results in higher yields but a different risk profile than, say,
non-callable corporate bonds. Our expertise in protecting against mortgage
prepayment risk is a key feature in each of these bond funds.
We are willing to spend part of the higher yield that mortgage securities
provide to pay for the cost of hedging (protecting) our investments from
homeowner prepayment risk. With both of our bond funds, our goal is to mimic
the risk profile of our benchmarks but deliver higher total returns.
Fund Spotlight:
Equity Market Plus Fund
Fund Manager:
(PICTURE OF JOHN B.SPROW
APPEARS HERE)
John B. Sprow
I am often asked about the unique strategy used by the Equity Market Plus
Fund. So I would like to discuss how the Fund works.
The Equity Market Plus Fund, like our bond funds, is designed to match the risk
profile of a specific benchmark. In this case it's the S&P 500 stock index. But
unlike a purely passive index fund, we use a strategy designed to outperform
the S&P 500 without adding additional equity market risk.
The Equity Market Plus Fund can be viewed as comprising income and equity
segments. The income segment invests in a combination of U.S. Government Agency
mortgage securities, hedged to a low level of interest rate risk, a strategy
similar to that of our Short Duration bond fund. The Equity segment invests in
S&P 500 index futures contracts. (S&P 500 index futures contracts only require
the posting of 5% margin, so 95% of the cash in the Fund is available to invest
in the income segment.) When the "excess" returns we generate in the income
segment (using our expertise in the mortgage markets) exceed the funding cost
of the S&P 500 futures contracts plus the operating expenses incurred by the
Fund, the Fund is able to outperform the S&P 500 Index.
While S&P 500 futures contracts are designed to track the S&P 500 index, they
are not stocks and their performance can differ from the actual S&P index.
Smith Breeden was one of the first firms to implement this institutional
strategy in a no-load mutual fund and we've been very pleased with the results.
DFU 7/97
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Past performance is not indicative of future results. Share prices and returns
will fluctuate and when redeemed, shares may be worth more or less than their
original investment. There are special risks associated with investing in
futures and option contracts which may or may not be suitable for all
investors.
<PAGE>
(LOGO)
NOT PART OF THE PROSPECTUS
Fund Spotlight:
Financial Services Fund
Fund Managers:
(PICTURE OF DOUGLAS T. (PICTURE OF MICHAEL J. (PICTURE OF ROBERT B.
BREEDEN APPEARS HERE) GIARLA APPEARS HERE) PERRY APPEARS HERE)
Douglas T. Breeden Michael J. Giarla Robert B. Perry
Smith Breeden Associates began life in 1982 as a business consultant to
financial services firms. These past 15 years, the firm has had extensive
consulting relationships with over 50 financial firms. Additionally, Smith
Breeden's principals have made substantial investments in financial services
firms. With such depth of specialized experience, managing a financial services
mutual fund is a natural extension of our expertise.
Successful analysis of investments in the financial services sector depends on
understanding the internal workings of the companies themselves, the industry
in which they operate, how that industry is regulated, and how it is impacted
by economic events. Here we are uniquely qualified.
My work teaching graduate level courses in banking as well as serving as Editor
for the Journal of Fixed Income helps enormously in keeping our investment
research techniques at the leading edge of this rapidly changing
industry. Assisting me in managing this portfolio will be Michael J. Giarla,
President of Smith Breeden and Robert B. Perry, a Principal of Smith Breeden,
both of whom have extensive experience in consulting for financial
institutions. Our goal is to invest in firms where the values seem reasonable
in relation to the growth prospects and risks of the firms. Banks, thrifts,
financial and leasing companies, brokerage, investment banking and advisory
firms, these are the primary types of firms we analyze.
Knowing that the fortunes of these firms can be related to changes in the
market and in interest rates, we may also seek to protect investments in this
area through the use of interest rate and equity futures and options,
securities in which we have extensive experience. Although all investments
involve a degree of risk, and we can't guarantee future results, we are
confident that our skills and unique qualifications will provide investors with
the potential to reap the rewards from the dynamic financial services sector.
DFU 12/97
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Past performance is not indicative of future results. Share prices and returns
will fluctuate and when redeemed, shares may be worth more or less than their
original investment. There are special risks associated with investing in
futures and option contracts which may or may not be suitable for all
investors.
<PAGE>
(LOGO)
NOT PART OF THE PROSPECTUS
Tips for Successful Investing
1. Invest Regularly. Most mutual fund share prices fluctuate, and we
do not believe that anyone can predict future share prices. By
investing at regular intervals you don't have to worry about buying
at the "right" time. With regular periodic investing you are more
likely to buy shares at a variety of prices and achieve an average
purchase price that is satisfactory. Smith Breeden has an automatic
investment plan that makes regular investing easy.(1)
2. Invest For The Long Term. You should expect daily fluctuations in
the performance of most mutual funds. Short-term fluctuations may
result in gains or losses. But mutual fund performance over longer
(monthly, annual or multi-year) periods tend to be less volatile. By
focusing on the long-term, you are less likely to sell your shares
prematurely due to daily news events.
3. Defer Taxes When Possible. If you can invest through an IRA
(Individual Retirement Account) or other tax-deferred account, you
will benefit from compounded returns on a portion of investment
gains you might otherwise pay in federal or state income taxes. Such
compounded returns can increase your overall investment success.
Please call us at 800-221-3138 if you wish to set up a Smith Breeden
IRA account or have other questions.
(1)Dollar cost averaging does not guarantee a profit or loss against
a declining market and an investor should consider his or her ability
to continue investing through periods of low price levels.
DFU 7/97
<PAGE>
(LOGO)
JUNE 15, 1998
SMITH BREEDEN MUTUAL FUNDS
PROSPECTUS
The Smith Breeden Mutual Funds consist of four no-load, diversified Series (the
"Funds") of two management investment companies -- Smith Breeden Trust and
Smith Breeden Series Fund. The investment adviser for the Funds is Smith
Breeden Associates, Inc. (the "Adviser").
Smith Breeden Equity Market Plus Fund (the "Equity Market Plus Fund", a series
of the Smith Breeden Trust) seeks to provide a total return exceeding the
Standard & Poor's 500 Composite Stock Index without additional equity market
risk. The Fund does not invest principally in the common stocks that make up
the S&P 500 Index (the "Index") or any other index. Instead, the Fund uses S&P
500 futures and swaps in an effort to maintain an equity market exposure
similar to that which would be achieved if all of the Fund's assets were
invested in the stocks comprising the Index. Since the Equity Market Plus Fund
utilizes index futures contracts and equity swap contracts to track the S&P 500
Index, it can invest substantially all of its cash in fixed-income securities
and related hedging instruments. Whether the Fund's total return equals or
exceeds the performance of the S&P 500 Index depends largely on whether the
total return on the Equity Market Plus Fund's fixed-income investments equals
or exceeds the Fund's total operating expenses, as well as other factors.
Smith Breeden Financial Services Fund (the "Financial Services Fund", a series
of the Smith Breeden Trust) seeks capital appreciation. To pursue this goal,
the Fund invests in U.S. and foreign financial services companies. These
include banks, thrift, finance and leasing companies, brokerage, investment
banking and advisory firms, real estate related firms and insurance companies.
Smith Breeden Short Duration U.S. Government Fund (the "Short Fund", a series
of the Smith Breeden Series Fund) seeks a high level of current income
consistent with low volatility of net asset value. The Short Fund seeks to
match the duration, or interest-rate risk, of a portfolio that invests
exclusively in six month U.S. Treasury securities on a constant maturity
basis. The dollar weighted average maturity of the Fund's securities may at
times significantly exceed six months.
Smith Breeden Intermediate Duration U.S. Government Fund (the "Intermediate
Fund", a series of the Smith Breeden Series Fund) seeks a total return in
excess of the total return of the major market indices for mortgage-backed
securities. The major market indices for mortgage-backed securities currently
include, but are not limited to, the Salomon Brothers Mortgage Index and the
Lehman Brothers Mortgage Index. These indices include all outstanding
government sponsored fixed-rate mortgage-backed securities, weighted in
proportion to their current market capitalization. The duration, or
interest-rate risk, of these indices is similar to that of intermediate-term
U.S. Treasury Notes, and typically will range between three and five years. The
Intermediate Fund consistently seeks to achieve a volatility of net asset value
similar to that of a portfolio that invests exclusively in mortgage-backed
securities, as weighted in the major mortgage market indices.
An investment in any of the Funds is neither insured nor guaranteed by the
U.S. Government. There can be no assurance that any of the Funds will meet
their investment objectives. This Prospectus sets forth concisely the
information about the Funds that you should know before investing. Please read
this Prospectus carefully and keep it for future reference. Statements of
Additional Information dated June 15, 1998 have been filed with the Securities
and Exchange Commission with respect to each Trust and are legally part of this
prospectus. The Statements of Additional Information can be obtained without
charge by writing to the Funds at 100 Europa Drive, Chapel Hill, North Carolina
27514 or by calling 1-800-221-3138.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
1
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(LOGO)
TABLE OF CONTENTS
Expense Table...............................................................3
Financial Highlights -- Equity Market Plus Fund.............................5
Financial Highlights -- Financial Services Fund.............................6
Financial Highlights -- Short Fund..........................................7
Financial Highlights -- Intermediate Fund...................................8
Smith Breeden Mutual Funds..................................................9
Investment Objectives, Policies and Risk Considerations.....................9
Other Investment Practices and Risk Considerations.........................15
Management of the Funds....................................................19
Pricing of Fund Shares.....................................................23
How to Purchase Shares.....................................................23
How to Exchange Shares.....................................................25
How to Redeem Shares.......................................................26
Dividends and Distributions................................................28
Shareholder Reports and Information........................................29
Retirement Plans...........................................................29
Service and Distribution Plans.............................................30
Taxes......................................................................30
Capital Structure..........................................................30
Transfer, Dividend Disbursing Agent, Custodian and
Independent Accountants...................................................31
Fund Performance...........................................................31
No person has been authorized to give any information or to make any
representations not contained in this Prospectus and, if given or made, such
information or representations must not be relied upon as having been
authorized by the Funds. The Prospectus does not constitute an offering by the
Funds in any jurisdiction in which such offering may not be lawfully made.
2
<PAGE>
(LOGO)
EXPENSE TABLE
The following table is designed to assist you in understanding the expenses you
will bear as a shareholder of a Fund. Shareholder Transaction Expenses are
charges that you pay when buying or selling shares of a Fund. Annual Fund
Operating Expenses are paid out of a Fund's assets and include fees for
portfolio management, maintenance of shareholder accounts, shareholder
servicing, accounting and other services. The annual fund operating expenses
shown below reflect expense limitations agreed to by the Adviser, and are based
on each Fund's expenses for the past fiscal year, if applicable, or on good
faith estimates provided by the Advisor.
<TABLE>
<CAPTION>
Equity
Market Financial
Plus Services Short Intermediate
Fund Fund Fund Fund
<S> <C> <C> <C> <C>
Shareholder Transaction Expenses
Maximum Sales Load Imposed on Purchases None None None None
Maximum Sales Load Imposed on Reinvested Dividends None None None None
Deferred Sales Load Imposed on Redemptions None None None None
Redemption Fees(1) None None None None
Exchange Fees None None None None
Annual Fund Operating Expenses
(as a percentage of average net assets)
Management Fees(2) 0.70% 1.48% 0.70% 0.70%
Other Expenses (net of reimbursement)(3) 0.18% 0.00% 0.08% 0.18%
Total Fund Operating Expenses (net of reimbursement)(3) 0.88% 1.48% 0.78% 0.88%
</TABLE>
- -------------------------
(1) A transaction charge of $9 may be imposed on redemptions by wire transfer.
(2) Pursuant to a distribution and services plan in respect of each Fund, the
Adviser may pay annual distribution and servicing fees of up to 0.25% of
each of the Fund's net assets out of its management fee. See "Service and
Distribution Plans."
(3) The Other Expenses and Total Fund Operating Expenses in the table reflect
undertakings by the Adviser to bear expenses of each of the Funds and/or
waive its fees to the extent necessary to limit Total Fund Operating
Expenses to 0.78% for the Short Fund and 0.88% for each of the Equity Market
Plus Fund and Intermediate Fund and to 1.48% for the Financial Services Fund
through August 1, 1999. Absent the expense limitation, Other expenses and
Total Fund Operating Expenses for the past fiscal year would have been 0.30%
and 1.00% for the Short Fund, 0.43% and 1.13% for the Intermediate Fund, and
0.53% and 1.23% for the Equity Market Plus Fund, and are estimated to be
about 1.70% and 3.20% for the Financial Services Fund.
3
<PAGE>
(LOGO)
The following examples illustrate the expenses that apply to a $1,000
investment in each Fund over various time periods assuming: (1) a 5% annual
rate of return, and (2) redemption or no redemption at the end of each time
period. Except as noted in the table above, the Funds charge no redemption
fees.
Short Duration Fund
<TABLE>
<CAPTION>
1 Year 3 Years 5 Years 10 Years
- -------- --------- --------- ---------
<S> <C> <C> <C>
$ 8 $ 26 $ 45 $ 99
</TABLE>
Intermediate Duration Fund and Equity Market Plus Fund
<TABLE>
<CAPTION>
1 Year 3 Years 5 Years 10 Years
- -------- --------- --------- ---------
<S> <C> <C> <C>
$ 9 $ 29 $ 50 $ 111
</TABLE>
Financial Services Fund
<TABLE>
<CAPTION>
1 Year 3 Years 5 Years 10 Years
- -------- --------- --------- ---------
<S> <C> <C> <C>
$ 16 $ 48 $ 83 $ 182
</TABLE>
These examples are based on the annual operating expenses shown above and
should not be considered a representation of past or future expenses or
performance. Actual expenses may be greater or less than those shown. The
annual rate of return may be more or less than 5%.
The Funds may be recommended to investors by registered investment
advisors. Such advisors customarily impose fees that would be in addition to
any fees and expenses presented in the above table. Certain broker- dealers may
also charge a fee for purchase or redemption of shares through their
network. Neither the Funds, nor the Adviser, exercise any control over such
advisory or broker-dealer fees and may not be informed of the level of such
fees.
4
<PAGE>
(LOGO)
EQUITY MARKET PLUS FUND
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
The following selected per share data and ratios cover the fiscal periods from
June 30, 1992, the date the Fund commenced operations, through March 31, 1998,
and are part of the Fund's financial statements, which have been audited by
Deloitte & Touche LLP, independent auditors. This data should be read in
conjunction with the Fund's most recent annual audited financial statements and
the report of Deloitte & Touche LLP thereon, which appear in the Statement of
Additional Information for the Smith Breeden Trust.
<TABLE>
<CAPTION>
Year Ended Year Ended
March 31, March 31,
1998 1997
---------------- ---------------
<S> <C> <C>
Net Asset Value, Beginning of
Period ................................. $ 12.56 $ 12.27
------------ -----------
Income From Investment Operations
- -----------------------------------------
Net investment income ................... 0.591 0.592
Net realized and unrealized gain (loss)
on Investments ......................... 4.940 1.813
------------ -----------
Total from investment operations ........ 5.531 2.405
------------ -----------
Less Distributions
- ------------------------------------------
Dividends from net investment income..... ( 0.586) ( 0.590)
Dividends in excess of net investment
income ................................. -- --
Distributions from net realized gains on
Investments ............................ ( 0.645) ( 1.525)
Distributions in excess of net realized
gains on Investments ................... -- --
------------ -----------
Total distributions ..................... ( 1.231) ( 2.115)
------------ -----------
Net Asset Value, End of Period .......... $ 16.86 $ 12.56
============ ===========
Total Return ............................ 45.71% 21.41%
Ratios/Supplemental Data
- ------------------------------------------
Net assets, end of period ............... $136,667,439 $13,507,377
Ratio of expenses to average net assets
Before expense limitation .............. 1.23% 2.60%
After expense limitation ............... 0.88% 0.88%
Ratio of net income to average net
assets
Before expense limitation .............. 4.44% 3.58%
After expense limitation ............... 4.79% 5.30%
Portfolio turnover rate ................. 424% 182%
<CAPTION>
Year Ended Year Ended Year Ended Period Ended
March 31, March 31, March 31, March 31,
1996 1995 1994 1993
-------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of
Period ................................. $ 10.84 $ 9.88 $ 10.85 $ 10.00
---------- ---------- ---------- ---------
Income From Investment Operations
- -----------------------------------------
Net investment income ................... 0.615 0.568 0.476 0.355
Net realized and unrealized gain (loss)
on Investments ......................... 2.768 1.081 ( 0.216) 1.281
---------- ---------- ---------- ---------
Total from investment operations ........ 3.383 1.649 0.260 1.636
---------- ---------- ---------- ---------
Less Distributions
- ------------------------------------------
Dividends from net investment income..... ( 0.583) ( 0.568) ( 0.472) ( 0.311)
Dividends in excess of net investment
income ................................. -- ( 0.001) -- --
Distributions from net realized gains on
Investments ............................ ( 1.370) ( 0.047) ( 0.701) ( 0.420)
Distributions in excess of net realized
gains on Investments ................... -- ( 0.073) ( 0.057) ( 0.055)
---------- ---------- ---------- ---------
Total distributions ..................... ( 1.953) ( 0.689) ( 1.230) ( 0.786)
---------- ---------- ---------- ---------
Net Asset Value, End of Period .......... $ 12.27 $ 10.84 $ 9.88 $ 10.85
========== ========== ========== =========
Total Return ............................ 32.30% 17.18% 2.19% 22.59%*
Ratios/Supplemental Data
- ------------------------------------------
Net assets, end of period ............... $4,766,534 $2,107,346 $1,760,519 $903,846
Ratio of expenses to average net assets
Before expense limitation .............. 4.58% 7.75% 7.08% 28.48%*
After expense limitation ............... 0.90% 0.90% 0.90% 0.57%*
Ratio of net income to average net
assets
Before expense limitation .............. 1.85% 0.59% 1.84% (22.63 %)*
After expense limitation ............... 5.53% 7.44% 8.02% 5.28%*
Portfolio turnover rate ................. 107% 120% 119% 271%
</TABLE>
* Annualized
Additional performance information is presented in the Fund's Annual Report,
which is available without charge upon request.
5
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FINANCIAL SERVICES FUND
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
The following selected per share data and ratios cover the period from December
22, 1997, the date the Fund commenced operations, through March 31, 1998, and
are part of the Fund's financial statements, which have been audited by
Deloitte & Touche LLP, independent auditors. This data should be read in
conjunction with the Fund's most recent audited financial statements and the
report of Deloitte & Touche LLP thereon, which appear in the Statement of
Additional Information for the Smith Breeden Trust.
<TABLE>
<CAPTION>
Period Ended
March 31, 1998
---------------
<S> <C>
Net Asset Value, Beginning of Period ................................. $ 9.00
Income From Investment Operations
- -----------------------------------------------------------------------
Net investment income ................................................ 0.017
Net realized and unrealized gain (loss) on Investments ............... 1.043
---------
Total from investment operations ..................................... 1.060
Less Distributions
- -----------------------------------------------------------------------
Dividends from net investment income ................................. --
Dividends in excess of net investment income ......................... --
Distributions from net realized gains on Investments ................. --
Distributions in excess of net realized gains on Investments ......... --
---------
Total distributions .................................................. --
---------
Net Asset Value, End of Period ....................................... $ 10.06
=========
Total Return ......................................................... 11.78 %
Ratios/Supplemental Data
- -----------------------------------------------------------------------
Net assets, end of period ............................................ $7,316,716
Ratio of expenses to average net assets
Before expense limitation ........................................... 3.20%*
After expense limitation ............................................ 1.48%*
Ratio of net income to average net assets
Before expense limitation ........................................... -0.92%*
After expense limitation ............................................ 0.79%*
Portfolio turnover rate .............................................. 85%
Average Commission Paid Per Share .................................... $ 0.09
</TABLE>
* Annualized
Additional performance information is presented in the Fund's Annual Report,
which is available without charge upon request.
6
<PAGE>
(LOGO)
SHORT DURATION FUND
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
The following selected per share data and ratios cover the fiscal periods from
March 31, 1992, the date the Fund commenced operations, through March 31, 1998,
and are part of the Short Fund's financial statements which have been audited
by Deloitte & Touche LLP, independent auditors. This data should be read in
conjunction with the Short Fund's most recent annual audited financial
statements and the report of Deloitte & Touche LLP thereon, which appear in the
Statement of Additional Information for the Smith Breeden Series Fund.
<TABLE>
<CAPTION>
Year Ended Year Ended
March 31, March 31,
1998 1997
--------------- ----------------
<S> <C> <C>
Net Asset Value, Beginning of
Period .................................... $ 9.83 $ 9.74
----------- ------------
Income From Investment Operations
- -------------------------------------------------------------
Net investment income ....................... 0.484 0.476
Net gain (loss) on securities (both
realized and unrealized) .................. 0.114 0.146
----------- ------------
Total from investment operations ............ 0.598 0.622
----------- ------------
Less Distributions
- ----------------------------------------------
Dividends from net investment income ........ (0.508) (0.476)
Dividends in excess of net investment
income .................................... -- (0.056)
----------- ------------
Total distributions ......................... (0.508) (0.532)
----------- ------------
Net Asset Value, End of Period .............. $ 9.92 $ 9.83
=========== ============
Total Return ................................ 6.24% 6.57%
Ratios/Supplemental Data
- ----------------------------------------------
Net assets, end of period ................... $78,427,855 $118,988,609
Ratio of expenses to average net assets
Before expense limitation ................. 1.00% 0.93%
After expense limitation................... 0.78% 0.78%
Ratio of net income to average net assets
Before expense limitation ................. 5.06% 4.90%
After expense limitation................... 5.28% 5.04%
Portfolio turnover rate ..................... 626% 556%
<CAPTION>
Year Ended Year Ended Year Ended Period Ended
March 31, March 31, March 31, March 31,
1996 1995 1994 1993
---------------- ---------------- ---------------- ---------------
<S> <C> <C> <C> <C>
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 gain (loss) on securities (both
realized and unrealized) .................. (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 net 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
Before expense limitation ................. 0.93% 0.92% 1.00% 2.58%
After expense limitation................... 0.78% 0.78% 0.78% 0.78%
Ratio of net income to average net assets
Before expense limitation ................. 6.13% 6.18% 3.95% 2.73%
After expense limitation................... 6.29% 6.33% 4.17% 4.53%
Portfolio turnover rate ..................... 225% 47% 112% 3%
</TABLE>
Additional performance information is presented in the Short Fund's Annual
Report, which is available without charge upon request.
7
<PAGE>
(LOGO)
INTERMEDIATE DURATION FUND
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
The following selected per share data and ratios cover the fiscal periods from
March 31, 1992, the date the Fund commenced operations, through March 31, 1998,
and are part of the Intermediate Fund's financial statements which have been
audited by Deloitte & Touche LLP, independent auditors. This data should be
read in conjunction with the Intermediate Fund's most recent annual audited
financial statements and the report of Deloitte & Touche LLP thereon, which
appear in the Statement of Additional Information for the Smith Breeden Series
Fund.
<TABLE>
<CAPTION>
Years Ended Year Ended
March 31, March 31,
1998 1997
--------------- ---------------
<S> <C> <C>
Net Asset Value, Beginning of
Period .................................. $ 9.73 $ 10.01
----------- -----------
Income From Investment Operations
- ------------------------------------------
Net investment income .................... 0.590 0.599
Net gain (loss) on securities (both
realized and unrealized) ................ 0.419 ( 0.024)
----------- -----------
Total from investment operations ......... 1.009 0.575
----------- -----------
Less Distributions
- -------------------------------------------
Dividends from net investment
income .................................. ( 0.561) ( 0.604)
Dividends in excess of net investment
income .................................. -- --
Distributions from net realized gains
on Investments .......................... ( 0.178) ( 0.251)
Distributions in excess of net realized
gains on Investments .................... -- --
----------- -----------
Total distributions ...................... ( 0.739) ( 0.855)
----------- -----------
Net Asset Value, End of Period ........... $ 10.00 $ 9.73
=========== ===========
Total Return ............................. 10.65% 5.92%
Ratios/Supplemental Data
- -------------------------------------------
Net assets, end of period ................ $38,641,879 $37,735,525
Ratio of expenses to average net
assets
Before expense limitation ............... 1.13% 1.16%
After expense limitation ................ 0.88% 0.88%
Ratio of net income to average net
assets
Before expense limitation ............... 5.36% 5.92%
After expense limitation ................ 5.61% 6.19%
Portfolio turnover rate .................. 583% 409%
<CAPTION>
Year Ended Year Ended Year Ended Period Ended
March 31, March 31, March 31, March 31,
1996 1995 1994 1993
--------------- --------------- -------------- ---------------
<S> <C> <C> <C> <C>
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 1.05 0.826
Net gain (loss) on securities (both
realized and unrealized) ................ 2.77 ( 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
Before expense limitation ............... 1.14% 2.33% 2.34% 17.52%
After expense limitation ................ 0.90% 0.90% 0.90% 0.82%
Ratio of net income to average net
assets
Before expense limitation ............... 6.26% 4.77% 6.30% ( 8.52%)
After expense limitation ................ 6.49% 6.20% 7.74% 8.18%
Portfolio turnover rate .................. 193% 557% 84% 42%
</TABLE>
Additional performance information is presented in the Intermediate Fund's
Annual Report, which is available without charge upon request.
8
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SMITH BREEDEN MUTUAL FUNDS
The Short and Intermediate Funds are funds of the Smith Breeden Series Fund
(the "Series Fund"), an open-end diversified management investment company. The
Equity Market Plus and Financial Services Funds are series of the Smith Breeden
Trust (the "Trust"), an open-end diversified management investment company.
Smith Breeden Associates, Inc. ("Smith Breeden" or the "Adviser") acts as
investment adviser to the Funds. Smith Breeden is a money management and
consulting firm founded in 1982 whose clients include pension funds, financial
institutions, corporations, government entities, and charitable foundations.
INVESTMENT OBJECTIVES, POLICIES, AND RISK CONSIDERATIONS
Each of the Funds has a different investment objective and different investment
policies, and is designed to meet different investment needs.
The investment objectives and certain investment policies of the Short and
Intermediate Funds are fundamental and may not be changed without a vote of
shareholders of the relevant Fund. The investment objectives of the Equity
Market Plus and Financial Services Funds are not fundamental.
Since shares of each Fund represent an investment in securities with
fluctuating market prices, the net asset value per share of each Fund will vary
as the aggregate value of a Fund's portfolio securities increases or
decreases. Due to the risks inherent in all investments, there can be no
assurance that the objectives of the Funds will be met. The descriptions that
follow are designed to help you choose the Fund or combination of Funds that
best fits your investment objectives.
Short Fund
The Short Fund's investment objective is to provide investors with a high level
of current income, consistent with a volatility of net asset value similar to
that of a portfolio which invests exclusively in six-month U.S. Treasury
securities on a constant maturity basis. There is no assurance that the Short
Fund will be able to maintain a low volatility of net asset value.
The Short Fund will seek its investment objective by investing, under normal
circumstances, at least 70% of its total assets in U.S. Government Securities
(see "Investment Objectives, Policies and Risk Considerations --
Characteristics and Risks of the Securities in which the Short and Intermediate
Funds and Fixed Income Segment of the Equity Market Plus Fund Invest"). It is
anticipated that the Short Fund will invest primarily in mortgage-backed
securities issued by the U.S. Government, its agencies and
instrumentalities. The Fund will also invest in fixed-rate and adjustable-rate
mortgage-backed securities issued by non-governmental issuers. The Fund may
hold a portion of its assets in money market instruments and in time and
savings deposits (including fixed-rate or adjustable certificates of deposit)
in commercial banks or institutions whose accounts are insured by the FDIC.
Under normal circumstances the Short Fund will seek to achieve an interest-rate
risk or option-adjusted duration (See "Other Investment Practices and Risk
Considerations -- Adjusting Investment and Interest Rate Risk Exposure")
similar to that of a six-month U.S. Treasury security on a constant maturity
basis. However, the Short Fund expects that, under normal circumstances, the
dollar-weighted average life (or period until the next reset date) of its
portfolio securities will be longer than six months, sometimes significantly
longer.
The Adviser believes that by investing in mortgage securities from a variety of
market sectors on a selective basis and adjusting the overall option-adjusted
duration of the portfolio to approximate that of a six-month U.S. Treasury
security, the Short Fund will achieve a more consistent and less volatile net
asset value than is characteristic of mutual funds that invest primarily in
mortgage securities paying a fixed rate of interest or those that invest
exclusively in adjustable-rate mortgage securities. The securities in which the
Short Fund may invest may not yield as high a level of income as other
securities in which other funds may invest. However, such higher yielding
securities may be more volatile and may be issued by less creditworthy
entities.
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Intermediate Fund
The Intermediate Fund's investment objective is to provide investors with a
total return in excess of the total return of the major market indices for
mortgage-backed securities. The Intermediate Fund will seek its investment
objective by investing, under normal circumstances, at least 70% of its total
assets in U.S. Government Securities. It is anticipated that the Intermediate
Fund will invest primarily in mortgage-backed securities issued by the
U.S. Government, its agencies or instrumentalities. The Fund will also invest
in fixed-rate and adjustable rate mortgage-backed securities issued by
non-governmental issuers. The Fund may hold a portion of its assets in money
market instruments and in time and savings deposits (including fixed-rate or
adjustable-rate certificates of deposit) in commercial banks or institutions
whose accounts are insured by the FDIC.
The major market indices for mortgage-backed securities currently include, but
are not limited to, the Salomon Brothers Mortgage Index and the Lehman Brothers
Mortgage Index. These indices include all outstanding government sponsored
fixed-rate mortgage-backed securities, weighted in proportion to their current
market capitalization. Total return is the change in value of the investment,
assuming reinvestment of all distributions. Under normal circumstances, the
Intermediate Fund will seek to achieve an interest-rate risk or option-adjusted
duration (see "Other Investments and Risk Considerations") similar to that of a
portfolio that invests exclusively in mortgage-backed securities, as weighted
in the major market indices. The duration, or interest-rate risk, of these
indices is believed by the Adviser to be similar to the that of intermediate-
term U.S. Treasury Notes, and typically will range between three and five
years. When market interest rates decline, the value of a portfolio invested in
intermediate-term fixed-rate obligations can be expected to rise. Conversely,
when market interest rates rise, the value of a portfolio invested in
intermediate-term fixed-rate obligations can be expected to fall.
There is no assurance that the Intermediate Fund will be able to maintain a
total return in excess of the total return of major market indices for
mortgage-backed securities, or that it will match the interest rate risk of a
portfolio investing exclusively in these securities.
Fundamental Policies. As a matter of fundamental policy, the Short and
Intermediate Funds will limit purchases to securities from the following
classes of assets:
1. Securities issued directly or guaranteed by the U.S. Government or its
agencies or instrumentalities;
2. Mortgage-Backed Securities rated AAA by S&P or Aaa by Moody's or unrated but
deemed of equivalent quality by the Adviser;
3. Securities fully collateralized by assets in either of the above classes;
4. Assets which would qualify as liquidity items under federal regulations if
held by a commercial bank or savings institution; and
5. Hedge instruments, which may only be used for risk management purposes. Any
securities described in the "Hedging" section and any stripped Mortgage-Backed
Securities may only be used for risk management purposes.
Equity Market Plus Fund
The Equity Market Plus Fund seeks to provide a total return exceeding the
Standard & Poor's 500 Composite Stock Price Index (the "Index") without
additional equity market risk. The Fund does not invest principally in the
common stocks that make up the Index or any other stock index. Instead, the
Fund uses S&P 500 futures and swaps in an effort to maintain an equity market
exposure similar to that which would be achieved if all of the Fund's assets
were invested in the stocks comprising the Index. Since the Equity Market Plus
Fund utilizes index futures contracts and equity swap contracts to track the
S&P 500 Index, it can invest substantially all of its cash in fixed-income
securities and related hedging instruments. Whether the Fund's total return
equals or exceeds the performance of the S&P 500 Index depends largely on
whether the
10
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total return on the Equity Market Plus Fund's fixed-income investments equals
or exceeds the Fund's total operating expenses, as well as other factors.
The S&P 500 Index is an unmanaged index composed of 500 common stocks, most of
which are listed on the New York Stock Exchange. Standard & Poor's, which is
not a sponsor of or in any other way affiliated with the Fund, chooses the 500
stocks included in the S&P 500 Index on the basis of market value and industry
diversification. The S&P 500 Index assigns relative values to the stocks
included in the index, weighted according to each stock's total market value
relative to the total market value of the other stocks included in the index.
The Equity Market Plus Fund seeks its objective by dividing its portfolio into
two segments: an "S&P 500 Index Segment" and a "Fixed Income Segment." Through
the S&P 500 Index Segment, the Fund invests in a combination of equity swap
contracts, futures contracts on the S&P 500 Index and on other stock indices,
including, but not limited to, the New York Stock Exchange Composite Index, and
common stocks whose return (before deducting allocated costs) is expected to
track movements in the S&P 500 Index. By employing this strategy, the Equity
Market Plus Fund seeks to achieve the same investment opportunity and risk
profile for the S&P 500 Index Segment as that of a hypothetical portfolio,
equal in size to the Fund, invested in the common stocks comprising the S&P 500
Index in proportion to their respective weightings in the S&P 500 Index.
When index futures contracts and/or equity swap contracts are, in the judgment
of the Adviser, overpriced relative to the common stocks underlying the S&P 500
Index, the Fund may invest directly in the common stocks represented by the S&P
500 Index. The Fund will not own all 500 issues, but will attempt to purchase a
basket of common stocks which the Adviser expects will, on average, match
movements in the S&P 500 Index. Subject to limits on the Fund's investments in
other investment companies, the Fund may also invest in these stocks indirectly
by purchasing interests in asset pools investing in such stocks. To the extent
that the Fund purchases interests in other investment companies, shareholders
of the Fund may be subject to a layering of expenses because they may
indirectly bear a proportionate share of the expenses of such investment
companies (including advisory fees) in addition to bearing the direct expenses
of the Fund.
Through the Fixed Income Segment, the Fund invests in fixed-income securities
and uses related hedging techniques such as futures, options, floors, caps and
swaps. The Fixed-Income Segment will invest substantially all of its assets in
U.S. Government Securities, and may also invest in bank certificates of
deposit, corporate debt obligations, and mortgage-backed and other asset-backed
securities of non-governmental issuers. The Fund may also engage in loans of
portfolio securities, dollar rolls, and reverse repurchase agreements to
enhance income and total return. With these investments, the Fund seeks to
generate income (consisting primarily of interest income) and gains which
exceed the total costs of operating the Fund (including the costs associated
with the S&P 500 Index Segment). Thus, whether the Fund's total return equals
or exceeds the performance of the S&P 500 Index depends largely on whether the
total return on the Fund's Fixed-Income Segment equals or exceeds the Fund's
total operating expenses, as well as other factors described below.
The S&P 500 Index Segment's actual opportunities for gain or loss may be
greater than a hypothetical portfolio invested in the stocks comprising the S&P
500 Index depending upon the Fund's exposure to the S&P 500 Index, which could
at times be higher or lower than the Fund's total assets. For example, the
total net notional amount of the Fund's equity swap contracts, S&P 500 or other
stock index futures plus the market value of common stocks owned by the Fund
may exceed the Fund's total net assets as a result of purchases and redemptions
of Fund shares. In addition, since S&P 500 Index futures can only be purchased
for specific amounts, the Fund might not be able to match accurately a notional
amount of futures contracts to the Fund's total net assets. Under normal market
conditions, the Fund expects that such variations in S&P 500 Index exposure
will generally be up to 5% greater or less than the Fund's total net
assets. Also, the ability of the S&P 500 Index Segment of the Fund's portfolio
to replicate the investment opportunity and risk profile of a hypothetical
stock portfolio may be diminished by imperfect correlations between price
movements of the S&P 500 Index with price movements of S&P 500 and other stock
index futures and/or the common stocks purchased by the Fund. In addition, the
purchase and sale of common stocks and S&P 500 and other stock index futures
involve transaction costs. Equity swap contracts require the Fund to pay
interest on the
11
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notional amount of the contract. Therefore, assuming the Fund has successfully
tracked the movement of the S&P 500 Index, the Fund will outperform the S&P 500
Index only if the total net return on the Fixed Income Segment of the Fund's
portfolio exceeds the sum of (to the extent applicable) (1) the Fund's
transaction costs on S&P 500 and other stock index futures and common stock
transactions, (2) the interest payments under the Fund's equity swap contracts
and (3) the Fund's operating expenses as described more fully under "Management
of the Fund."
Example. Set forth below is an example of how the Equity Market Plus Fund might
invest a $100 million portfolio:
1. Enter into an equity swap contract with a notional amount of $50 million;
2. Purchase S&P 500 index futures contracts with a total contract value of $45
million; and
3. Purchase $5 million worth of common stocks comprising the S&P 500 Index in
proportion to their respective weightings in the S&P 500 Index.
Because equity swap contracts and futures contracts may generally be initially
entered into without making cash payments, the Fixed Income Segment would have
$95 million to invest in various fixed income securities with appropriate
hedging strategies. If, during the course of the year, the stocks comprising
the S&P 500 Index appreciate 10% on average and pay a 4% dividend, and if the
interest on the equity swap contract's notional amount is 6%, at the end of the
year the following would occur:
1. The counterparty to the equity swap contract would be required to pay the
Fund $4 million ($7 million appreciation and dividends minus $3 million
interest);
2. The S&P 500 index futures contract would be closed out at a gain of $3.6
million ($6.3 million S&P 500 Index appreciation less $2.7 million for the S&P
500 Futures implicit cost of carry);
3. Dividend income and gain on the common stocks would total $0.7 million and
in sum;
4. The S&P 500 Index Segment's return, before related operating expenses, would
total $8.3 million dollars or 8.3%.
The Fund's total operating expenses (other than brokerage expenses and the
interest on the notional amount of the equity swap contract as described above)
are 0.88% of total net assets, or $0.88 million dollars. After consideration of
these expenses, the S&P 500 Index Segment's return would total
7.42%. Therefore, the Fund would achieve a total return equal to the S&P 500
Index only if the Fixed Income Segment has a total return equal to 6.93% per
annum. If the Fixed Income Segment achieves this result, then the Fund's total
net assets would be $114 million -- an increase of 14% and a total return equal
to the S&P 500 Index. If the Fixed Income Segment's total return were greater
or less than 6.93% per annum, the Fund's total return would, in turn, be
greater or less than the S&P 500 Index.
Smith Breeden Financial Services Fund
The Financial Services Fund seeks capital appreciation. To pursue this goal,
the fund will invest at least 65% of its assets in U.S. and foreign financial
services companies. These include banks, thrifts, finance and leasing
companies, brokerage, investment banking and advisory firms, real estate
related firms and insurance companies. The Fund will generally invest in common
stock and in other equity securities such as preferred stock and warrants. The
Fund may also engage in other investment practices. See "Other Investment
Practices and Risk Considerations."
Because the Financial Services Fund invests in a single sector, its performance
is largely dependent on the sector's performance, which may differ from that of
the overall stock market. Changing interest rates or deteriorating economic
conditions can adversely affect the performance of financial services
companies' stocks. The Fund may buy or sell interest rate futures and options
to attempt to mitigate the affect of changing interest rates upon the
portfolio. However, the use of interest rate futures in such a strategy
involves the
12
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risk that the price movements of the hedging instrument will not accurately
reflect price movements in the security due to changing interest rates, so that
the hedge will not be fully effective or may result in losses.
The Fund may also buy or sell stock index futures or options on such indices to
adjust the risk and return characteristics of the Fund's stock portfolio. If
the Adviser judges market conditions incorrectly or employs a strategy that
does not correlate well with the Fund's investments, the use of stock index
futures could result in a loss, regardless of whether the intent was to reduce
risk or increase return. These techniques may also increase the volatility of
the Fund relative to the Financial Services sector of the stock market. See
also "Other Investment Practices and Risk Considerations" and the Statement of
Additional Information for a discussion of the use of financial futures and
options and their risks.
Financial services companies are subject to extensive government regulation
which may limit both the amounts and types of loans and other financial
commitments they can make, and the interest rates and fees they
charge. Profitability is largely dependent upon on the availability and cost of
capital funds, and can fluctuate significantly when interest rates
change. Credit losses resulting from the financial difficulties of borrowers
can negatively impact the industry. Insurance companies may be subject to
severe price competition. Legislation is currently being considered which would
reduce the separation between commercial and investment banking businesses. If
enacted this could significantly impact the financial services sector and the
Fund.
The Fund may purchase securities of foreign financial services companies, which
are subject to additional risks. Currency fluctuations can adversely affect the
returns on investments held in foreign corporations. Other risks relate to the
fact that differences exist in accounting, auditing and financial reporting
standards. Political developments may also have an adverse impact. There is
also the possibility of changes in investment or exchange control regulations,
restrictions on the flow of international capital, and difficulties in pursuing
legal remedies against issuers. The Fund will primarily invest in foreign
financial securities through ADRs, which represent shares of a foreign
corporation held by an U.S. bank that entitles the holder to all dividends and
capital gains. ADRs are denominated in U.S. dollars and trade in the
U.S. securities markets. ADRs are still subject to the risks associated with
foreign investment generally described above. The Financial Services Fund may
hedge against fluctuations in foreign exchange rates by entering into foreign
currency forward and futures contracts. For more discussion of these contracts
and their risks, see "Other Investment Practices and Risk Considerations" and
the Statement of Additional Information.
Under regulations imposed by the Investment Company Act of 1940 and its rules
(the "1940 Act"), the Fund may not purchase more than 10% of the securities of
any domestic or foreign insurance company. The Fund may also not invest more
than 5% of its total assets in the equity securities of any company that
derives more than 15% of its revenues from brokerage or investment management
activities, unless such investment is limited to not more than 5% of the equity
securities or 10% of the debt securities of such company, and such investment
represents not more than 5% of the net assets of the Fund.
The Financial Services Fund intends to be a diversified fund, as defined under
the 1940 Act, and as such, with respect to 75% of its assets, will not invest
more than 5% of its assets in any single issuer, and such 5% holding cannot
represent more than a 10% voting interest in the acquired company.
Characteristics and Risks of the Securities in which the Short and Intermediate
Funds and Fixed Income Segment of the Equity Market Plus Fund Invest
U.S. Government Securities. The U.S. Government Securities in which the Funds
may invest include U.S. Treasury Bills, Notes, Bonds, discount notes and other
debt securities issued by the U.S. Treasury, and obligations issued or
guaranteed by the U.S. Government, its agencies and instrumentalities
including, but not limited to, the Government National Mortgage Association
("GNMA"), Federal National Mortgage Association ("FNMA") and Federal Home Loan
Mortgage Corporation ("FHLMC"). (Other U.S. Government agencies or
instrumentalities include Federal Home Loan Banks, Bank for Cooperatives, Farm
Credit Banks, Tennessee Valley Authority, Federal Financing Bank, Small
Business Administration, and Federal Agricultural Mortgage
Corporation.) Mortgage-backed securities are explained more fully below.
13
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Credit Risks. While certain U.S. Government securities such as U.S. Treasury
obligations and GNMAs are backed by the full faith and credit of the
U.S. Government, other securities in which the Funds may invest are subject to
varying degrees of risk of default. These risk factors include the
creditworthiness of the issuer and, in the case of mortgage-backed and
asset-backed securities, the ability of the mortgagor or other borrower to meet
its obligations. The Short and Intermediate Funds will seek to minimize this
credit risk by investing in securities of the highest credit quality
instruments, while the Equity Market Plus Fund will seek to minimize this risk
of default by investing in securities of at least investment grade, except that
the Equity Market Plus Fund's investment in mortgage backed securities will be
rated at least A by Standard & Poors ("S&P"). The individual securities
continue to be subject to the risk that their prices can fluctuate, in some
cases significantly, due to changes in prevailing interest rates.
Mortgage-Backed and Other Asset-Backed Securities. Mortgage-backed securities
are securities that directly or indirectly represent a participation in, or are
collateralized by and payable from, mortgage loans secured by real
property. The term "mortgage-backed securities," as used herein, includes
adjustable-rate mortgage securities, fixed-rate mortgage securities, and
derivative mortgage products such as collateralized mortgage obligations,
stripped mortgage-backed securities and other instruments described below.
There are currently three basic types of mortgage-backed securities: (i) those
issued or guaranteed by the U.S. Government or one of its agencies or
instrumentalities, such as GNMA, FNMA and FHLMC; (ii) those issued by private
issuers that represent an interest in or are collateralized by mortgage-backed
securities issued or guaranteed by the U.S. Government or one of its agencies
or instrumentalities; and (iii) those issued by private issuers that represent
an interest in or are collateralized by whole mortgage loans or mortgage-backed
securities without a government guarantee but usually having some form of
private credit enhancement.
The Short and Intermediate Funds may only invest in mortgage-backed securities
issued by private originators of, or investors in, mortgage loans issued by
private entities that are rated AAA by S&P or Aaa by Moody's Investors Service
("Moody's"), or, if unrated, determined by the Adviser to be of comparable
quality. The Short and Intermediate Funds will not pay any additional fees for
credit support and will not invest in private mortgage pass-through securities
unless they are rated AAA by S&P or Aaa by Moody's, or are unrated but deemed
to be of comparable credit quality by the Adviser. In addition, the Short and
Intermediate Funds will only purchase mortgage-backed securities which
constitute "Mortgage Related Securities" for purposes of the Secondary Mortgage
Market Enhancement Act of 1984.
The Funds will not purchase privately-issued mortgage-backed securities or CMOs
collateralized by interests in whole mortgage loans (not guaranteed by GNMA,
FNMA or FHLMC) if the securities of any one issuer would exceed 10% of any
Fund's assets at the time of purchase. The Funds will not purchase
privately-issued mortgage-backed securities or CMOs collateralized by U.S.
Government agency mortgage-backed securities if the securities of any one
issuer would exceed 20% of any Fund's assets at the time or purchase.
The Equity Market Plus Fund may invest in other mortgage-backed and
asset-backed securities. Its investment in mortgage-backed and other
asset-backed securities will be rated at least A by Moody's or S&P. Asset-backed
securities are structured like mortgage-backed securities, but instead of
mortgage loans or interests in mortgage loans, the underlying assets may
include, but are not limited to, pools of automobile loans, educational loans
and credit card receivables.
Mortgage-backed and asset-backed securities have yield and maturity
characteristics corresponding to their underlying assets. Unlike traditional
debt securities, which may pay a fixed rate of interest until maturity when the
entire principal amount comes due, payments on certain mortgage-backed and
asset-backed securities include both interest and a partial payment of
principal. This partial payment of principal may be comprised of a scheduled
principal payment as well as an unscheduled payment from the voluntary
prepayment, refinancing, or foreclosure of the underlying loans. As a result of
these unscheduled payments of principal, or prepayments on the underlying
securities, the price and yield of mortgage-backed securities can be adversely
affected. For example, during periods of declining interest rates, prepayments
can be expected to accelerate, and the Funds would be required to reinvest the
proceeds at the lower interest rates then
14
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available. Prepayments of mortgages which underlie securities purchased at a
premium could result in capital losses because the premium may not have been
fully amortized at the time the obligation is prepaid. In addition, like other
interest-bearing securities, the values of mortgage-backed securities generally
fall when interest rates rise, but when interest rates fall, their potential
for capital appreciation is limited due to the existence of the prepayment
feature. In order to hedge against possible prepayment, the Funds may purchase
certain options and options on futures contracts as described more fully in
"Other Investment Practices and Risk Considerations" and the Statement of
Additional Information.
Adjustable-Rate Securities. Adjustable-rate securities have interest rates that
are reset at periodic intervals, usually by reference to some interest rate
index or market interest rate. Some adjustable-rate securities are backed by
pools of mortgage loans. The Short and Intermediate Funds will only invest in
adjustable-rate securities backed by pools of mortgage loans ("ARMs"). The
Fixed Income Segment of the Equity Market Plus Fund may also invest in
adjustable-rate securities backed by assets other than mortgage pools.
Although the rate adjustment feature may act as a buffer to reduce large
changes in the value of adjustable-rate securities, these securities are still
subject to changes in value based on changes in market interest rates or
changes in the issuer's creditworthiness. Because the interest rate is reset
only periodically, changes in the interest rate on adjustable-rate securities
may lag changes in prevailing market interest rates. Also, some adjustable-rate
securities (or the underlying mortgages or other underlying loans or
receivables) are subject to caps or floors that limit the maximum change in
interest rate during a specified period or over the life of the
security. Because of the resetting of interest rates, adjustable-rate
securities are less likely than non-adjustable-rate securities of comparable
quality and maturity to increase significantly in value when market interest
rates fall. Adjustable-rate securities are also subject to the prepayment risks
associated generally with mortgage- backed securities.
Other Mortgage Backed Securities and Fixed Income Investments. The Short and
Intermediate Funds and Fixed Income Segment of the Equity Market Plus Fund may
also invest in other types of mortgage-backed and fixed income securities
including Collateralized Mortgage Obligations, Stripped Securities, and zero
coupon bonds. These types of securities, including their risks, are described
in detail in the Statement of Additional Information. New instruments and
variations of existing mortgage-backed securities continue to be developed. The
Funds may invest in any such instruments or variations to the extent consistent
with their investment objectives and policies and applicable regulatory
requirements.
OTHER INVESTMENT PRACTICES AND RISK CONSIDERATIONS
The Statement of Additional Information for each Fund contains more detailed
information about the following practices, including limitations designed to
reduce their risks.
Adjusting Investment and Interest Rate Risk Exposure. A Fund can use various
techniques to increase or decrease its exposure to changing security prices and
indices, currency exchange rates, interest rates or other factors that affect
security value, or to employ temporary substitutes for anticipated future
transactions. These techniques include buying or selling financial futures
contracts, purchasing call or put options, or selling covered call options on
such futures or entering into currency exchange contracts or swap
agreements. Any or all of these techniques may be used at one time, except that
only the Financial Services Fund may enter into currency exchange futures,
forward or swap contracts. Use of any particular transaction is a function of
market conditions. There is no overall limitation on the percentage of a Fund's
assets which may be subject to a hedge position.
Swap agreements are two-party contracts entered into primarily by institutional
investors for periods ranging from a few weeks to more than one year. In a
standard swap transaction, two parties agree to exchange the returns (or
differentials in rates of return) earned or realized on particular
predetermined investments or instruments, which may be adjusted for an interest
factor. The gross returns to be exchanged or "swapped" between the two parties
are generally calculated with respect to a "notional amount", i.e., the return
on or increase in value of a particular dollar amount invested at a particular
interest rate, in a particular foreign currency, or in a "basket" of securities
representing a particular index. Whether a Fund's use of swap agreements will
be successful in furthering its investment objective will depend on the
Advisor's ability to predict
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correctly whether certain types of investments are likely to produce greater
returns than other investments. Because they are two-party contracts and
because they may have terms of greater than seven days, swap agreements are
currently considered illiquid investments. Moreover, a Fund bears the risk of
loss of the amount expected to be received under a swap agreement in the event
of the default or bankruptcy of a swap agreement counterparty. The Funds will
enter into swap agreements only with counterparties that meet certain standards
for creditworthiness (generally such counterparties would have to be eligible
counterparties under the terms of the Funds' repurchase agreement
guidelines). Certain restrictions imposed on the Funds by the Internal Revenue
Code may limit the Funds' ability to use swap agreements. The swaps market is a
relatively new market and is largely unregulated. It is possible that
developments in the swaps market, including potential government regulation,
could adversely affect a Fund's ability to terminate existing swap agreements
or to realize amounts to be received under such agreements.
Options and futures transactions involve costs and may result in losses. The
losses from investing in futures transactions are potentially unlimited. In
addition, the effective use of options and futures strategies depends on a
Fund's ability to terminate options and futures positions at times when the
Adviser deems it desirable to do so. This ability to terminate positions when
the Adviser deems it desirable to do so may be hindered by the lack of a liquid
secondary market. Although a Fund will take an options or futures contract
position only if the Adviser believes there is a liquid secondary market for
the option or futures contract, there is no assurance that a Fund will be able
to effect closing transactions at any particular time or at an acceptable
price.
The use of options and futures strategies also involves the risk of imperfect
correlation between movements in the values of the securities underlying the
futures and options purchased and sold by a Fund, of the option and futures
contract itself, and of the securities which are the subject of a hedge. For
example, a Fund bears the risk that prices of hedged securities will not move
to the same degree as the hedging instrument, or that price movements in the
hedging instrument will not accurately reflect price movements in the security
underlying the hedging instrument. It is also possible for a Fund to incur a
loss on both the hedged securities and the hedging instrument. In the case of
the Short and Intermediate Funds, and the Fixed Income segment of the Equity
Market Plus Fund, this means that they may not achieve, and may at times
exceed, their targeted option-adjusted durations.
Option-adjusted duration is a measure of the price sensitivity of a portfolio
to changes in interest rates. The maturity of a security, another commonly used
measure of price sensitivity, measures only the time until final payment is
due, whereas option-adjusted duration takes into account the pattern of all
payments of interest and principal on a security over time, including how these
payments are affected by prepayments and by changes in interest rates. In
computing the duration of a Fund's portfolio, the Adviser will estimate the
duration of obligations that are subject to prepayment or redemption by the
issuer, taking into account the influence of changes in interest rates on
prepayments and coupon flows.
At times, a Fund may sell interest rate futures in a different dollar amount
than the dollar amount of securities being hedged, depending on the expected
relationship between the volatility of the prices of such securities and the
volatility of the futures contracts, based on duration calculations by the
Adviser. If the actual price movements of the securities and futures are
inconsistent with the Adviser's estimates of their durations, the hedge may not
be effective.
The Short, Intermediate and Equity Market Plus Fund will not maintain open
short positions in interest rate futures contracts if, in the aggregate, the
value of the open positions (marked to market) exceeds the current market value
of its fixed income securities portfolio plus or minus the unrealized gain or
loss on these open positions, adjusted for the expected volatility relationship
between the portfolio and the futures contracts based on duration
calculations. If this limitation should be exceeded at any time, a Fund will
take prompt action to close out the appropriate number of open contracts to
bring its open futures position into compliance with this limitation.
The Short and Intermediate Funds will not purchase a put or call option on
U.S. Government securities or mortgage-backed securities if, as a result of
such purchase, more than 10% of its total assets would be invested in such
options. The Short and Intermediate Funds will engage in OTC option
transactions only
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with primary United States government securities dealers recognized by the
Federal Reserve Bank of New York. The Short and Intermediate Funds will also
not sell options which are not covered.
The Equity Market Plus Fund will not purchase or sell S&P 500 or other stock
index futures, except for bona fide hedging purposes, if as a result the Fund's
aggregate initial margin deposits and premiums would be greater than 5% of the
Fund's total assets. In addition to margin deposits, when the Fund purchases an
S&P 500 or other stock index futures contract, it is required to maintain at
all times liquid securities in a segregated account with its Custodian, in an
amount which, together with the initial margin deposit on the futures contract,
is equal to the current delivery or cash settlement value of the futures
contract. The Statement of Additional Information provides additional
information regarding equity swap contracts, S&P 500 and other stock index
futures contracts and their related risks.
In accordance with regulations established by the Commodity Futures Trading
Commission, each Funds' aggregate initial margin and premiums on all futures
and options contract positions not held for bona fide hedging purposes, will
not exceed 5% of a Fund's net assets, after taking into account unrealized
profits and losses on such contracts.
The Funds' ability to engage in options and futures transactions and to sell
related securities might also be limited by tax considerations and by certain
regulatory requirements. See "Taxes" in the relevant Statement of Additional
Information.
Securities Lending, Repurchase Agreements and Forward Commitments. The Funds
may lend portfolio securities to broker-dealers and may enter into repurchase
agreements. These transactions must be fully collateralized at all times but
involve some risk to the Funds if the other party should default on its
obligations and a Fund is delayed in or prevented from recovering the
collateral. None of the Funds will lend portfolio securities if, as a result,
the aggregate of such loans exceeds 33 1/3% of the total asset value (including
such loans). The Funds will only enter into repurchase agreements with or lend
securities to (i) member banks of the Federal Reserve System having total
assets in excess of $500 million and (ii) securities dealers, provided such
banks or dealers meet the creditworthiness standards established by the Board
of Trustees ("Qualified Institutions"). The Adviser will monitor the continued
creditworthiness of Qualified Institutions, subject to the oversight of the
Board of Trustees.
The Funds may also purchase securities for future delivery, which may increase
overall investment exposure and involves a risk of loss if the value of the
securities declines prior to the settlement date. At the time a Fund enters
into a transaction on a when-issued or forward commitment basis, a segregated
account consisting of liquid securities equal to at least 100% of the value of
the when-issued or forward commitment securities will be established and
maintained with the Funds' custodian. Subject to this requirement, the Funds
may purchase securities on such basis without limit. Settlements in the
ordinary course, which may be substantially more than three business days for
mortgage-backed securities, are not treated as when-issued or forward
commitment transactions, and are not subject to the foregoing limitations,
although some of the risks described above may exist.
Reverse Repurchase Agreements, Dollar Roll Agreements and Borrowing. The Funds
may enter into reverse repurchase agreements or dollar roll agreements with
commercial banks and registered broker-dealers in amounts up to 33 1/3% of
their assets. The Short and Intermediate Funds may only enter into these
transactions with commercial banks and registered broker-dealers which are also
Qualified Institutions. The Statement of Additional Information for each Trust
contains a more detailed explanation of these practices. Reverse repurchase
agreements and dollar rolls are considered borrowings by a Fund and require
segregation of assets with a Fund's custodian in an amount equal to the Fund's
obligations pending completion of such transactions. Each Fund may also borrow
money from banks in an amount up to 33 1/3% of a Fund's total assets to realize
investment opportunities, for extraordinary or emergency purposes, or for the
clearance of transactions. Borrowing from banks usually involves certain
transaction and ongoing costs and may require
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a Fund to maintain minimum bank account balances. Use of these borrowing
techniques to purchase securities is a speculative practice known as
"leverage." Depending on whether the performance of the investments purchased
with borrowed funds is sufficient to meet the costs of borrowing, a Fund's net
asset value per share will increase or decrease, as the case may be, more
rapidly than if the Fund did not employ leverage.
Short Sales. The Funds may make short sales of securities. A short sale is a
transaction in which the Fund sells a security it does not own in anticipation
that the market price of that security will decline. The Short, Intermediate,
and Equity Market Plus Funds expect to engage in short sales as a form of
hedging in order to shorten the overall duration of the portfolio and maintain
portfolio flexibility. The Financial Services Fund may make short sales of
securities to reduce the risk of the portfolio to the market or to increase
return. While a short sale may act as effective hedge to reduce the market or
interest rate risk of a portfolio, it may also result in losses which can
reduce the portfolio's total return.
When a Fund makes a short sale, it must borrow the security sold short and
deliver it to the broker-dealer through which it made the short sale as
collateral for its obligation to deliver the security upon completion of the
transaction. A Fund may have to pay a fee to borrow particular securities, and
is often obligated to relinquish any payments received on such borrowed
securities.
Until a Fund replaces a borrowed security, it will maintain daily a segregated
account with its custodian into which it will deposit liquid securities such
that the amount deposited in the account plus any amount deposited with the
broker as collateral will equal the current value of the security sold
short. Depending on arrangements made with the broker, a Fund may not receive
any payments (including interest) on collateral deposited with the broker. If
the price of the security sold short increases between the time of the short
sale and the time a Fund replaces the borrowed security, the Fund will incur a
loss; conversely, if the price declines, the Fund will realize a gain. Although
a Fund's gain is limited to the amount at which it sold the security short, its
potential loss is limited only by the maximum attainable price of the security
less the price at which the security was sold.
A Fund will not make a short sale if, after giving effect to such sale, the
market value of all securities sold exceeds 25% of the value of the Fund's
total net assets. A Fund may also effect short sales where the Fund owns, or
has the right to acquire at no additional cost, the identical security (a
technique known as a short sale "against the box"). Such transactions might
accelerate the recognition of gain. See "Taxes" in the relevant Statement of
Additional Information.
Illiquid Securities. A Fund may invest up to 15% of its net assets in illiquid
securities. The term illiquid securities for this purpose means securities that
cannot be disposed of within seven days in the ordinary course of business. The
SEC staff takes the position that this includes non-terminable repurchase
agreements having maturities of more than seven days.
The Financial Services Fund may invest in restricted securities, which
represent securities that can be sold in privately negotiated transactions,
pursuant to an exemption from registration under the Securities Act of 1933, or
in registered public offering. Restricted securities deemed to be liquid under
procedures established by the Board are not subject to the limitations on
illiquid securities.
The determination of whether certain IO/PO Strips issued by the U.S. Government
and backed by fixed-rate mortgages or any other securities in which a Fund
desires to invest are liquid shall be made by the Adviser under guidelines
established by the Trustees in accordance with applicable pronouncements of the
SEC. At present, all other IO/PO Strips, other residual interests of CMOs and
OTC options are treated as illiquid securities. The SEC staff also currently
takes the position that the interest rate swaps, caps and floors discussed in
the Statement of Additional Information, as well as equity swap contracts and
reverse equity swap contracts, are illiquid.
Portfolio Turnover. The Adviser buys and sells securities for a Fund whenever
it believes it is appropriate to do so. Portfolio turnover generally involves
some expense to a Fund, including brokerage commissions or dealer mark-ups and
other transaction costs on the sale of securities and reinvestment in other
securities.
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Such transactions may result in realization of taxable capital gains. The
portfolio turnover rate for each Fund's previous fiscal periods is shown in the
table under the heading "Financial Highlights". The Adviser expects that for
the Financial Services Fund, the portfolio turnover rate will not exceed 400%
on an annualized basis.
The portfolio turnover rates reported in the "Financial Highlights" for the
Short, Intermediate, and Equity Market Plus Funds for the fiscal year ended
March 31, 1998 were relatively high. Since the Funds' holdings are very liquid,
the Funds may reposition their holdings between different mortgage sectors
relatively frequently, but without generating substantial transaction
costs. The mortgage securities in which the Short, Intermediate and Equity
Market Plus Funds invest are generally traded on a "net" basis with dealers
acting as principals for their own account without a stated commission.
The Funds will pay commissions in connection with options and future
transactions and, for the Equity Market Plus Fund and Financial Services Fund,
in relation to any purchase of common stocks or other equity securities.
MANAGEMENT OF THE FUNDS
Its Board of Trustees manages the business affairs of the Funds. Each of the
Funds has entered into an investment advisory agreement with Smith Breeden
Associates, Inc., 100 Europa Drive, Chapel Hill, North Carolina, 27514 (the
"Investment Advisory Agreements"). Pursuant to such investment advisory
agreements, the Adviser furnishes continuous investment advisory services to
each of the Funds.
Trustees and Officers
The following is a listing of the Trustees and officers of the Series Fund and
Trust, the legal entities that have issued shares in the Funds. Unless
otherwise indicated, all of the named individuals serve in their capacities for
both the Series Fund and Trust.
Douglas T. Breeden* Trustee and Chairman
Portfolio Manager, Financial Services Fund
Dr. Breeden, the Chairman of the Board of Smith Breeden Associates, co-founded
the firm in 1982. In conjunction with Michael J. Giarla and Robert B. Perry, he
is responsible for the day-to-day operations of the Financial Services
Fund. Dr. Breeden has served on business school faculties at Duke University,
Stanford University and the University of Chicago, and as a visiting professor
at Yale University and at the Massachusetts Institute of Technology. He is the
Editor of The Journal of Fixed Income. Dr. Breeden served as Associate Editor
for five journals in financial economics, and was elected to the Board of
Directors of the American Finance Association. He has published several
well-cited articles in finance and economics journals. He holds a Ph.D. in
Finance from the Stanford University Graduate School of Business, and a B.S. in
Management Science from the Massachusetts Institute of Technology. He serves as
Chairman of Harrington Financial Group, the holding company for Harrington
Bank, F.S.B., of Richmond, Indiana.
Michael J. Giarla* Trustee and President
Portfolio Manager, Financial Services Fund
Mr. Giarla is Chief Operating Officer, President and Director of Smith Breeden
Associates. In conjunction with Douglas T. Breeden and Robert B. Perry, he is
responsible for the day-to-day operations of the Financial Services Fund. He
also serves as a Director of Harrington Financial Group, the holding company
for Harrington Bank, F.S.B., of Richmond, Indiana. Formerly Smith Breeden's
Director of Research, he was involved in research and programming, particularly
in the development and implementation of models to evaluate and hedge mortgage
securities. He also consults with institutional clients and conducts special
projects. Before joining Smith Breeden Associates, Mr. Giarla was a Summer
Associate in Goldman Sachs &
* Interested Person
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Company's Equity Strategy Group in New York. Mr. Giarla has published a number
of articles and book chapters regarding MBS investment, risk management and
hedging. He served as an Associate Editor of The Journal of Fixed Income from
1991-1993. Mr. Giarla holds a Master of Business Administration with
Concentration in Finance from the Stanford University Graduate School of
Business, where he was an Arjay Miller Scholar. He earned a Bachelor of Arts in
Statistics, summa cum laude, from Harvard University, where he was elected to
Phi Beta Kappa and was a Harvard Club of Boston Scholar. Mr. Giarla is a
Trustee of the Roxbury Latin School, West Roxbury, Massachusetts.
Stephen M. Schaefer Trustee
Stephen M. Schaefer is Esmee Fairbairn Professor of Finance at the London
Business School. Previously on the Faculty of the Graduate School of Business
of Stanford University, he has also taught at the Universities of California
(Berkeley), Chicago, British Columbia and Venice. His research interests focus
on capital markets and financial regulation. He served on the editorial board
of a number of professional journals including, currently, the Journal of Fixed
Income, the Review of Derivative Research, and Ricerche Economiche. He consults
for a number of leading financial institutions, including the Investment
Adviser, and is a former Independent Board Member of the Securities and Futures
Authority of Great Britain.
Myron S. Scholes Trustee
Myron S. Scholes is a Principal in the money management firm Long-Term Capital
Management Co. (since 1993). He is the Frank E. Buck Professor of Finance
Emeritus at the Graduate School of Business at Stanford University (since
1983). He is a member of the Econometric Society. Professor Scholes was also a
Managing Director and co-head of the fixed income derivatives group at Salomon
Brothers between 1991-1993. Prior to coming to Stanford University in 1983,
Professor Scholes was the Edward Eagle Brown Professor of Finance at the
Graduate School of Business, University of Chicago (1974-1983). He served as
the Director of the University of Chicago's Center for Research in Security
Prices from 1974-1980. Prior to coming to the University of Chicago, Professor
Scholes was first an Assistant Professor then an Associate Professor at the
Sloan School of Management at M.I.T. from 1968 to 1973. He received his
Ph.D. in 1969 from the Graduate School of Business, University of Chicago. He
has honorary Doctor of Law degrees from the University of Paris and McMaster
University. He is a past president of the American Finance Association (1990).
Dr. Scholes has published numerous articles in academic journals and in
professional volumes. He is most noted as the co-originator of the
Black-Scholes Options Pricing Model as described in the paper, "The Pricing of
Options and Corporate Liabilities," published in the Journal of Political
Economy (with Fischer Black, May 1973), for which he was awarded the Nobel
Prize in Economic Sciences in 1997. His other papers include such topics as
risk-return relationships, the effects of dividend policy on stock prices, and
the effects of taxes and tax policy on corporate decision making. His book with
Mark Wolfson (Stanford University) Taxes and Business Strategy: A Planning
Approach was published by Prentice Hall in 1991.
William F. Sharpe Trustee
William F. Sharpe is the STANCO 25 Professor of Finance at Stanford
University's Graduate School of Business. He is best known as one of the
developers of the Capital Asset Pricing Model, including the beta and alpha
concepts used in risk analysis and performance measurement. He developed the
widely used binomial method for the valuation of options and other contingent
claims. He also developed the computer algorithm used in many asset allocation
procedures, a procedure for estimating the style of an investment manager from
its historic returns, and the Sharpe ratio for measuring investment
performance. Dr. Sharpe has published articles in a number of professional
journals. He has also written six books, including Portfolio Theory and Capital
Markets, (McGraw-Hill, 1970), Asset Allocation Tools, (Scientific Press, 1987),
Fundamentals of Investments (with Gordon J. Alexander and Jeffery Bailey,
Prentice-Hall, 1993) and Investments (with Gordon J. Alexander and Jeffrey
Bailey, Prentice-Hall, 1990). Dr. Sharpe is a past President of the American
Finance Association. He also served as consultant to a number of corporations
and investment organizations. He is Trustee of the Barr Rosenberg mutual funds,
a director of Stanford Management Company and the Chairman of the Board of
Financial Engines, a company providing electronic portfolio advice. He received
the Nobel Prize in Economic Sciences in 1990.
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Daniel C. Dektar Vice President, Smith Breeden Series Fund
Portfolio Manager, Short and Intermediate
Funds
Daniel C. Dektar is a Principal, Executive Vice President, Director of
Portfolio Management, and Director of Smith Breeden Associates. Mr. Dektar has
been primarily responsible for the day-to-day management of the Short and
Intermediate Funds since their commencement of operations in 1992. In December
1997, Timothy D. Rowe joined Mr. Dektar as co-Portfolio Manager of the
Intermediate Fund, and shares responsibility for the day-to-day management of
that Fund. As head of Smith Breeden Associates' portfolio management group,
Mr. Dektar is constantly in touch with developments on Wall Street. He serves
as a liaison among the portfolio management, client service, and research
groups to ensure accurate analysis and timely execution of portfolio management
opportunities. Mr. Dektar consults with institutional clients in the areas of
investments and risk management. He made several presentations on mortgage
investments and risk management at seminars for institutional
investors. Mr. Dektar was an Associate in the Mergers and Acquisitions Group of
Montgomery Securities in San Francisco, California and a Financial Analyst in
the Investment Banking Division of Morgan Stanley & Co., Incorporated, New York
before joining Smith Breeden Associates. He holds a Master of Business
Administration with Concentration in Finance from Stanford University Graduate
School of Business, where he was an Arjay Miller Scholar. Mr. Dektar received a
Bachelor of Science in Business Administration, summa cum laude, from the
University of California at Berkeley, where he was University of California
Regent's Scholar, was elected to Phi Beta Kappa and Phi Eta Sigma, and won the
White Award as the top student in finance.
Timothy D. Rowe Vice President, Smith Breeden Series Fund
Portfolio Manager, Intermediate Fund
Timothy D. Rowe is a Principal, Director, and Vice President of Smith Breeden
Associates. Mr. Rowe, in conjunction with Daniel C. Dektar, is responsible for
the day-to-day management of the Intermediate Fund. Mr. Rowe is a senior
portfolio manager working primarily with discretionary separate account
clients. He implements investment strategies designed to generate portfolio
returns superior to the broad investment grade and mortgage market indices. Mr.
Rowe joined Smith Breeden in 1988. His prior experience includes three years as
Assistant Economist at the Federal Reserve Bank of Richmond, Virginia. While at
the Bank, he co-edited the sixth edition of Instruments of the Money Market,
and produced research papers for publication in the Bank's Economic Review
magazine. He holds a Master of Business Administration with specialization in
Finance from the University of Chicago Graduate School of Business, and a
Bachelor of Arts in Economics and History from Duke University. He graduated
from Duke magna cum laude, earned Class Honors and was a National Merit
Scholar.
John B. Sprow Vice President, Smith Breeden Trust
Portfolio Manager, Equity Market Plus Fund
John B. Sprow is a Principal, Director and Executive Vice President of Smith
Breeden Associates. Mr. Sprow has been primarily responsible for the day-to-day
management of the Equity Market Plus Fund from the commencement of its
operations in 1992. Mr. Sprow is a senior portfolio manager who works primarily
with discretionary pension accounts. In addition to traditional mortgage
accounts, he also manages S&P 500 indexed accounts. Prior to directly managing
discretionary accounts, Mr. Sprow assisted in the development of the Adviser's
models for pricing and hedging mortgage-related securities, risky commercial
debt, and forecasting mortgage prepayment behavior. Mr. Sprow came to Smith
Breeden Associates from the Fuqua School of Business, Duke University, where he
was Research Assistant. Previously, Mr. Sprow was a Research Assistant to the
Department Head of the Materials Science Department, Cornell University. He
received a Master of Business Administration with Emphasis in Finance from the
Fuqua School of Business, Duke University. Mr. Sprow holds a Bachelor of
Science in Materials Science and Engineering from Cornell University, where he
was awarded the Carpenter Technology Scholarship three successive years.
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Robert B. Perry Vice President, Smith Breeden Trust
Portfolio Manager, Financial Services Fund
Robert B. Perry is a Principal at Smith Breeden Associates, providing hedging
and investment advice to Smith Breeden's financial services clients. He is also
responsible for calculating market-to-market values and projected income of
institutions, and assesses the effects of interest rate and economic
changes. In conjunction with Douglas T. Breeden and Michael J. Giarla, Mr.
Perry is responsible for the day-to-day operations of the Financial Services
Fund. Prior to joining Smith Breeden, Mr. Perry served as an interest rate risk
analyst for Centura Bank, and secretary to the ALCO committee. He has also
served as a Director for Community First Financial Group, a multi-bank holding
company located in Indianapolis, Indiana. Mr. Perry earned his Bachelor of Arts
in Business Administration from North Carolina State University.
Marianthe S. Mewkill Vice President, Secretary, Treasurer, and
Chief Accounting Officer
Marianthe S. Mewkill is a Principal, Vice President and Chief Financial Officer
of Smith Breeden Associates. Ms. Mewkill handles financial reporting,
budgeting, tax research and planning for the Smith Breeden Mutual Funds and for
Smith Breeden Associates, Inc. She ensures compliance with agency regulations
and administers the Adviser's internal trading and other policies. She was
previously employed as a Controller for the Hunt Alternatives Fund, as an
Associate at Goldman Sachs & Co., and as a Senior Auditor at Arthur Andersen &
Co. She earned a Master of Business Administration with Concentrations in
Finance and Accounting from New York University and graduated from Wellesley
College, magna cum laude with a Bachelor of Arts degree in History and French
and a Minor in Economics.
Investment Adviser
Smith Breeden Associates, Inc., a registered investment adviser, acts as
investment adviser to the Funds. Approximately 62% of the Adviser's voting
stock on a fully diluted basis is owned by Douglas T. Breeden, its
Chairman. Under its Investment Advisory Agreement with each Fund, the Adviser,
subject to the general supervision of the Board of Trustees, manages the Funds'
portfolios and provides for the administration of all of the Funds' other
affairs. For these services, the Adviser receives a fee, computed daily and
payable monthly, at the annual rate of 0.70% of the Short, Intermediate and
Equity Market Plus Funds' average daily net assets. The Adviser receives a fee
at the rate of 1.50% for its management of the Financial Services Fund. Until
the renewal date of its contracts with the Funds, August 1, 1999, the Adviser
has voluntarily agreed to reduce its compensation, and to the extent necessary
absorb other expenses of the Funds, such that the total expenses (exclusive of
ordinary brokerage commissions, investment transaction taxes and extraordinary
expenses) do not exceed 0.88% of the average net assets for each of the Equity
Market Plus Fund and the Intermediate Fund, 0.78% of the average net assets of
the Short Fund and 1.48% of the Financial Services Fund.
The Adviser places all orders for purchases and sales of the Funds'
securities. Subject to seeking the most favorable price and execution
available, the Adviser may consider sales of shares of the Funds as a factor in
the selection of broker-dealers.
Distribution
FPS Broker Services, Inc. (the "Principal Underwriter") acts as distributor for
the Funds for which the Adviser pays the Principal Underwriter an annual fee of
$30,000. Shares may also be sold by authorized dealers who have entered into
dealer agreements with the Principal Underwriter or the Adviser.
Expenses
The Funds pay all of their own expenses, including, without limitation, the
cost of preparing and printing their registration statements required under the
Securities Act of 1933 and the 1940 Act and any amendments thereto, the expense
of registering their shares with the Securities and Exchange Commission and the
various states, the printing and distribution costs of prospectuses mailed to
existing investors, reports to
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investors, reports to government authorities and proxy statements, fees paid to
directors who are not interested persons of the Adviser, interest charges,
taxes, legal expenses, association membership dues, auditing services,
insurance premiums, brokerage commissions and expenses in connection with
portfolio transactions, fees and expenses of the custodian of their assets,
printing and mailing expenses and charges and expenses of dividend disbursing
agents, accounting services agents, registrars and stock transfer agents.
PRICING OF FUND SHARES
The price you pay when buying a Fund's shares, and the price you receive when
selling (redeeming) a Fund's shares, is the net asset value of the shares next
determined after receipt of a purchase or redemption request in proper form. No
front-end sales charge or commission of any kind is added by the Fund upon a
purchase, and no charge is deducted upon redemption. These charges may apply if
you purchase or sell shares through certain broker-dealers. The Funds currently
charge a $9 fee for each redemption made by wire. See "How to Redeem Shares."
The per share net asset value of a Fund is determined by dividing the total
value of its assets, less its liabilities, by the total number of its shares
outstanding at that time. The net asset value is determined as of the close of
regular trading (usually at 4:00 p.m. Eastern time) each day that the Adviser
and Transfer Agent are open for business and on which there is a sufficient
degree of trading in a Fund's securities such that the net asset value of a
Fund's shares might be affected. Accordingly, Purchase Applications accepted or
redemption requests received in proper form by the Transfer Agent, or other
agent designated by the Funds, prior to the close of regular trading each day
that the Adviser and Transfer Agent are open for business, will be confirmed at
that day's net asset value. Purchase Applications accepted or redemption
requests received in proper form after the close of regular trading by the
Transfer Agent, or other agent designated by the Funds, will be confirmed at
the net asset value of the following business day.
Current holiday schedules indicate that the Funds' net asset values will not be
calculated on New Year's Day, Martin Luther King Day, President's Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, the day
following Thanksgiving, Christmas Eve and Christmas Day. The Short and
Intermediate Funds will also not be priced on Columbus Day and Veterans' Day.
Under procedures approved by the Board of Trustees, a Fund's securities for
which market quotations are readily available are valued at current market
value provided by a pricing service, bank or broker-dealer experienced in such
matters. Short-term investments that will mature in 60 days or less are
generally valued at amortized cost, which approximates market value. All other
securities and assets are valued at fair market value as determined by
following procedures approved by the Board of Trustees.
HOW TO PURCHASE SHARES
All of the Funds are no-load, so you may purchase, redeem or exchange shares
directly at net asset value without paying a sales charge. Because the Funds'
net asset value changes daily, your purchase price will be the next net asset
value determined after the Funds' Transfer Agent, or other agent designated by
the Funds, receives and accepts your purchase order. See "Pricing of Fund
Shares."
<TABLE>
<CAPTION>
Initial Minimum Additional Minimum
Type of Account Investment Investment
<S> <C> <C>
Regular $1000 $50
Automatic Investment Plan None $50
Individual Retirement Account $ 250 $50
Gift to Minors $ 250 $50
</TABLE>
Each Fund reserves the right to reject any orders for the purchase of its
shares or to limit or suspend, without prior notice, the offering of its
shares. The required minimum investments may be waived in the case of qualified
retirement plans.
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How to Open Your Account by Mail. Please complete the Purchase Application. You
can obtain additional copies of the Purchase Application and a copy of the IRA
Purchase Application from the Funds by calling 1-800-221-3138.
Your completed Purchase Application should be mailed directly to:
Smith Breeden Mutual Funds
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA 19406-0903
All applications must be accompanied by payment in the form of a check or money
order made payable to "Smith Breeden Mutual Funds." All purchases must be made
in U.S. dollars, and checks must be drawn on U.S. banks. No cash, credit cards
or third party checks will be accepted. When a purchase is made by check and a
redemption is made shortly thereafter, the Funds will delay the mailing of a
redemption check until the purchase check has cleared your bank, which may take
up to 15 calendar days from the purchase date. If you contemplate needing
access to your investment shortly after purchase, you should purchase the
shares by wire as discussed below.
How to Open Your Account by Wire. You may make purchases by direct wire
transfers. To ensure proper credit to your account, please call the Funds at
1-800-221-3137 for instructions prior to wiring funds. Funds should be wired
through the Federal Reserve System as follows:
United Missouri Bank
A.B.A. Number 10-10-00695
For the account of First Data Investor Services Group, Inc.
Account Number 98-7037-071-9
For credit to (identify which Fund to purchase)
For further credit to: (investor account number)
(name or account registration)
(Social Security or Tax Identification Number)
Following such wire transfer, you must promptly complete a Purchase Application
and mail it to the Funds at the following address: Smith Breeden Mutual Funds,
3200 Horizon Drive, P.O. Box 61503, King of Prussia, PA 19406-0903. Shares will
be redeemed with Federal tax withheld if the Funds do not receive a properly
completed and executed Purchase Application.
Telephone Transactions. The privilege to initiate redemption or exchange
transactions by telephone is made automatically available to shareholders when
opening an account, unless they indicate otherwise by checking the appropriate
boxes on the Purchase Application. Each Fund will employ reasonable procedures
to ensure that instructions communicated by telephone are genuine. If
reasonable procedures are not implemented, the Funds may be liable for any loss
due to unauthorized or fraudulent transactions. In all other cases, you are
liable for any loss due to unauthorized transactions. The Funds reserve the
right to refuse a telephone transaction if they believe it is advisable to do
so.
If you have any questions, please call the Funds at 1-800-221-3138.
How to Add to Your Account. You may make additional investments by mail or by
wire in an amount equal to or greater than $50. When adding to an account by
mail, you should send the Funds your check, together with the additional
investment form from a recent statement. If this form is unavailable, you
should send a signed note giving the full name of the account and the account
number. For additional investments made by wire transfer, you should use the
wiring instructions listed above. Be sure to include your account number.
Automatic Investment Plan. You may make purchases of shares of each Fund
automatically on a regular basis ($50 minimum per transaction). You have two
options under the Plan to make investments. One is by automatic payroll
deduction. Under this method, you authorize your employer to direct a portion
of each
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paycheck to be invested in the Fund of your choice. Your employer must be using
direct deposit to process its payroll in order for you to elect this
method. Under the other method, your bank debits a pre-authorized amount from
your checking or savings account each month and applies the amount to your
investment in Fund shares. In order to have your bank account debited
automatically for investment into the Funds, your financial institution must be
a member of the Automated Clearing House. No service fee is currently charged
by the Funds for participation in either method under the Plan. A $20 fee will
be imposed by the Funds if sufficient funds are not available in your bank
account, or if your bank account has been closed at the time of the automatic
transaction. You may adopt either method under the Plan at the time an account
is opened by completing the appropriate section of the Purchase
Application. Enclosed with the application are the necessary forms to deliver
to your employer to set up the payroll deduction. You may obtain an application
to establish the Automatic Investment Plan after an account is opened by
calling the Funds at 1-800-221-3138. In the event you discontinue participation
in the Plan, the Funds reserve the right to redeem your Fund account
involuntarily, upon sixty days' written notice, if the account's net asset
value is $1000 or less.
Purchasing Shares Through Other Institutions. The Funds have authorized dealers
besides the Principal Underwriter to accept on its behalf purchase and
redemption orders. If you purchase shares through a program of services offered
or administered by one of these broker-dealers, financial institutions, or
other service provider, you should read the program materials, including
information relating to fees, in addition to this Prospectus. Certain services
of a Fund may not be available or may be modified in connection with the
program of services provided, and service providers may establish higher
minimum investment amounts. The Funds may only accept requests to purchase
additional shares into a broker-dealer street name account from the broker-
dealer.
Certain broker-dealers, financial institutions, or other service providers that
have entered into an agreement with the Adviser or Principal Underwriter may
enter purchase and redemption orders on behalf of their customers by phone,
with payment to follow within several days as specified in the agreement. These
broker-dealers and service providers may designate other intermediaries to
accept purchase and redemption orders on the Funds' behalf. The Funds will be
deemed to have effected such purchase or redemption orders at the net asset
value next determined after acceptance of the telephone purchase order by the
authorized broker or the authorized broker's designee. It is the responsibility
of the broker-dealer, financial institution, or other service provider to place
the order with the Funds on a timely basis. If payment is not received within
the time specified in the agreement, the broker-dealer, financial institution,
or other service provider could be held liable for any resulting fees or
losses.
Miscellaneous. The Funds will charge a $20 service fee against your account for
any check or electronic funds transfer that is returned unpaid. You will also
be responsible for any losses suffered by the Funds as a result. In order to
relieve you of responsibility for the safekeeping and delivery of stock
certificates, the Funds do not currently issue certificates.
HOW TO EXCHANGE SHARES
Shares of any Fund may be exchanged for shares of another Fund at any
time. This exchange offer is available only in states where shares of such
other Fund may be legally sold. You may open a new account, or purchase
additional shares in an existing account, by making an exchange from an
identically registered Smith Breeden Fund account. A new account will have the
same registration as the existing account from which the exchange was made, and
is subject to the same initial investment minimums.
Exchanges may be made either in writing or by telephone. Written instructions
should be mailed to 3200 Horizon Drive, P.O. Box 61503, King of Prussia, PA
19406 and must be signed by all account owners, and accompanied by any properly
endorsed outstanding share certificates, if applicable. The telephone exchange
is automatically accepted unless checked otherwise. The telephone exchange
privilege is available only for uncertificated shares. During periods of
drastic economic or market changes, it is possible that exchanges by telephone
may be difficult to implement. In this event, shareholders should follow the
written exchange procedures. The telephone exchange privilege may be modified
or discontinued by the Funds at any time upon a 60-day notice to the
shareholders. To exchange by telephone, you must follow the instructions below
under "How to Redeem by Telephone."
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The Funds will accept exchange orders by telephone or other means of electronic
transmission from broker- dealers, financial institutions or other service
providers who execute an agreement with the Adviser or Principal
Underwriter. It is the responsibility of the broker-dealer, financial
institution or other service provider to place the exchange order on a timely
basis.
Exchanges are made on the basis of the Funds' relative net asset
values. Because the exchange is considered a redemption and purchase of shares,
the shareholder may recognize a gain or loss for federal income tax
purposes. Backup withholding and information reporting may also
apply. Additional information regarding the possible tax consequences of such
an exchange is included under the caption "Taxes" in the Funds' Statements of
Additional Information.
There are differences among the Funds. When exchanging shares, shareholders
should be aware that the Funds might have different dividend payment dates. The
dividend payment schedules should be checked before exchanging shares. The
amount of any accumulated, but unpaid, dividend is included in the net asset
value per share.
If you buy shares by check, you may not exchange those shares for up to 15
calendar days to ensure your check has cleared. If you intend to exchange
shares soon after their purchase, you should purchase the shares by wire or
contact the Funds at 1-800-221-3137 for further information.
The Funds reserve the right to temporarily or permanently terminate, with or
without advance notice, the exchange privilege of any investor who makes
excessive use of the exchange privilege (e.g., more than four exchanges per
calendar year).
Additional documentation may be required for exchange requests if shares are
registered in the name of a corporation, partnership or fiduciary. Please
contact the Funds for additional information concerning the exchange privilege.
HOW TO REDEEM SHARES
You may redeem shares of the Funds at any time. The price at which the shares
will be redeemed is the net asset value per share next determined after proper
redemption instructions are received by the Transfer Agent or other agent
designated by the Funds. See "Pricing of Fund Shares." There are no charges for
the redemption of shares, except that a fee of $9 is charged for each wire
redemption. Depending upon the redemption price you receive, you may realize a
capital gain or loss for federal income tax purposes.
How to Redeem by Mail to Receive Proceeds by Check. To redeem shares by mail,
simply send an unconditional written request to the Funds specifying the number
of shares or dollar amount to be redeemed, the name of the Fund, the name(s) on
the account registration and the account number. A request for redemption must
be signed exactly as the shares are registered. If the amount requested is
greater than $25,000, or the proceeds are to be sent to a person other than the
recordholder or to a location other than the address of record, each signature
must be guaranteed by a commercial bank or trust company in the United States,
a member firm of the National Association of Securities Dealers, Inc. or other
eligible guarantor institution. A notary public is not an acceptable
guarantor. Guarantees must be signed by an authorized signatory of the bank,
trust company, or member firm, and "Signature Guaranteed" must appear with the
signature. Additional documentation may be required for the redemption of
shares held in corporate, partnership or fiduciary accounts. In case of any
questions, please contact the Funds in advance.
A Fund will mail payment for redemption within seven days after receiving
proper instructions for redemption. However, the Funds will delay payment for
15 calendar days on redemptions of recent purchases made by check. This allows
the Funds to verify that the check used to purchase Fund shares will not be
returned due to insufficient funds and is intended to protect the remaining
investors from loss.
How to Redeem by Telephone. The redemption of shares by telephone is available
automatically unless you elected to refuse this redemption privilege on your
Purchase Application. Shares may be redeemed by calling the Funds at
1-800-221-3137. Proceeds redeemed by telephone will be mailed to your address,
or
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wired or credited to your pre-authorized bank account. To establish wire
redemption privileges, you must select the appropriate box on the Purchase
Application and enclose a voided check.
In order to arrange for telephone redemptions after your account has been
opened, or to change the bank account or address designated to receive
redemption proceeds, you must send a written request to your Fund. The request
must be signed by each registered holder of the account with the signatures
guaranteed by a commercial bank or trust company in the United States, a member
firm of the National Association of Securities Dealers, Inc. or other eligible
guarantor institution. A notary public is not an acceptable guarantor. Further
documentation as provided above may be requested from corporations, executors,
administrators, trustees and guardians.
Payment of the redemption proceeds for Fund shares redeemed by telephone where
you request wire payment will normally be made in federal funds on the next
business day. The Funds reserve the right to delay payment for a period of up
to seven days after receipt of the redemption request. There is currently a $9
fee for each wire redemption, which will be deducted from your account.
The Funds reserve the right to refuse a telephone redemption or exchange
transaction if they believe it is advisable to do so. Procedures for redeeming
or exchanging shares of the Funds by telephone may be modified or terminated by
the Funds at any time. In an effort to prevent unauthorized or fraudulent
redemption or exchange requests by telephone, the Funds have implemented
procedures designed to reasonably assure that telephone instructions are
genuine. These procedures include: requesting verification of certain personal
information; recording telephone transactions; confirming transactions in
writing; and restricting transmittal of redemption proceeds only to
pre-authorized designations. Other procedures may be implemented from time to
time. If reasonable procedures are not implemented, the Funds may be liable for
any loss due to unauthorized or fraudulent transactions. In all other cases,
you are liable for any loss for unauthorized transactions.
You should be aware that during periods of substantial economic or market
change, telephone or wire redemptions may be difficult to implement. If you are
unable to contact the Funds by telephone, you may also redeem shares by
delivering or mailing the redemption request to: Smith Breeden Mutual Funds,
3200 Horizon Drive, P.O. Box 61503, King of Prussia, PA 19406-0903.
The Funds reserve the right to suspend or postpone redemptions during any
period when trading on the New York Stock Exchange ("Exchange") is restricted
as determined by the Securities and Exchange Commission ("SEC"), or the
Exchange is closed for other than customary weekend and holiday closing; the
SEC has by order permitted such suspension; or an emergency, as determined by
the SEC, exists, making disposal of portfolio securities or valuation of net
assets of a Fund not reasonably practicable.
Due to the relatively high cost of maintaining small accounts, if your account
balance falls below $1000 as a result of a redemption or exchange, or if you
discontinue the Automatic Investment Plan before your account balance reaches
$1000, you may be given a 60-day notice to bring your balance to $1000 or
reactivate an Automatic Investment Plan. If this requirement is not met, your
account may be closed and the proceeds sent to you.
Check Writing. In addition to telephone and written redemption requests, the
Short Fund offers redemption through check writing. Shareholders electing this
option will receive checks that may be used like personal or business
checks. Checks are not ordered to be mailed to the shareholder until 15 days
after the account is opened, if the account is opened by check by the
shareholder. This allows the Fund to verify that the check used to open the
account will not be returned due to insufficient funds. There is no limit on
the number of checks you may write. Checks must be written for at least
$100. There is a $30 fee for returned checks. Because dividends declared on
shares held in a shareholder's account, prior redemptions, and possible changes
in net asset value may cause the value of the account to change, shareholders
should not write a check for the entire value of the account or close the
account by writing a check.
In using the check writing privilege, shareholders bear the responsibility of
ensuring that the check amount does not exceed the value of their account on
the day the check is presented to the Transfer Agent for
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payment. The day the check is presented for payment is the day the redemption
of Fund shares takes place. If insufficient shares are in the account, the
check will be returned and no shares will be redeemed. The clearing agent for
the check writing facility is United Missouri Bank. Shareholders utilizing
check writing are subject to United Missouri Bank's rules governing checking
accounts. However, this check writing facility is purely a means to redeem Fund
shares. No facilities characteristic of bank accounts, such as deposit
insurance, are provided along with the check writing option. Cancelled checks
will not be returned to the shareholder. If you need to request a copy of a
cancelled check, please contact Shareholder Services for procedures and
applicable fees.
If you would like to initiate check writing, please call Shareholder Services
at 1-800-221-3137 or check the appropriate box on the Purchase Application.
Systematic Withdrawal Plan. A shareholder may establish a Systematic Withdrawal
Plan to receive regular periodic payments from the account. An initial balance
of $10,000 is required to establish a Systematic Withdrawal Plan. There are no
service charges for establishing or maintaining a Systematic Withdrawal
Plan. The minimum amount which the shareholder may withdraw periodically is
$100. Capital gain distributions and income dividends to the shareholder's
account are received in additional shares at net asset value. Payments are
then made from the liquidation of shares at net asset value to meet the
specified withdrawals. Liquidation of shares may reduce or possibly exhaust
the shares in the shareholder's account, to the extent withdrawals exceed
shares earned through dividends and distributions, particularly in the event of
a market decline. No payment pursuant to a Systematic Withdrawal Plan will be
made if there are insufficient shares on deposit on the date of the scheduled
distribution. A subsequent deposit of shares will not result in a payment under
the plan retroactive to the distribution date. As with other redemptions, a
liquidation to make a withdrawal payment is a sale for federal income tax
purposes. The entire Systematic Withdrawal Plan payment cannot be considered as
actual yield or income since part of the Plan's payment may be a return of
capital.
A Systematic Withdrawal Plan may be terminated upon written notice by the
shareholder, or by a Fund on a 30 day written notice, and it will terminate
automatically if all shares are liquidated or withdrawn from the account or
upon the Fund's receipt of notification of the death or incapacity of the
shareholder. Shareholders may change the amount (but not below the specified
minimums) and schedule of withdrawal payments, or suspend such payments, by
giving written notice to the Transfer Agent at least five business days prior
to the next scheduled payment. Share certificates may not be issued while a
Systematic Withdrawal Plan is in effect.
DIVIDENDS AND DISTRIBUTIONS
The Short and Intermediate Funds intend to make monthly distributions to their
shareholders of net investment income. The Equity Market Plus Fund intends to
make quarterly distributions of net investment income. All Funds will
distribute net realized gains at least annually. The Financial Services Fund
will most likely make only this annual distribution of net realized gains, and
at this time, will also distribute any net investment income. Each Fund may
make additional distributions if necessary to avoid imposition of a 4% excise
tax or other tax on undistributed income and gains.
The monthly distributions for the Short Fund's shares are quoted ex-dividend on
the business day after record date (the "ex-date"). Record date is usually the
first or second business day of the month. If a shareholder elects to reinvest
dividends, the date the dividends are reinvested is also the ex-date. Dividends
are paid in cash by the Short Fund generally one week after the ex-date.
The Intermediate Fund will declare daily dividends for shareholders of
record. The Intermediate Fund's dividend payable date, and the day that
dividends are reinvested for shareholders who have made this election, is the
last business day of the month. Shares begin accruing dividends on the business
day after federal funds (funds credited to a member bank's account at the
Federal Reserve Bank) are available from the purchase payment for such shares,
and continue to accrue dividends through and including the day the redemption
order for the shares is executed. If an investor closes his account, any
accrued dividends through and including the day of redemption will be paid as
part of the redemption proceeds.
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Dividends and capital gains distributions may be declared more or less
frequently at the direction of the Trustees. In order to be entitled to a
dividend or a distribution, an investor must acquire a Fund's shares on or
before the record date. Caution should be exercised, however, before purchasing
shares immediately prior to a distribution record date. Since the value of a
Fund's shares is based directly on the amount of its net assets, rather than on
the principle of supply and demand, any distribution of income or capital gain
will result in a decrease in the value of its shares equal to the amount of the
distribution. While a dividend or capital gain distribution received shortly
after purchasing shares represents, in effect, a return of the shareholder's
investment, it may be taxable as dividend income or capital gain. You may
separately elect to reinvest income dividends and capital gains distributions
in shares of a Fund or receive cash as designated on the Purchase
Application. You may change your election at any time by sending written
notification to your Fund. The election is effective for distributions with a
dividend record date on or after the date that the Funds receive notice of the
election. If you do not specify an election, all income dividends and capital
gains distributions will automatically be reinvested in full and fractional
shares of the Fund from which they were paid. Shareholders may also elect to
have dividends automatically reinvested in a fund different than the one from
which the dividends were paid. A shareholder may write the transfer agent, or
complete the appropriate section of the Purchase Application, to designate such
an election, but must have already established an account in the other
fund. The transfer agent's address is on the back of the Prospectus. Reinvested
dividends and distributions receive the same tax treatment as those paid in
cash.
SHAREHOLDER REPORTS AND INFORMATION
The Funds will provide the following statements and reports:
Confirmation and Account Statements. After each transaction that affects the
account balance or account registration, including the payment of dividends,
you will receive a confirmation statement.
Form 1099. By January 31 of each year, all shareholders will receive Form 1099,
which will report the amount and tax status of distributions paid to you by the
Funds for the preceding calendar year.
Financial Reports. Financial reports are provided to shareholders
semiannually. Annual reports will include audited financial statements. To
reduce the Funds' expenses, one copy of each report will be mailed to each
Taxpayer Identification Number even though the investor may have more than one
account in a Fund.
Reports to Depository Institutions. Shareholders of the Short or Intermediate
Funds who are financial institutions may request receipt of monthly or
quarterly reports which provide information about the Short or Intermediate
Fund's investments considering regulatory risk-based asset categories.
If you need additional copies of previous statements, you may order statements
for the current and preceding year at no charge. Call 1-800-221-3137 to order
past statements. If you need information on your account with the Funds or if
you wish to submit any applications, redemption requests, inquiries or
notifications, please contact: Smith Breeden Mutual Funds, 3200 Horizon Drive,
P.O. Box 61503, King of Prussia, PA 19406-0903 or call 1-800-221-3137.
RETIREMENT PLANS
The Funds have a program under which you may establish an Individual Retirement
Account ("IRA") with the Funds and purchase shares through such
account. Shareholders wishing to establish an IRA should consult their tax
adviser regarding (1) their individual qualifying status and (2) the tax
regulations governing these accounts. The minimum initial investment in each
Fund for an IRA is $250. There is a $12 annual maintenance fee charged to
process an account. This fee is waived for accounts greater than $10,000. You
may obtain additional information regarding establishing such an account by
calling the Funds at 1-800-221-3138.
The Funds may be used as investment vehicles for established defined
contribution plans, including simplified employee, 401(k), 403(b),
profit-sharing, money purchase, and simple pension plans ("Retirement
Plans"). For details concerning Retirement Plans, please call 1-800-221-3138.
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SERVICE AND DISTRIBUTION PLANS
Each Fund has adopted a Distribution and Services Plan (the "Plans"). The
purpose of the Plans 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 Funds,
reducing redemptions, or otherwise maintaining or improving services provided
to shareholders by such dealers or other persons. The Plans provide for
payments by the Adviser out of its advisory fee to dealers and other persons at
an annual rate of up to 0.25% of a Fund's average net assets, subject to the
authority of the Trustees 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 Adviser shall determine the amount of such payments and
the purposes for which they are made.
Any distribution and service related payments made by the Adviser to investment
dealers or other persons are subject to the continuation of the Plans, the
terms of any related service agreements, and any applicable limits imposed by
the National Association of Securities Dealers, Inc.
TAXES
Each Fund intends to qualify as a regulated investment company under the
Internal Revenue Code. In each taxable year that a Fund so qualifies, such Fund
(but not its shareholders) will be relieved of federal income tax on the part
of its net investment income and net capital gain that is distributed to
shareholders. Each Fund will distribute at least annually substantially all of
the sum of its taxable net investment income, its net tax-exempt income and the
excess, if any, of net short-term capital gains over the net long-term capital
losses for such year.
All Fund distributions from net investment income (whether paid in cash or
reinvested in additional shares) will be taxable to its shareholders as
ordinary income, except that any distributions of a Fund's net long-term
capital gain will be taxable to its shareholders as long-term capital gain,
regardless of how long they have held their Fund shares. Pursuant to the
Taxpayer Relief Act of 1997, long-term capital gains are taxed at a maximum of
28% or 20%, depending on the Fund's holding period in the portfolio
investments. Each Fund provides federal tax information to its shareholders
annually about distributions paid during the preceding year.
It is not anticipated that any of the Funds' distributions will qualify for
either the corporate dividends-received deduction or tax-exempt interest
income. Distributions will also probably be subject to state and local taxes,
depending on each shareholder's tax situation. While many states grant tax-free
status to mutual fund distributions paid from interest income earned from
direct obligations of the U.S. Government, none of the Short or Intermediate
Fund's distributions are expected to qualify for such tax-free treatment, and
only an insignificant amount of the Equity Market Plus Fund's distributions are
expected to so qualify.
The Funds will be required to withhold federal income tax at a rate of 31%
("backup withholding") from distribution payments and redemption and exchange
proceeds if you fail to properly complete the Purchase Application.
The foregoing is only a summary of some of the important federal tax
considerations generally affecting each Fund and its shareholders. See "Taxes"
in the relevant Statement of Additional Information for further
discussion. There may be other federal, state or local tax considerations
applicable to you as an investor. You therefore are urged to consult your tax
adviser regarding any tax-related issues.
CAPITAL STRUCTURE
The Smith Breeden Trust and the Smith Breeden Series Fund are both
Massachusetts business trusts. The Trust was organized under an Agreement and
Declaration of Trust, dated December 18, 1991. The Series Fund was organized
under an Agreement and Declaration of Trust dated October 3, 1991. Copies of
both Agreements, which are governed by Massachusetts law, are on file with the
Secretary of State of the Commonwealth of Massachusetts. The Trust and the
Series Fund have the same Trustees.
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The Trustees have the authority to issue shares in an unlimited number of funds
of either the Series Fund or Trust. Each such fund's shares may be further
divided into classes. The assets and liabilities of each such fund will be
separate and distinct. All shares when issued are fully paid, non-assessable
and redeemable, and have equal voting, dividend and liquidation rights.
Shareholders of the separate funds of the Series Fund or Trust will vote
together in electing trustees and in certain other matters. Shareholders in
each fund of the Series Fund should be aware that the outcome of the election
of trustees and of certain other matters could be controlled by the
shareholders of another fund. The shares have non-cumulative voting rights,
which means that holders of more than 50% of the shares voting for the election
of the trustees can elect 100% of the trustees if they choose to do so.
Although neither the Series Fund nor the Trust is required to hold annual
meetings of its shareholders, shareholders have the right to call a meeting to
elect or remove trustees, or to take other actions as provided in the
respective Declaration of Trust. Upon written request by the holders of at
least 1% of the outstanding shares stating that such shareholders wish to
communicate with the other shareholders for the purpose of obtaining the
signatures necessary to demand a meeting to consider the removal of a trustee,
both the Series Fund and Trust have undertaken to provide a list of
shareholders or to disseminate appropriate materials (at the expense of the
requesting shareholders).
Under Massachusetts law, shareholders of a business trust may, under certain
circumstances, be held personally liable as partners for its
obligations. However, the risk of a shareholder incurring financial loss on
account of shareholder liability is limited to circumstances in which both (i)
any liability was greater than a Fund's insurance coverage and (ii) a Fund
itself was unable to meet its obligations.
TRANSFER AND DIVIDEND DISBURSING AGENT, CUSTODIAN AND
INDEPENDENT ACCOUNTANTS
First Data Investor Services Group, Inc. (the "Transfer Agent"), 3200 Horizon
Drive, P.O. Box 61503, King of Prussia, PA 19406, a wholly owned subsidiary of
First Data Corporation, which has its principal place of business at 4400
Computer Drive, Westboro, MA, 01581, acts as each Fund's Transfer and Dividend
Disbursing Agent. See "Management of the Funds." The Bank of New York acts as
the custodian of each Fund's assets. The Bank of New York's address is 48 Wall
Street, New York, New York 10286. Neither the Transfer and Dividend Disbursing
Agent nor the Custodian has any part in deciding the Funds' investment policies
or which securities are to be purchased or sold for the Funds'
portfolios. Deloitte & Touche, LLP, has been selected to serve as independent
auditors of the Company.
FUND PERFORMANCE
Each Fund may quote the Fund's average annual total and/or aggregate total
return for various time periods in advertisements or communications to
shareholders. An average annual total return refers to the rate of return
which, if applied to an initial investment at the beginning of a stated period
and compounded over that period, would result in the redeemable value of the
investment at the end of the period assuming reinvestment of all dividends and
distributions and reflecting the effect of all recurring fees. An investor's
principal in each Fund and the Fund's return are not guaranteed and will
fluctuate according to market conditions. When considering "average" total
return figures for periods longer than one year, you should note that a Fund's
annual total return for any one year in the period might have been greater or
less than the average for the entire period. Each Fund also may use "aggregate"
total return figures for various periods, representing the cumulative change in
value of an investment in the Fund for a specific period (again reflecting
changes in the Fund's share price and assuming reinvestment of dividends and
distributions).
The Short and Intermediate Funds may also advertise current yield and
distribution rate information. Current yield reflects the income per share
earned by the Short or Intermediate Fund's portfolio investments, and is
calculated by dividing a Fund's net investment income per share during a recent
30-day period by a Fund's net asset value on the last day of that period and
annualizing the result. The current yield (or "SEC Yield"), which is calculated
according to a formula prescribed by the SEC (see the relevant Statement of
Additional Information), is not indicative of the dividends or distributions
which were or will be paid to a
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Fund's shareholders. SEC regulations require that net investment income be
calculated on a "yield-to-maturity" basis, which has the effect of amortizing
any premiums or discounts in the current market value of fixed income
securities. Dividends or distributions paid to shareholders are reflected in
the current distribution rate which may be quoted to shareholders, and may not
reflect amortization in the same manner.
A Fund may also compare its performance to that of other mutual funds and to
stock and other relevant indices, or to rankings prepared by independent
services or industry publications. For example, a Fund's total return may be
compared to data prepared by Lipper Analytical Services, Inc., Morningstar,
Inc., Value Line Mutual Fund Survey and CDA Investment Technologies, Inc. Total
return data as reported in such national financial publications as The Wall
Street Journal, The New York Times, Investor's Business Daily, USA Today,
Barron's, Money and Forbes, as well as in publications of a local or regional
nature, may be used in comparing Fund performance.
The Equity Market Plus Fund's total return may also be compared to the return
of the Standard & Poor's 500 Composite Stock Price Index. For purposes of
showing the returns of large company stocks versus small company stocks, or to
compare returns versus inflation, the Equity Market Plus Fund's total return
may also be compared to the total return of the Nasdaq Composite OTC Index,
Nasdaq Industrials Index, Russell 2000 Index, or the Consumer Price Index. The
Short Fund's total return may also be compared to that of taxable money funds
as quoted in Donaghue's Money Fund Report and other suppliers, and to total
returns for the six month U.S. Treasury as published by Merrill Lynch or
others. The Intermediate Fund's return will most likely be compared to the
total return of the Salomon Brothers Mortgage Index, or the total return of
intermediate U.S. Treasury Notes as published by various brokerage firms and
others. The Financial Services Fund's return may be compared to the S&P 500
Index return, an investment of 80% in the S&P Financial Composite Index and 20%
in money market funds, the Keefe, Bruyette & Woods Index, or the average of the
mutual funds in the Morningstar Specialty Financial Category. Further
information on performance measurement may be found in the relevant Statement
of Additional Information.
Performance quotations of a Fund represent the Fund's past performance and
should not be considered representative of future results. The investment
return and principal value of an investment in a Fund will fluctuate so that an
investor's shares, when redeemed, may be worth more or less than their original
cost. The methods used to compute a Fund's total return and yield are described
in more detail in the relevant Statement of Additional Information.
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Shareholder Services
Account Inquiries, Balance
and Transaction Information
1-800-221-3137
Dealer Services
Current Prospectuses, Sales Literature
Yields, Prices, Fund Information
1-800-221-3138
Distributed by:
FPS Broker Services, Inc.
3200 Horizon Drive
P.0. Box 61503
King of Prussia, PA 19406-0903
(LOGO)
SMITH BREEDEN
----------------
MUTUAL FUNDS
100 Europa Drive, Suite 200
Chapel Hill, NC 27514-2310
(919) 967-7221
