<PAGE>
<TABLE>
<S><C>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
===================================================================================================================================
</TABLE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
PERFORMANCE REVIEW
The Smith Breeden Short Duration U.S. Government Fund provided a total
return of 6.24% in the year ended March 31, 1998. The Fund's return exceeded
its benchmark, the six-month U.S. Treasury Bill, by 0.57% for the year. The
Fund's return versus money-market funds was even more compelling, with the
average money-market fund yielding 5.03%1 in the year. This was accomplished
steadily over the year, with the Fund's return exceeding the benchmark return
in each calendar quarter. Since the Fund's inception in June 1992, it has
provided an annualized return 0.71% in excess of the six-month U.S. Treasury
Bill. The graph below plots the Fund's return versus both its benchmark and the
average return of Morningstar's Ultra-Short Bond Fund category.
(graph appears here with the following plot points)
CHANGE IN VALUE OF A $10,000 INVESTMENT
Average Annual Returns (%)-Period Ended March 31, 1998(1)
Since
Inception
1 yr. 5 yr. 3/31/92
----- ----- -------
Smith Breeden Short Duration U.S. Gov't. Fund 6.24 5.60 5.61
Morningstar Avg. Ultrashort Bond 5.98 5.05 5.04
6 Month U.S. T-Bill per Merrill Lynch 5.67 5.03 4.90
<TABLE>
<CAPTION>
Fund Name Jun-92 Sep-92 Dec-92 Mar-93 Jun-93 Sep-93 Dec-93 Mar-94 Jun-94
- --------- ------ ------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Cat: Ultrashort Bond 0.643 0.421 0.503 0.36 0.394 0.274 0.366 -0.222 0.254
1.81% 3.41% 3.95% 5.34% 6.43% 7.57% 8.49% 8.53% 8.96%
$10,181 $10,341 $10,395 $10,534 $10,643 $10,757 $10,849 $10,853 $10,896
Short Series 0.31% 0.43% 0.74% 0.45% 0.75% -0.01% 0.88% -0.90% -0.72%
1.99% 3.63% 4.97% 5.67% 7.32% 8.31% 9.49% 9.56% 10.32%
$10,199 $10,363 $10,497 $10,567 $10,732 $10,831 $10,949 $10,956 $11,032
6M UST 0.40% 0.45% 0.40% 0.30% 0.30% 0.28% 0.34% 0.24% 0.44%
1.29% 2.57% 3.30% 4.26% 5.03% 5.94% 6.81% 7.52% 8.46%
$10,129 $10,257 $10,330 $10,426 $10,503 $10,594 $10,681 $10,752 $10,846
Fund Name Sep-94 Dec-94 Mar-95 Jun-95 Sep-95 Dec-95 Mar-96 Jun-96 Sep-96
- --------- ------ ------ ------ ------ ------ ------ ------ ------ ------
Cat: Ultrashort Bond 0.135 0.351 0.493 0.421 0.195 0.573 0.3 0.53 0.624
9.99% 10.80% 12.94% 14.95% 16.28% 18.25% 19.52% 21.04% 22.87%
$10,999 $11,080 $11,294 $11,495 $11,628 $11,825 $11,952 $12,104 $12,287
Short Series 0.11% 0.91% 0.39% 0.24% 0.34% 0.54% 0.28% 0.48% 0.52%
12.22% 14.02% 16.76% 17.95% 19.67% 21.01% 22.54% 24.46% 26.52%
$11,222 $11,402 $11,676 $11,795 $11,967 $12,101 $12,254 $12,446 $12,652
6M UST 0.28% 0.43% 0.51% 0.53% 0.42% 0.56% 0.34% 0.43% 0.52%
9.66% 10.95% 12.90% 14.79% 16.42% 18.21% 19.63% 21.12% 22.81%
$10,966 $11,095 $11,290 $11,479 $11,642 $11,821 $11,963 $12,112 $12,281
Fund Name Sep-96 Dec-96 Mar-97 YTD 1YR 3YR 5YR
- --------- ------ ------ ------ --- --- --- ---
Cat: Ultrashort Bond 0.624 0.32 0.277
22.87% 24.80% 26.23% 1.15% 5.62% 5.17% 4.77%
$12,287 $12,480 $12,623
1.2623*10000
Short Series 0.52% 0.55% 0.24%
26.52% 28.61% 30.59%
$12,652 $12,861 $13,059
6M UST 0.52% 0.44% 0.39%
22.81% 24.49% 26.10%
$12,281 $12,449 $12,610
</TABLE>
Quarterly
Returns Morning. Short 6mo. T-Bill
------- -------- ----- -----------
3/31/92 $10,000 $10,000 $10,000
6/30/92 $10,160 $10,199 $10,130
9/30/92 $10,308 $10,363 $10,258
12/31/92 $10,378 $10,497 $10,331
3/31/93 $10,502 $10,567 $10,427
6/30/93 $10,608 $10,732 $10,503
9/30/93 $10,721 $10,831 $10,595
12/31/93 $10,807 $10,949 $10,681
3/31/94 $10,845 $10,956 $10,753
6/30/94 $10,895 $11,032 $10,847
9/30/94 $10,998 $11,222 $10,966
12/31/94 $11,082 $11,402 $11,096
3/31/95 $11,295 $11,676 $11,291
6/30/95 $11,496 $11,795 $11,480
9/30/95 $11,659 $11,967 $11,643
12/31/95 $11,857 $12,101 $11,822
3/31/96 $11,990 $12,254 $11,964
6/30/96 $12,146 $12,446 $12,112
9/30/96 $12,333 $12,652 $12,282
12/31/96 $12,527 $12,861 $12,450
3/31/97 $12,676 $13,059 $12,611
6/30/97 $12,896 $13,289 $12,801
9/30/97 $13,092 $13,490 $12,978
12/31/97 $13,258 $13,673 $13,144
3/31/98 $13,434 $13,874 $13,326
(1) Fund Returns are net of fees and sales charges. Index returns are market
returns without deduction of fees or rebalancing transaction costs.
Past performance is no guarantee of future results.
Interest rates declined in the year, with the five-year U.S. Treasury Note
yield dropping 1.12%, from 6.74% at March 31, 1997 to 5.62% at March 31, 1998.
At the short end of the yield curve, the yield on the six-month U.S. T-Bill
fell from 5.54% to 5.26%, or just 0.28%. This overall flattening in the yield
curve resulted from a combination of economic events. The Federal Government
budget deficit declined, which reduced the U.S. Treasury's need to issue new
debt. The resultant reduction in supply of U.S. Treasury securities helped
drive yields down. Financial turmoil in Asia made U.S. Treasury securities even
more popular as a financial safe-harbor, increasing demand for U.S. Treasury
debt while supply was falling. Meanwhile, the Federal Reserve continued to be
watchful for signs of inflation amid strong economic growth and unemployment at
thirty-year lows, and they maintained their short-term rate at 5.50%. This
placed a floor under short-term rates, preventing a significant decline in
yields on Treasury Bills, and the result was a flatter yield curve.
- ---------
1. Average money-market fund yield from The Wall Street Journal.
2
<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
Part of the Fund's return over the return on the six-month U.S. Treasury
Bill was due to the favorable performance of mortgage-backed securities when
compared with U.S. Treasury securities. Expectations of future interest rate
volatility declined in tandem with the fall in interest rates. Mortgage-backed
securities perform best in steady interest rate environments, and so investors
are willing to pay comparatively more for mortgages when they expect stable
interest rates. The decline in expected interest rate volatility occurred
despite some unsettled periods during the year, especially at the height of the
recent Asian crisis. As long-term interest rates fell below 6.0% at the end of
the third quarter of 1997, many mortgage investors braced for an expected surge
in prepayments, and longer-duration mortgages underperformed comparable U.S.
Treasury securities. The benign effect of declining volatility was enough,
however, to outweigh the effect of faster prepayments for the mortgage sector
as a whole.
The Fund aims to add value by investing selectively in favorably valued
sectors of the mortgage market. During the year, the Fund reduced its overall
level of investment in mortgages and increased its cash holdings as interest
rates declined and the likelihood of a prepayment surge increased. The Fund
also reduced holdings in longer-term and higher-coupon fixed-rate mortgages in
the latter part of 1997, to reduce prepayment risk in the fund. The first
quarter of 1998 saw the expected surge in prepayments, and the Fund was
successful in outperforming the six-month U.S. Treasury Bill even in this
difficult period.
3
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
SCHEDULE OF INVESTMENTS MARCH 31, 1998
Market
Face Amount Security Value
----------- -------- ----------
U.S. GOVERNMENT & AGENCY OBLIGATIONS -- 132.69%
FREDDIE MAC -- 32.91% (1)
FH Gold
$7,900,000 6.00%, due 4/1/13...................................................................... $7,785,511
10,000,000 6.50%, due 4/1/13...................................................................... 10,036,719
7,650,530 8.50%, due 5/1/25 to 12/1/25........................................................... 7,984,036
---------
25,806,266
----------
FANNIE MAE -- 32.82% (1)
FN Interest only (2)
1,324,877 9.00%, due 7/25/21..................................................................... 351,642
FN
20,199,991 6.50%, due 1/1/28 to 2/1/28............................................................ 19,978,824
4,000,000 6.50%, due date to be announced........................................................ 3,955,406
1,395,490 7.04%, due 12/1/06..................................................................... 1,457,381
---------
25,743,253
----------
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION -- 66.45% (1)
GNMA ARM
26,245,770 5.00%, due 7/20/27 to 3/20/28.......................................................... 26,221,553
19,633,725 5.50%, due 8/20/27 to 11/20/27 (5)..................................................... 19,804,312
3,591,256 7.00%, due 7/20/17 to 9/20/22.......................................................... 3,691,293
1,268,641 7.375%, due 5/20/22 to 4/20/24......................................................... 1,301,807
GNMA
1,017,522 9.50%, due 7/15/09 to 9/15/21.......................................................... 1,098,553
---------
52,117,518
----------
U.S. TREASURY BILLS -- 0.51%
400,000 5.51% due 5/28/98 (3).................................................................. 396,802
-------
396,802
-------
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(COST $103,210,947).................................................................... 104,063,839
-----------
NOTIONAL
AMOUNT THREE-MONTH LIBOR INTEREST RATE SWAP CONTRACTS -- (0.97)%
$20,000,000 Contract dated 6/22/93 with Prudential Global Funding, Expires 6/22/98,
pay rate 5.458%........................................................................ 17,095
20,000,000 Contract dated 8/31/93 with Salomon Swapco, Expires 8/30/00,
pay rate 5.34%......................................................................... 259,820
20,000,000 Contract dated 5/15/95 with Salomon Swapco, Expires 5/15/05,
pay rate 6.951%........................................................................ (1,038,677)
-----------
TOTAL THREE-MONTH LIBOR INTEREST RATE SWAP CONTRACTS................................... (761,762)
---------
THREE-MONTH LIBOR INTEREST RATE CAP CONTRACTS -- 0.34%
50,000,000 CONTRACT WITH SALOMON SWAPCO, EXPIRES 4/23/03, STRIKE RATE 7.50%....................... 269,500
-------
TOTAL THREE-MONTH LIBOR INTEREST RATE CAP CONTRACTS (COST $1,509,907).................. 269,500
-------
CONTRACTS OPTION CONTRACTS -- 0.07%
80 Call on 5 Year US Treasury Note Futures, expires 5/98, strike price $111............... $2,500
40 Call on 30 Year US Treasury Bond Futures, expires 5/98, strike price $126.............. 5,000
80 Put on 5 Year US Treasury Note Futures, expires 5/98, strike price $108................ 18,750
40 Put on 30 Year US Treasury Bond Futures, expires 5/98, strike price $118............... 25,000
------
TOTAL OPTION CONTRACTS (Cost $78,112).................................................. 51,250
------
TOTAL INVESTMENTS -- 132.13% (Cost $104,798,966)....................................... 103,622,827
-----------
4
</TABLE>
<PAGE>
<TABLE>
<S> <C>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
==================================================================================================================================
SCHEDULE OF INVESTMENTS (CONTINUED) MARCH 31, 1998
MARKET
FACE AMOUNT SECURITY VALUE
----------- --------- ------
REVERSE REPURCHASE AGREEMENTS -- (5.10%)
$(4,000,000) Morgan Stanley 5.74% due 4/7/98 dated 3/31/98 (4)............................. (4,000,000)
-----------
(4,000,000)
-----------
SHORT SALES -- (25.22%)
(20,000,000) FN 6.50% due date to be announced (5)......................................... (19,777,031)
------------
(19,777,031)
------------
Other Liabilities, Less Cash and Other Assets -- (1.81%) (1,417,941)
-----------
NET ASSETS -- 100.00%......................................................... $78,427,855
===========
- --------------
(1) Mortgage-backed obligations are subject to principal paydowns as a result
of prepayments or refinancings of the underlying mortgage instruments. As a
result, the average life may be substantially less than the original
maturity. ARMs have coupon rates that adjust periodically. The interest
rate shown is the rate in effect at March 31, 1998. The adjusted rate is
determined by adding a spread to a specified index.
(2) Represents an interest only stripped mortgage-backed security.
(3) Security is held as collateral by Carr Futures, Inc. The interest rate
shown is the discount rate paid at time of purchase.
(4) Reverse repurchase agreement is collateralized by $4,166,424 face of GNMA
ARM 5.50% due 8/20/27.
(5) Short sale represents the sale "against the box" of $20,000,000 FN 6.50%
securities owned by the Fund.
Portfolio Abbreviations:
ARM -- Adjustable-Rate Mortgage
FH -- Freddie Mac
FN -- Fannie Mae
GNMA -- Government National Mortgage Association
===================================================================================================================================
The accompanying notes are an integral part of these financial statements.
</TABLE>
5
<PAGE>
<TABLE>
<S> <C>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
==================================================================================================================================
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 1998
Assets
Investments at market value (identified cost $104,798,966) (Note 1).................................. $103,622,827
Cash................................................................................................. 7,459
Restricted cash held to cover checkwriting privileges................................................ 28,000
Receivables:
Variation margin on futures contracts (Note 2)..................................................... 43,765
Subscriptions...................................................................................... 155,740
Interest........................................................................................... 487,618
Securities sold.................................................................................... 40,676,438
Other assets......................................................................................... 11,649
-----------
Total Assets....................................................................................... 145,033,496
-----------
Liabilities
Reverse repurchase agreement (proceeds $4,000,000) (Note 1).......................................... 4,000,000
Short sales at market value (proceeds $19,806,250)................................................... 19,777,031
Payables:
Redemptions........................................................................................ 25,915
Securities purchased............................................................................... 42,629,141
Swap Interest (Note 2)............................................................................. 33,441
Due to Advisor (Note 3)............................................................................ 48,169
Accrued expenses..................................................................................... 91,944
----------
Total Liabilities.................................................................................. 66,605,641
----------
Net Assets
(Applicable to outstanding shares of 7,904,459 unlimited number of shares of beneficial
interest authorized; no stated par)............................................................... $78,427,855
===========
Net asset value, offering price and redemption price per share ($78,427,855 / 7,904,459). $9.92
==========
Source of Net Assets
Paid in capital..................................................................................... $82,964,182
Overdistributed net investment income............................................................... (631,273)
Accumulated net realized loss on investments........................................................ (2,702,907)
Net unrealized depreciation of investments, interest rate swaps, interest rate caps,
short
sales and futures contracts....................................................................... (1,202,147)
------------
Net Assets........................................................................................ $78,427,855
===========
=================================================================================================================================
The accompanying notes are an integral part of these financial statements.
</TABLE>
6
<PAGE>
<TABLE>
<S> <C>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
==================================================================================================================================
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1998
Investment Income
Interest and discount earned, net of premium amortization and interest expense (Note 1) .............. $6,296,431
Expenses
Advisory fees (Note 3)................................................................................ 727,735
Accounting and pricing services fees.................................................................. 59,134
Custodian fees........................................................................................ 37,145
Audit and tax preparation fees........................................................................ 33,860
Legal fees............................................................................................ 27,305
Transfer agent fees................................................................................... 33,609
Registration fees..................................................................................... 24,489
Trustees fees and expenses............................................................................ 66,931
Insurance............................................................................................. 21,599
Other................................................................................................. 10,482
----------
Total Expenses Before Reimbursement................................................................. 1,042,289
Expenses reimbursed by Advisor (Note 3)............................................................. (231,365)
----------
Net Expenses........................................................................................ 810,924
----------
Net Investment Income............................................................................... 5,485,507
----------
Realized and Unrealized Gain (Loss) on Investments
Net realized gain on investments...................................................................... 2,886,352
Change in unrealized appreciation (depreciation) of investments, interest rate swaps,
interest
rate caps, and futures contracts.................................................................... (2,022,049)
-----------
Net realized and unrealized gain on investments....................................................... 864,303
-----------
Net increase in net assets resulting from operations.................................................. $6,349,810
==========
===================================================================================================================================
The accompanying notes are an integral part of these financial statements.
</TABLE>
7
<PAGE>
<TABLE>
<S> <C>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
===================================================================================================================================
STATEMENTS OF CHANGES IN NET ASSETS
YEAR ENDED YEAR ENDED
MARCH 31, 1998 MARCH 31, 1997
-------------- ---------------
Operations
Net investment income........................................................... $5,485,507 $10,225,930
Net realized gain on investments................................................ 2,886,352 846,686
Change in unrealized appreciation (depreciation) of investments,
interest rate swaps, interest rate caps and futures contracts................. (2,022,049) 1,887,652
----------- ----------
Net increase in net assets resulting from operations............................ 6,349,810 12,960,268
----------- ----------
Distributions to Shareholders
Dividends from net investment income............................................ (5,439,867) (10,225,930)
Dividends in excess of net investment income.................................... -- (929,596)
---------- ---------
Total distributions............................................................. (5,439,867) (11,155,526)
----------- ------------
Capital Share Transactions
Shares sold..................................................................... 46,118,603 59,328,830
Shares issued on reinvestment of distributions.................................. 2,600,980 2,816,807
Shares redeemed................................................................. (90,190,280) (166,786,906)
------------ -------------
Decrease in net assets resulting from capital share transactions (a)............ (41,470,697) (104,641,269)
------------ -------------
Total Decrease in Net Assets.................................................. (40,560,754) (102,836,527)
Net Asset
Beginning of period............................................................. 118,988,609 221,825,136
----------- -----------
End of period................................................................... $78,427,855 $118,988,609
=========== ============
(a) Transactions in capital shares were as follows:
Shares sold................................................................... 4,669,660 6,065,723
Shares issued on reinvestment of distributions................................ 264,390 289,222
Shares redeemed............................................................... (9,136,010) (17,017,982)
----------- ------------
Net decrease.................................................................. (4,201,960) (10,663,037)
Beginning balance............................................................. 12,106,419 22,769,456
----------- ----------
Ending balance................................................................ 7,904,459 12,106,419
=========== ==========
===================================================================================================================================
The accompanying notes are an integral part of these financial statements.
</TABLE>
8
<PAGE>
<TABLE>
<S> <C>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
==================================================================================================================================
FINANCIAL HIGHLIGHTS
The following average per share data, ratios and supplemental information have
been derived from information provided in the financial statements.
Year Year
Ended Ended
March 31, March 31,
1998 1997
-------- ----------
Net Asset Value,
Beginning of Period.................. $ 9.83 $ 9.74
--------- ----------
INCOME FROM INVESTMENT
OPERATIONS
Net investment income................ 0.484 0.476
Net realized and
unrealized gain (loss)
on investments..................... 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
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 (2)............. 0.78% 0.78%
Ratio of net investment
income to average net
assets............................. 5.28% 5.04%
Portfolio turnover rate.............. 626% 556%
Ratio of expenses to
average net assets
before reimbursement
of expenses by the
Advisor (2) 1.00% 0.93%
Ratio of net investment
income to average net
assets before
reimbursement of
expenses by the
Advisor 5.06% 4.90%
<CAPTION>
<S> <C>
For the Period
Year Year Year March 31,
Ended Ended Ended 1992 (1)
March 31, March 31, March 31, to March 31,
1996 1995 1994 1993
---------- --------- --------- -------------
Net Asset Value,
Beginning of Period.................. $ 9.90 $ 9.90 $ 10.00 $ 10.00
---------- ----------- ----------- -----------
INCOME FROM INVESTMENT
OPERATIONS
Net investment income................ 0.621 0.628 0.432 0.552
Net realized and
unrealized gain (loss)
on investments..................... (0.148) -- (0.070) 0.002
----------- ------------- ----------- -----------
Total from investment
operations........................ 0.473 0.628 0.362 0.554
----------- ------------- ----------- -----------
Less Distributions
Dividends from net
investment income.................. (0.621) (0.628) (0.462) (0.554)
Dividends in excess of
investment income.................. (0.012) -- -- --
------------ -------------- ------------ ------------
Total distributions................ (0.633) (0.628) (0.462) (0.554)
------------ ------------- ------------ ------------
Net Asset Value, End of
Period............................... $ 9.74 $ 9.90 $ 9.90 $ 10.00
------------ ------------- ------------ -------------
Total Return........................... 4.95% 6.58% 3.67% 5.67%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period............ $221,825,136 $218,431,665 $218,167,491 $48,531,206
Ratio of expenses to
average net assets (2)............. 0.78% 0.78% 0.78% 0.78%
Ratio of net investment
income to average net
assets............................. 6.29% 6.33% 4.17% 4.53%
Portfolio turnover rate.............. 225% 47% 112% 3%
Ratio of expenses to
average net assets
before reimbursement
of expenses by the
Advisor (2)........................ 0.93% 0.92% 1.00% 2.58%
Ratio of net investment
income to average net
assets before
reimbursement of
expenses by the
Advisor............................ 6.13% 6.18% 3.95% 2.73%
(1) Commencement of operations.
(2) Through March 31, 1995, expense ratios include both the direct expenses
of the Smith Breeden Short Duration U.S. Government Fund, and the indirect
expenses incurred through the Fund's investment in the Smith Breeden
Institutional Short Duration U.S. Government Fund.
==================================================================================================================================
The accompanying notes are an integral part of these financial statements.
</TABLE>
9
<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
===============================================================================
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Breeden Series Fund (the "Trust") is an open-end, diversified
management investment company registered under the Investment Company Act of
1940, as amended. The Fund offers shares in two series: the Smith Breeden Short
Duration U.S. Government Fund (the "Short Fund" or "Fund", formerly the Smith
Breeden Short Duration U.S. Government Series) and the Smith Breeden
Intermediate Duration U.S. Government Fund (formerly, the Smith Breeden
Intermediate Duration U.S. Government Series). The following is a summary of
accounting policies consistently followed by the Fund.
A. Security Valuation: Portfolio securities are valued at the current market
value provided by a pricing service, or by a bank or broker/dealer experienced
in such matters when over-the-counter market quotations are readily available.
Securities and other assets for which market prices are not readily available
are valued at fair market value as determined in accordance with procedures
approved by the Board of Trustees.
B. Repurchase Agreements: Repurchase agreements may be entered into with member
banks of the Federal Reserve System with total assets in excess of $500 million,
and securities dealers, provided that such banks or dealers meet the credit
guidelines of the Fund's Board of Trustees. In a repurchase agreement, the Fund
acquires securities from a third party, with the commitment that they will be
repurchased by the seller at a fixed price on an agreed upon date. The Fund's
custodian maintains control or custody of the securities collateralizing the
repurchase agreement until maturity. The value of the collateral is monitored
daily, and, if necessary, additional collateral is received to ensure that the
market value of the collateral remains sufficient to protect the Fund in the
event of the seller's default. However, in the event of default or bankruptcy of
the seller, the Fund's right to the collateral may be subject to legal
proceedings.
C. Reverse Repurchase Agreements: A reverse repurchase agreement involves the
sale of portfolio assets together with an agreement to repurchase the same
assets later at a fixed price. Additional assets are maintained in a segregated
account with the custodian, and are marked to market daily. The segregated
assets may consist of cash, U.S. Government securities, or other liquid
high-grade debt obligations equal in value to the obligations under the reverse
repurchase agreements. In the event the buyer of securities under a reverse
repurchase agreement files for bankruptcy or becomes insolvent, the Fund's use
of the proceeds under the agreement may be restricted pending a determination by
the other party, or its trustee or receiver, whether to enforce the obligation
to repurchase the securities.
D. Dollar Roll Agreements: A dollar roll is an agreement to sell securities for
delivery in the current month and to repurchase substantially similar (same type
and coupon) securities on a specified future date. During the roll period,
principal and interest paid on these securities are not received. The Fund is
compensated by the difference between the current sales price and the forward
price for the future purchase (often referred to as the "drop") as well as by
earnings on the cash proceeds of the initial sale.
E. Distributions and Taxes: Dividends to shareholders are recorded on the
ex-dividend date. The Fund intends to continue to qualify for and elect the
special tax treatment afforded regulated investment companies under Subchapter M
of the Internal Revenue Code, thereby relieving the Fund of Federal income
taxes. To so qualify, the Fund intends to distribute substantially all of its
net investment income and net realized capital gains, if any, less any available
capital loss carryforward. As of March 31, 1998, the Fund had a net capital loss
carryforward of $1,792,811, with $963,255 expiring on March 31, 2004, and
$829,556 expiring on March 31, 2005.
F. Securities Transactions, Investment Income and Expenses: Securities
transactions are recorded on the trade date. Interest income is accrued daily,
and includes net amortization from the purchase of fixed-income securities.
Discounts and premiums on securities purchased are amortized over the life of
the respective securities. Gains or losses on the sale of securities are
calculated for accounting and tax purposes on the identified cost basis.
Expenses are accrued daily. Common expenses incurred by the Trust are allocated
among the funds comprising the Trust based on the ratio of net assets of each
fund to the combined net assets of the Trust. Other expenses are charged to each
fund on a specific identification basis.
10
<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
===============================================================================
NOTES TO FINANCIAL STATEMENTS (continued)
1. SIGNIFICANT ACCOUNTING POLICIES -- Continued
G. Accounting Estimates: The preparation of financial statements in accordance
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the amounts of income
and expense during the reporting period. Actual results could differ from those
estimates.
2. FINANCIAL INSTRUMENTS
Derivative Financial Instruments Held or Issued for Purposes other than Trading:
Interest rate futures, swap, cap and option contracts are used for risk
management purposes in order to reduce fluctuations in the Fund's net asset
value relative to its targeted option-adjusted duration.
A. Futures Contracts: On entering into a futures contract, either cash or
securities in an amount equal to a certain percentage of the contract value
(initial margin) must be deposited with the futures broker. Subsequent payments
(variation margin) are made or received each day. The variation margin payments
equal the daily changes in the contract value and are recorded as unrealized
gains or losses. The Fund recognizes a realized gain or loss when the contract
is closed or expires equal to the difference between the value of the contract
at the time it was opened and the value at the time it was closed.
<TABLE>
<S> <C>
The Fund had the following open futures contracts as of March 31, 1998:
Number of Expiration Unrealized
Type Contracts Position Month Gain/(Loss)
- ---- --------- --------- --------- -------------
5 Year Treasury....................... 39 Long June, 1998 $(5,355)
10 Year Treasury...................... 86 Long June, 1998 (59,512)
3 Month Eurodollar.................... 95 Long June, 1998 (6,365)
3 Month Eurodollar.................... (60) Short March, 1999 (143,770)
3 Month Eurodollar.................... 50 Long September, 2001 159,775
---------
Total $(55,227)
=========
</TABLE>
Futures transactions involve costs and may result in losses. The effective use
of futures depends on the Fund's ability to close futures positions at times
when the Fund's Advisor deems it desirable to do so. The use of futures also
involves the risk of imperfect correlation among movements in the values of the
securities underlying the futures purchased and sold by the Fund, of the futures
contract itself, and of the securities which are the subject of a hedge.
The aggregate market value of investments pledged to cover margin requirements
for the open positions at March 31, 1998 was $396,802.
B. Interest Rate Swap Contracts: The Fund may enter into over-the-counter
transactions swapping interest rates. Interest rate swaps represent an agreement
between counterparties to exchange cash flows based on the difference between
two interest rates, applied to a notional principal amount for a specified
period. The most common type of interest rate swap involves the exchange of
fixed-rate cash flows for variable-rate cash flows. Interest rate swaps do not
involve the exchange of principal between the parties. The Fund's interest rate
swap contracts have been entered into on a net basis, i.e., the two payment
streams are netted out, with the Fund receiving or paying, as the case may be,
only the net amount of the two payments. As of March 31, 1998, the Fund had
three open interest rate swap contracts. In each of the contracts, the Fund has
agreed to pay a fixed rate and receive a floating rate. The floating rate on the
contracts resets quarterly and is the three month London Inter-Bank Offered Rate
("LIBOR"). The Fund will not enter into interest rate swap contracts unless the
unsecured commercial paper, unsecured senior debt or the claims-paying ability
of the counterparty is rated either AA or A-1 or better by Standard & Poor's
Corporation, or Aa or P-1 or better by Moody's Investors Service, Inc. (or is
otherwise
11
<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
================================================================================
NOTES TO FINANCIAL STATEMENTS (continued)
2. FINANCIAL INSTRUMENTS -- Continued acceptable to either agency) at the time
of entering into such a transaction. If the counterparty to the swap transaction
defaults, the Fund will be limited to contractual remedies pursuant to the
agreements governing the transaction. There is no assurance that interest rate
swap contract counterparties will be able to meet their obligations under the
swap contracts or that, in the event of default, the Fund will succeed in
pursuing contractual remedies. The Fund thus assumes the risk that it may be
delayed in, or prevented from, receiving payments owed to it under the swap
contracts. Should interest rates move unexpectedly, the Fund may not achieve the
anticipated benefits of the interest rate swaps, and may realize a loss. The
Fund records gains and losses under interest rate swap contracts as realized
gains or losses on investments.
The Fund's interest payable on the interest rate swap contracts as of March 31,
1998 was $33,441, and swap contract interest receivable was $6,410. No
collateral is required under these contracts.
The purchase of an interest rate cap entitles the purchaser, to the extent that
a specified index exceeds a predetermined interest rate, to receive payments of
interest on a notional principal amount from the party selling such interest
rate caps. The Fund had one interest rate cap contract open at March 31, 1998.
3. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES
Smith Breeden Associates, Inc. (the "Advisor"), a registered Investment Advisor,
provides the Fund with investment management services. As compensation for these
services, the Fund pays the Advisor a fee computed daily and payable monthly at
an annual rate equal to 0.70% of the Fund's average daily net assets.
The Advisor has voluntarily agreed to reimburse normal business expenses of the
Fund through August 1, 1998 so that total direct and indirect operating expenses
do not exceed 0.78% of its average net assets. This voluntary agreement may be
terminated or modified at any time by the Advisor in its sole discretion except
that the Advisor has agreed to limit expenses of the Fund to 0.78% through
August 1, 1998. For the year ended March 31, 1998, the Advisor received $727,735
in fees and reimbursed the Fund $231,365.
The Fund has adopted a Distribution and Services Plan (the "Plan") under Rule
12b-1 under the Investment Company Act of 1940. The purpose of the Plan is to
permit the Advisor 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 Fund, reducing redemptions, or otherwise
maintaining or improving services provided to shareholders by such dealers or
other persons. The Plan provides for payments by the Advisor, out of the
advisory fee to dealers and other persons at the annual rate of up to 0.25% of
the Fund's average net assets, subject to the authority of the Trustees of the
Fund, 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 Advisor shall determine the amount of such payments and the purposes for
which they are made.
Certain officers and trustees of the Fund are also officers and directors of the
Advisor.
4. INVESTMENT TRANSACTIONS
During the year ended March 31, 1998 purchases and proceeds from sales of
securities, other than short-term investments, aggregated $653,578,765 and
$688,170,564 respectively for the Fund. The cost of the Fund's securities for
federal income tax purposes at March 31, 1998, is $104,798,966. Net unrealized
depreciation of investments, short sales and futures contracts consists of:
Gross unrealized appreciation $1,838,234
Gross unrealized depreciation (3,040,381)
------------
Net unrealized depreciation $(1,202,147)
============
12
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders, Smith Breeden Short Duration U.S.
Government Fund of the Smith Breeden Series Fund:
We have audited the accompanying statements of assets and liabilities, including
the schedule of investments, of the Smith Breeden Short Duration U.S. Government
Fund (formerly "Smith Breeden Short Duration U.S. Government Series") of the
Smith Breeden Series Fund (the "Fund") as of March 31, 1998, and the related
statements of operations for the year then ended, the statements of changes in
net assets for each of the years in the two-year period then ended and the
financial highlights for each of the years in the five-year period presented.
These financial statements and the financial highlights are the responsibility
of the Fund's management. Our responsibility is to express an opinion on these
financial statements and the financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at March
31, 1998 by correspondence with the custodian and brokers, and where replies
were not received, we performed other auditing procedures. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights referred to
above present fairly, in all material respects, the financial positions of the
Smith Breeden Short Duration U.S. Government Fund of the Smith Breeden Series
Fund as of March 31, 1998, the results of its operations, the changes in its net
assets, and the financial highlights for the respective stated periods in
conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
May 15, 1998
13
<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
================================================================================
PERFORMANCE REVIEW
The Smith Breeden Intermediate Duration U.S. Government Fund provided a
total return of 10.65% in the year ending March 31, 1998. By comparison, the
return on the Fund's benchmark, the Salomon Smith Barney Mortgage Index, was
10.92%. The one-year return for the five-year U.S. Treasury Note, which is
comparable in interest rate risk to the Fund, was 10.52%. The return on the
average Government Mortgage mutual fund for the year was 10.15%, as measured by
Morningstar. Over five years, the Fund has returned 7.27%, versus the 5.80%
return on the average Government Mortgage Fund, and the 7.05% return on the
Salomon Smith Barney Mortgage Index. Since the Fund's inception, its return of
8.51% has exceeded that of its benchmark by 0.29% on an annualized basis. The
graph below plots the Fund's return versus its benchmark, which as noted in the
graph, changed effective January 1, 1994. The graph also shows the Fund's return
versus the average return of the Morningstar's Government Mortgage Fund
category.
(graph appears here with the following plot points)
CHANGE IN VALUE OF A $10,000 INVESTMENT
Average Annual Returns (%)-Period Ended March 31, 1998(1)
Since
Inception
1 yr. 5 yr. 3/31/92
----- ----- -------
Smith Breeden Intermediate Duration U.S. Gov't. Fund 10.65 7.27 8.51
Morningstar Avg. Gov't Bond Mortgage 10.15 5.80 6.70
5YR/SMBI (2) 10.92 7.05 8.22
<TABLE>
<CAPTION>
Fund Name Jun-92 Sep-92 Dec-92 Mar-93 Jun-93 Sep-93 Dec-93 Mar-94 Jun-94
- --------- ------ ------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Obj: Govt Bond--Mortgage 1.298 0.845 1.339 0.419 1.234 0.02 0.707 -2.511 -0.268
3.89% 7.41% 7.85% 11.29% 13.64% 15.12% 15.49% 12.44% 10.89%
$10,389 $10,741 $10,785 $11,129 $11,364 $11,512 $11,549 $11,244 $11,089
Intermediate Series 0.99% 1.16% 1.88% 0.43% 2.48% -0.02% 1.00% -2.79% -0.88%
4.80% 9.54% 10.21% 14.93% 19.10% 22.55% 22.43% 19.67% 18.92%
$10,480 $10,954 $11,021 $11,493 $11,910 $12,255 $12,243 $11,967 $11,892
5Yr/SBMI 1.89% 1.43% 1.24% 0.43% 1.85% 0.55% 0.25% -2.47% -0.25%
4.51% 10.37% 8.80% 14.28% 16.76% 19.88% 19.29% 16.78% 16.15%
$10,451 $11,037 $10,880 $11,428 $11,676 $11,988 $11,929 $11,678 $11,615
Fund Name Sep-94 Dec-94 Mar-95 Jun-95 Sep-95 Dec-95 Mar-96 Jun-96 Sep-96
- --------- ------ ------ ------ ------ ------ ------ ------ ------ ------
Obj: Govt Bond--Mortgage -1.317 0.781 0.459 0.6 0.912 1.235 -0.464 1.075 1.551
11.33% 11.42% 16.62% 22.52% 24.81% 29.16% 27.78% 28.19% 30.52%
$11,133 $11,142 $11,662 $12,252 $12,481 $12,916 $12,778 $12,819 $13,052
Intermediate Series -1.48% 0.61% 0.36% 0.27% 0.82% 1.19% -0.49% 1.30% 1.42%
19.82% 20.38% 26.95% 33.13% 36.10% 40.13% 39.25% 40.61% 43.30%
$11,982 $12,038 $12,695 $13,313 $13,610 $14,013 $13,925 $14,061 $14,330
5Yr/SBMI -1.34% 0.83% 0.41% 0.53% 0.89% 1.24% -0.34% 1.28% 1.68%
17.08% 17.59% 23.79% 30.20% 32.84% 37.31% 36.81% 37.74% 40.64%
$11,708 $11,759 $12,379 $13,020 $13,284 $13,731 $13,681 $13,774 $14,064
Fund Name Dec-96 Mar-97 YTD 1YR 3YR 5YR
- --------- ------ ------ --- --- --- ---
Obj: Govt Bond--Mortgage -0.659 -0.912
34.10% 33.89% -0.16% 4.78% 5.99% 6.01%
$13,410 $13,389
Intermediate Series -0.36% -0.84%
47.20% 47.48%
$14,720 $14,748
5Yr/SBMI -0.46% -0.83%
44.68% 44.86%
$14,468 $14,486
</TABLE>
Quarterly
Returns Morning. Intermed. SBMI-5yr
------- -------- --------- --------
3/31/92 $10,000 $10,000 $10,000
6/30/92 $10,389 $10,480 $10,455
9/30/92 $10,741 $10,954 $11,040
12/31/92 $10,785 $11,021 $10,884
3/31/93 $11,129 $11,493 $11,432
6/30/93 $11,361 $11,910 $11,680
9/30/93 $11,509 $12,255 $11,992
12/31/93 $11,546 $12,243 $11,933
3/31/94 $11,244 $11,967 $11,682
6/30/94 $11,092 $11,892 $11,619
9/30/94 $11,137 $11,982 $11,712
12/31/94 $11,145 $12,038 $11,763
3/31/95 $11,664 $12,695 $12,384
6/30/95 $12,253 $13,313 $13,025
9/30/95 $12,482 $13,610 $13,288
12/31/95 $12,916 $14,013 $13,736
3/31/96 $12,780 $13,925 $13,685
6/30/96 $12,823 $14,061 $13,779
9/30/96 $13,057 $14,330 $14,069
12/31/96 $13,415 $14,720 $14,473
3/31/97 $13,395 $14,748 $14,491
6/30/97 $13,848 $15,266 $15,019
9/30/97 $14,237 $15,682 $15,451
12/31/97 $14,556 $16,045 $15,813
3/31/98 $14,754 $16,320 $16,071
Interest rates declined in the year, with the five-year U.S. Treasury Note
yield dropping 1.12%, from 6.74% at March 31, 1997 to 5.62% at March 31, 1998.
At the short end of the yield curve, the yield on the six-month U.S. T-Bill fell
from 5.54% to 5.26%, or just 0.28%. This overall flattening in the yield curve
resulted from a combination of economic events. The Federal Government budget
deficit declined, which reduced the U.S. Treasury's need to issue new debt. The
resultant reduction in supply of U.S. Treasury securities helped drive yields
down. Financial turmoil in Asia made U.S. Treasury securities even more popular
as a financial safe-harbor, increasing demand for U.S. Treasury debt while
supply was falling. Meanwhile, the Federal Reserve continued to be watchful for
signs of inflation amid strong economic growth and unemployment at thirty-year
lows, and they maintained their short-term rate at 5.50%. This placed a floor
under short-term rates, preventing a significant decline in yields on Treasury
Bills, and the result was a flatter yield curve.
The Fund's return over the return on comparable-duration U.S. Treasury Notes
was due to three factors:
1) The higher yield offered by mortgage-backed securities as compared to
U.S. Treasury securities,
2) The decline in expectations of future interest rate volatility, and
3) How the fund was positioned within the mortgage sector.
14
<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
===============================================================================
Expectations of future interest rate volatility declined in tandem with the
fall in interest rates. Mortgage-backed securities perform best in steady
interest rate environments, and so investors are willing to pay comparatively
more for mortgages when they expect stable interest rates. The decline in
expected interest rate volatility occurred despite some unsettled periods during
the year, especially at the height of the recent Asian crisis. As long-term
interest rates fell below 6.0% at the end of the third quarter of 1997, many
mortgage investors braced for an expected surge in prepayments, and
longer-duration mortgages underperformed comparable U.S. Treasury securities.
The benign effect of declining volatility was enough, however, to outweigh the
effect of faster prepayments for the mortgage sector as a whole.
Given the decline in interest rates in the year, we adjusted the level of
prepayment risk to which the Fund was exposed. The weighting of fixed-rate
mortgages, which are more susceptible than adjustable-rate mortgages to poor
performance when prepayments are high, was reduced from 73% of net assets in
March 1997, to 57% of net assets in March 1998. We raised the level of
short-term cash investments in the fund by a comparable amount. The fund's
investment in adjustable-rate mortgages remained steady at about 30% of net
assets. Within the fixed-rate segment of the portfolio, we reduced the range of
coupons from 7.0%-9.5% to 6.0%-7.5%. Higher coupon fixed-rate mortgages see
faster prepayments when interest rates fall significantly as homeowners have the
opportunity to refinance their mortgages at lower rates.
15
<PAGE>
<TABLE>
<S> <C>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
===================================================================================================================================
SCHEDULE OF INVESTMENTS MARCH 31, 1998
Market
Face Amount Security Value
------------ -------- -----------------
U.S. GOVERNMENT & AGENCY OBLIGATIONS -- 119.62%
Freddie Mac -- 30.61% (1)
FH Gold
$2,000,000 6.00%, due date to be announced.................................................. $1,971,017
9,950,001 6.50%, due 2/1/28 to 3/1/28...................................................... 9,852,906
----------
11,823,923
----------
Fannie Mae -- 51.25% (1)
FN
13,129,998 6.50%, due 1/1/28 to 3/1/28...................................................... 12,986,239
739,097 6.98%, due 6/1/07................................................................ 769,228
2,540,268 7.00%, due 1/1/28 to 2/1/28...................................................... 2,566,380
3,400,000 7.50%, due date to be announced.................................................. 3,486,195
----------
19,808,042
----------
Government National Mortgage Association -- 37.55% (1)
GNMA
3,035,275 7.00%, due 3/15/26 to 1/15/28.................................................... 3,067,892
GNMA ARM
3,029,997 5.00%, due 2/20/28............................................................... 3,015,425
2,000,000 5.00%, due date to be announced.................................................. 1,989,688
2,986,617 5.50%, due 11/20/27.............................................................. 3,010,007
1,854,871 7.00%, due 3/20/16 to 8/20/18.................................................... 1,906,272
1,479,719 7.375%, due 6/20/16 to 4/20/22................................................... 1,520,438
----------
14,509,722
----------
U.S. Treasury Bills -- 0.21%
10,000 5.11%, due 8/20/98 (2)........................................................... 9,801
70,000 5.51%, due 5/28/98 (2)........................................................... 69,440
----------
79,241
----------
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS (Cost $46,188,181).................... 46,220,928
----------
TOTAL INVESTMENTS (Cost $46,188,181)--119.62%.................................... 46,220,928
----------
Short Sales -- (33.27%)
(13,000,000) FN 6.50%, due date to be announced (3)........................................... (12,855,070)
------------
(12,855,070)
Cash and Other Assets Less Liabilities -- 13.65%................................. 5,276,021
-----------
NET ASSETS -- 100.00%............................................................ $38,641,879
===========
(1) Mortgage-backed obligations are subject to principal paydowns as a result
of prepayments or refinancings of the underlying mortgage instruments. As a
result, the average life may be substantially less than the original
maturity. ARMs have coupon rates that adjust periodically. The interest
rate shown is the rate in effect at March 31, 1998. The adjusted rate is
determined by adding a spread to a specified index.
(2) Security is held as collateral by Carr Futures, Inc. The interest rate shown
is the discount rate paid at time of purchase.
(3) Short sale represents the sale "against the box" of $13,000,000 FN 6.50%
securities owned by the fund.
Portfolio Abbreviations:
ARM -- Adjustable-Rate Mortgage
FH -- Freddie Mac
FN -- Fannie Mae
GNMA -- Government National Mortgage Association
==================================================================================================================================
The accompanying notes are an integral part of these financial statements.
</TABLE>
16
<PAGE>
<TABLE>
<S> <C>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
==================================================================================================================================
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 1998
Assets
Investments at market value (identified cost $46,188,181)(Note 1).................................... $46,220,928
Receivables:
Subscriptions...................................................................................... 157,910
Interest........................................................................................... 228,512
Securities sold.................................................................................... 20,849,757
Due from Advisor (Note 3).......................................................................... 1,021
Other assets......................................................................................... 5,479
-----------
Total Assets....................................................................................... 67,463,607
-----------
Liabilities
Bank overdraft....................................................................................... 458,254
Short sales at market value (proceeds $12,874,063)................................................... 12,855,070
Payables:
Variation margin on futures contracts (Note 2)..................................................... 5,623
Securities purchased............................................................................... 15,429,655
Redemptions........................................................................................ 32,575
Distributions...................................................................................... 4,236
Accrued expenses..................................................................................... 36,315
----------
Total Liabilities.................................................................................. 28,821,728
----------
Net Assets
(Applicable to outstanding shares of 3,865,492; unlimited number of shares of beneficial
interest authorized; no stated par)................................................................ $38,641,879
===========
Net asset value, offering price and redemption price per share ($38,641,879 / 3,865,492) $ 10.00
===========
Source of Net Assets
Paid in capital...................................................................................... $38,590,422
Overdistributed net investment income................................................................ (134,448)
Accumulated net realized gains on investments........................................................ 123,366
Net unrealized appreciation of investments........................................................... 62,539
-----------
Net Assets........................................................................................ $38,641,879
===========
===================================================================================================================================
The accompanying notes are an integral part of these financial statements.
</TABLE>
17
<PAGE>
<TABLE>
<S> <C>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
=================================================================================================================================
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1998
Investment Income
Interest and discount earned, net of premium amortization (Note 1)................................... $2,516,399
Expenses
Advisory fees (Note 3)............................................................................... 271,230
Accounting and pricing services fees................................................................. 39,913
Custodian fees....................................................................................... 15,432
Audit & tax preparation fees......................................................................... 19,794
Legal fees........................................................................................... 18,482
Transfer agent fees.................................................................................. 30,564
Registration fees.................................................................................... 12,333
Trustees fees and expenses........................................................................... 18,125
Insurance............................................................................................ 10,881
Other................................................................................................ 2,056
----------
Total Expenses Before Reimbursement............................................................... 438,810
Expenses reimbursed by Advisor (Note 3)........................................................... (97,835)
----------
Net Expenses...................................................................................... 340,975
----------
Net Investment Income............................................................................. 2,175,424
----------
Realized and Unrealized Gain (Loss) on Investments
Net realized gain on investments..................................................................... 1,835,038
Change in unrealized appreciation (depreciation) of investments...................................... (73,907)
----------
Net realized and unrealized gain on investments...................................................... 1,761,131
----------
Net increase in net assets resulting from operations................................................. $3,936,555
==========
===================================================================================================================================
The accompanying notes are an integral part of these financial statements.
</TABLE>
18
<PAGE>
<TABLE>
<S> <C>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
=================================================================================================================================
STATEMENTS OF CHANGES IN NET ASSETS
Year Ended Year Ended
March 31, 1998 March 31, 1997
--------------- ---------------
Operations
Net investment income............................................................ $2,175,424 $2,303,301
Net realized (loss) gain on investments.......................................... 1,835,038 (82,705)
Change in unrealized appreciation (depreciation) of investments.................. (73,907) (93,993)
-------- --------
Net increase in net assets resulting from operations............................. 3,936,555 2,126,603
Distributions to Shareholders
Dividends from net investment income............................................. (2,175,424) (2,260,030)
Dividends in excess of net investment income..................................... (10,140) --
Distributions from net realized gains on investments............................. (880,968) (943,662)
--------- ---------
Total distributions.............................................................. (3,066,532) (3,203,692)
----------- -----------
Capital Share Transactions
Shares sold...................................................................... 34,884,833 1,730,791
Shares issued on reinvestment of distributions................................... 1,570,705 935,335
Shares redeemed.................................................................. (36,419,207) (300,452)
------------ -----------
Increase in net assets resulting from capital share transactions (a)............. 36,331 2,365,674
------------ -----------
Total Increase in Net Assets................................................... 906,354 1,288,585
Net Assets
Beginning of period.............................................................. 37,735,525 36,446,940
---------- ----------
End of period.................................................................... $38,641,879 $37,735,525
=========== ===========
(a) Transactions in capital shares were as follows:
Shares sold...................................................................... 3,494,156 174,344
Shares issued on reinvestment of distributions................................... 157,456 94,439
Shares redeemed.................................................................. (3,664,130) (30,101)
--------- ---------
Net increase (decrease).......................................................... (12,518) 238,682
Beginning balance................................................................ 3,878,010 3,639,328
--------- ---------
Ending balance................................................................... 3,865,492 3,878,010
========= =========
===================================================================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
19
<PAGE>
<TABLE>
<S> <C>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
===================================================================================================================================
FINANCIAL HIGHLIGHTS
The following average per share data, ratios and supplemental information
have been derived from information provided in the financial statements.
Year Year
Ended Ended
March 31, March 31,
1998 1997
--------- ----------
Net Asset Value, Beginning
of Period........................ $9.73 $10.01
--------- ----------
INCOME FROM INVESTMENT
OPERATIONS
Net investment income............ 0.590 0.599
Net realized and unrealized
(loss) gain on
investments.................... 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 (2)......... 0.88% 0.88%
Ratio of net investment
income to average net
assets......................... 5.61% 6.19%
Portfolio turnover rate.......... 583% 409%
Ratio of expenses to
average net assets
before reimbursement of
expenses by the Advisor 1.13% 1.16%
Ratio of net investment
income to average net
assets before
reimbursement of
expenses by the Advisor 5.36% 5.92%
<CAPTION>
<S> <C>
For the period
Year Year Year March 31,
Ended Ended Ended 1992 (1)
March 31, March 31, March 31, to March 31,
1996 1995 1994 1993
---------- ----------- ----------- --------------
Net Asset Value, Beginning
of Period........................ $9.83 $10.01 $10.62 $10.00
--------- ------ ------ ------
INCOME FROM INVESTMENT
OPERATIONS
Net investment income............ 0.660 0.664 1.050 0.826
Net realized and unrealized
(loss) gain on
investments.................... 0.277 (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 (2) 0.90% 0.90% 0.90% 0.82%
Ratio of net investment
income to average net
assets 6.49% 6.20% 7.74% 8.18%
Portfolio turnover rate ......... 193% 557% 84% 42%
Ratio of expenses to
average net assets
before reimbursement of
expenses by the Advisor 1.14% 2.33% 2.34% 17.52%
Ratio of net investment
income to average net
assets before
reimbursement of
expenses by the Advisor 6.26% 4.77% 6.30% -8.52%
- -------------
(1) Commencement of operations.
(2) Through August 1, 1994, expense ratios include both the direct expenses of
the Intermediate Duration U.S. Government Fund, and the indirect expenses
incurred through the Fund's investment in the Smith Breeden Institutional
Intermediate Duration U.S. Government Fund.
==================================================================================================================================
The accompanying notes are an integral part of these financial statements.
</TABLE>
20
<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
================================================================================
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Breeden Series Fund (the "Trust") is an open-end, diversified
management investment company registered under the Investment Company Act of
1940, as amended. The Fund offers shares in two series: the Smith Breeden Short
Duration U.S. Government Fund (formerly the Smith Breeden Short Duration U.S.
Government Series) and the Smith Breeden Intermediate Duration U.S. Government
Fund (the "Fund", formerly, the Smith Breeden Intermediate Duration U.S.
Government Series). The following is a summary of accounting policies
consistently followed by the Fund.
A. Security Valuation: Portfolio securities are valued at the current market
value provided by a pricing service, or by a bank or broker/dealer experienced
in such matters when over-the-counter market quotations are readily available.
Securities and other assets for which market prices are not readily available
are valued at fair market value as determined in accordance with procedures
approved by the Board of Trustees.
B. Repurchase Agreements: Repurchase agreements may be entered into with member
banks of the Federal Reserve System with total assets in excess of $500 million,
and securities dealers, provided that such banks or dealers meet the credit
guidelines of the Fund's Board of Trustees. In a repurchase agreement, the Fund
acquires securities from a third party, with the commitment that they will be
repurchased by the seller at a fixed price on an agreed upon date. The Fund's
custodian maintains control or custody of the securities collateralizing the
repurchase agreement until maturity. The value of the collateral is monitored
daily, and, if necessary, additional collateral is received to ensure that the
market value of the collateral remains sufficient to protect the Fund in the
event of the seller's default. However, in the event of default or bankruptcy of
the seller, the Fund's right to the collateral may be subject to legal
proceedings.
C. Reverse Repurchase Agreements: A reverse repurchase agreement involves the
sale of portfolio assets together with an agreement to repurchase the same
assets later at a fixed price. Additional assets are maintained in a segregated
account with the custodian, and are marked to market daily. The segregated
assets may consist of cash, U.S. Government securities, or other liquid
high-grade debt obligations equal in value to the obligations under the reverse
repurchase agreements. In the event the buyer of securities under a reverse
repurchase agreement files for bankruptcy or becomes insolvent, the Fund's use
of the proceeds under the agreement may be restricted pending a determination by
the other party, or its trustee or receiver, whether to enforce the obligation
to repurchase the securities.
D. Dollar Roll Agreements: A dollar roll is an agreement to sell securities for
delivery in the current month and to repurchase substantially similar (same type
and coupon) securities on a specified future date. During the roll period,
principal and interest paid on these securities are not received. The Fund is
compensated by the difference between the current sales price and the forward
price for the future purchase (often referred to as the "drop") as well as by
earnings on the cash proceeds of the initial sale.
E. Distributions and Taxes: Dividends to shareholders are recorded on the
ex-dividend date. The Fund intends to continue to qualify for and elect the
special tax treatment afforded regulated investment companies under Subchapter M
of the Internal Revenue Code, thereby relieving the Fund of Federal income
taxes. To so qualify, the Fund intends to distribute substantially all of its
net investment income and net realized capital gains, if any, less any available
capital loss carryforward. As of March 31, 1998, the Fund had no capital loss
carryforward.
F. Securities Transactions, Investment Income and Expenses: Interest income is
accrued daily, and includes net amortization from the purchase of fixed-income
securities. Discounts and premiums on securities purchased are amortized over
the life of the respective securities. Securities transactions are recorded on
the trade date. Gains or losses on the sale of securities are calculated for
accounting and tax purposes on the identified cost basis.
Expenses are accrued daily. Common expenses incurred by the Trust are allocated
among the funds comprising the Trust based on the ratio of net assets of each
fund to the combined net assets of the Trust. Other expenses are charged to each
fund on a specific identification basis.
21
<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
================================================================================
NOTES TO FINANCIAL STATEMENTS (continued)
1. SIGNIFICANT ACCOUNTING POLICIES -- Continued
G. Accounting Estimates: The preparation of financial statements in accordance
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the amounts of income
and expense during the reporting period. Actual results could differ from those
estimates.
2. FINANCIAL INSTRUMENTS
A. Derivative Financial Instruments Held or Issued for Purposes other than
Trading: The Fund uses interest rate futures contracts for risk management
purposes in order to reduce fluctuations in the Fund's net asset value relative
to its targeted option-adjusted duration. On entering into a futures contract,
either cash or securities in an amount equal to a certain percentage of the
contract value (initial margin) must be deposited with the futures broker.
Subsequent payments (variation margin) are made or received by the Fund each
day. The variation margin payments equal the daily changes in the contract value
and are recorded as unrealized gains or losses. The Fund recognizes a realized
gain or loss when the contract is closed or expires equal to the difference
between the value of the contract at the time it was opened and the value at the
time it was closed.
<TABLE>
<S> <C>
The Fund had the following open futures contracts as of March 31, 1998:
Number of Expiration Unrealized
Type Contracts Position Month Gain/(Loss)
5 Year Treasury........................ 190 Long June, 1998 $(4,960)
10 Year Treasury....................... (240) Short June, 1998 15,759
-------
Total $10,799
=======
</TABLE>
Futures transactions involve costs and may result in losses. The effective use
of futures depends on the Fund's ability to close futures positions at times
when the Fund's Advisor deems it desirable to do so. The use of futures also
involves the risk of imperfect correlation among movements in the values of the
securities underlying the futures purchased and sold by the Fund, of the futures
contract itself, and of the securities which are the subject of a hedge.
The aggregate market value of investments pledged to cover margin requirements
for the open positions at March 31, 1998 was $79,241.
3. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES
Smith Breeden Associates, Inc. (the "Advisor"), a registered Investment Advisor,
provides the Fund with investment management services. As compensation for these
services, the Fund pays the Advisor a fee computed daily and payable monthly, at
an annual rate equal to 0.70% of the Fund's average daily net assets.
The Advisor has voluntarily agreed to reduce or otherwise limit other expenses
of the Fund (excluding advisory fees and litigation, indemnification and other
extraordinary expenses) to 0.88% of the Fund's average daily net assets. This
voluntary agreement may be terminated or modified at any time by the Advisor in
its sole discretion except that the Advisor has agreed to limit expenses of the
Fund to 0.88% through August 1, 1998. For the year ended March 31, 1998, the
Advisor received fees of $271,230 and reimbursed the Fund $97,835.
The Fund has adopted a Distribution and Services Plan (the "Plan") under Rule
12b-1 under the Investment Company Act of 1940. The purpose of the Plan is to
permit the Advisor 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 Fund, reducing redemptions, or otherwise
maintaining or improving services provided to shareholders by such dealers or
other persons. The Plan provides for payments by the Advisor, out of the
advisory fee to dealers and other persons at the annual rate of up to 0.25% of
the Fund's average net assets, subject to the authority of the Trustees of the
Fund, to reduce the amount of payments permitted under the Plan or
22
<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
================================================================================
NOTES TO FINANCIAL STATEMENTS (continued)
3. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES -- Continued
to suspend the Plan for such periods as they may determine. Subject to these
limitations, the Advisor shall determine the amount of such payments and the
purposes for which they are made.
Certain officers and trustees of the Fund are also officers and directors of the
Advisor.
4. INVESTMENT TRANSACTIONS
During the year ended March 31, 1998, purchases and proceeds from sales of
securities, other than short-term investments, aggregated $211,174,973 and
$216,659,693, respectively. The purchases and proceeds shown above do not
include dollar roll agreements which are considered borrowings by the Fund. The
cost of securities for federal income tax purposes is $46,188,181. Net
unrealized appreciation of investments, short sales and futures contracts
consist of:
Gross unrealized appreciation............................. $151,962
Gross unrealized depreciation............................. (89,423)
-------
Net unrealized appreciation............................... $62,539
========
23
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders, Smith Breeden Intermediate Duration U.S.
Government Fund of the Smith Breeden Series Fund:
We have audited the accompanying statements of assets and liabilities, including
the schedule of investments, of the Smith Breeden Intermediate Duration U.S.
Government Fund (formerly "Smith Breeden Intermediate Duration U.S. Government
Series") of the Smith Breeden Series Fund (the "Fund") as of March 31, 1998, and
the related statements of operations for the year then ended, the statements of
changes in net assets for each of the years in the two-year period then ended
and the financial highlights for each of the years in the five-year period
presented. These financial statements and the financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and the financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at March
31, 1998 by correspondence with the custodian and brokers, and where replies
were not received, we performed other auditing procedures. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights referred to
above present fairly, in all material respects, the financial positions of the
Smith Breeden Intermediate Duration U.S. Government Fund of the Smith Breeden
Series Fund as of March 31, 1998, the results of its operations, the changes in
its net assets, and the financial highlights for the respective stated periods
in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
May 15, 1998
24
