As filed with the Securities and Exchange Commission
on May 28, 1999
File No. 33-43089
File No. 811-6431
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
F O R M N-1A
Registration Statement Under the Securities Act of 1933
Post-Effective Amendment No. 18
and
Registration Statement Under the Investment Company
Act of 1940
Amendment No. 20
____________________
SMITH BREEDEN SERIES FUND
(Exact Name of Registrant as Specified in Charter)
100 Europa Drive, Suite 200
Chapel Hill, North Carolina 27514
(Address of Principal Executive Office)
(919) 967-7221
(Registrant's Telephone Number, Including Area Code)
MICHAEL J. GIARLA
100 Europa Drive, Suite 200
Chapel Hill, North Carolina 27514
(Name and Address of Agent for Service)
_______________
Please Send Copy of Communications to:
MARIANTHE S. MEWKILL
Smith Breeden Associates, Inc.
100 Europa Drive, Suite 200
Chapel Hill, NC 27514
(919)-967-7221
It is proposed that this filing will become effective
on July 31, 1999 pursuant to paragraph (a)(1) of Rule 485
under the Securities Act of 1933.
The Registrant has previously registered an indefinite
number of shares of beneficial interest pursuant to Rule
24f-2 under the Investment Company Act of 1940, as amended.
The Rule 24f-2 notice for the Registrant's most recent
fiscal year will be filed by June 30, 1999.
SMITH BREEDEN SERIES FUND
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
(THE "SHORT FUND")
SMITH BREEDEN INTERMEDIATE DURATION U.S.
GOVERNMENT FUND
(THE "INTERMEDIATE FUND")
CROSS REFERENCE SHEET
FORM N-1A
Part A: Information Required in Prospectus
N-1A
Item No. Item Location in the
Registration Statement
by Prospectus Heading
1. Front and Back Front and Back Cover
Cover Pages Pages
2. Risk/Return Summary: Smith Breeden Bond Funds:
Investments, Risk Investment Objectives,
and Performance Principal Investments
Strategies, Principal
Investment Risks, Annual
Performance
3. Risk/Return Summary: Smith Breeden Bond Funds:
Fee Table Your Expenses
4. Investment Objectives, Summary of Principal Risks
Principal Investment and Investment Strategies
Strategies, and
Related Risks
5. Management's Discussion Contained in the Funds'
of Fund's Performance Annual Report to
Shareholders
6. Management, Organization, Management of the Funds
and Capital Structure
7. Shareholder Information Pricing of Fund Shares,
How to Purchase Shares,
How to Exchange Shares,
How to Redeem Shares,
Dividends and
Distributions,
Shareholder Reports and
Information, Taxes
8. Distribution Arrangements How to Purchase Shares,
Service and Distribution
Plans
9. Financial Highlights Financial Highlights
Information
SMITH BREEDEN MUTUAL FUNDS
Smith Breeden Short Duration U.S. Government Fund
Smith Breeden Intermediate Duration U.S. Government Fund
Smith Breeden High Yield Bond Fund
Smith Breeden U.S. Equity Market Plus Fund
Smith Breeden Asian/Pacific Equity Market Fund
Smith Breeden European Equity Market Fund
Smith Breeden Financial Services Fund
PROSPECTUS
JULY 31, 1999
Advised by Smith Breeden Associates, Inc.
These securities have not been approved or disapproved by the
Securities and Exchange 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
SUMMARY INFORMATION
This Prospectus describes seven no load mutual funds offering
you a choice of investments to help fulfill your asset allocation
needs:
Smith Breeden Short Duration U.S. Government Fund
Smith Breeden Intermediate Duration U.S. Government Fund
Smith Breeden High Yield Bond Fund
Smith Breeden U.S. Equity Market Plus Fund
Smith Breeden Asian/Pacific Equity Market Fund
Smith Breeden European Equity Market Fund
Smith Breeden Financial Services Fund
Each Fund is a series of the Smith Breeden Series Fund or the
Smith Breeden Trust, each an open-end management investment
company. The investment adviser for the Funds is Smith Breeden
Associates, Inc. (the "Adviser"). The Adviser is a money
management and consulting firm founded in 1982 whose clients
include pension funds, financial institutions, corporations,
governmental entities and charitable foundations.
TABLE OF CONTENTS
Smith Breeden Bond Funds 3
Smith Breeden Equity Funds 8
Summary of Principal Risks and Investment Strategies 13
Characteristics and Risks of the Securities in which
the Funds May Invest 19
Management of Funds 24
Pricing of Fund Shares 29
How to Purchase Shares 30
How to Exchange Shares 32
How to Redeem Shares 33
Dividends and Distributions 36
Shareholder Reports and Information 37
Retirement Plans 38
Service and Distribution Plans 38
Taxes 38
Capital Structure 39
Transfer and Dividend Disbursing Agent, Custodian
and Independent Auditors 40
Fund Performance 40
Financial Highlights 42
2
SMITH BREEDEN BOND FUNDS
Smith Breeden Short Duration U.S. Government Fund
Smith Breeden Intermediate Duration U.S. Government Fund
Investment Objectives
The Short Duration U.S. Government Fund (the "Short Fund")
seeks to provide investors with a high level of current income,
consistent with a low volatility of net asset value.
The Intermediate Duration U.S. Government Fund (the
"Intermediate Fund") seeks to provide investors with a total
return in excess of the total return of the major market indices
for mortgage-backed securities.
Principal Investment Strategies
The Short Fund seeks to achieve its objective by matching
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 Intermediate Fund seeks to achieve its objective by
matching the duration, or interest-rate risk, of a portfolio that
invests exclusively in mortgage-backed securities, as weighted in
the major market indices for mortgage-backed securities. These
indices currently include, but are not limited to, the Salomon
Brothers Mortgage Index and the Lehman Brothers Mortgage Index,
each of which includes all outstanding government sponsored fixed-
rate mortgage-backed securities, weighted in proportion to their
current market capitalization. The duration of these indices is
generally similar to that of intermediate-term U.S. Treasury
Notes, and typically will range between three and five years.
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 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. Each year of
duration represents an approximate 1% change in price for a 1%
change in interest rates. For example, if a bond fund has an
average duration of three years, its price will fall
approximately 3% when interest rates rise by one percentage
point. Conversely, the bond fund's price will rise approximately
3% when interest rates fall by one percentage point.
Under normal circumstances, each Fund will invest at least 70%
of its total assets in U.S. Government Securities, primarily in
mortgage-backed securities issued by the U.S. Government, its
agencies and instrumentalities. The Funds will also invest in
fixed-rate and adjustable-rate mortgage-backed securities issued
by non-governmental issuers and may hold a portion of their
assets in money market instruments and in time and savings
deposits in commercial banks or institutions whose accounts are
insured by the Federal Deposit Insurance Corporation.
3
The investment objectives of the Short and Intermediate Funds
are fundamental, meaning they may not be changed without a vote
of the shareholders of the relevant Fund. In addition, as a
matter of fundamental policy the Funds will limit purchases to
securities from the following classes of assets:
Securities issued directly or guaranteed by the U.S. Government
or its agencies or instrumentalities.
Mortgage-Backed Securities rated AAA by Standard & Poor's
Corporation ("S&P") or Aaa by Moody's Investors Service, Inc.
("Moody's") or unrated but deemed of equivalent quality by the
Adviser.
Securities fully collateralized by assets in either of the
above classes.
Assets which would qualify as liquidity items under federal
regulations (which may change from time to time) if held by a
commercial bank or savings institution.
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.
Principal Investment Risks
Among the primary risks of investing in the Funds are:
Market Risk
Interest Rate Risk
Prepayment Risk
Derivatives Risk
Management Risk
Year 2000 Risk
Please see "Summary of Principal Risks and Investment
Strategies" for a discussion of these and other risks of
investing in the Funds.
Annual Performance
The bar charts below show how the Funds' performance has
varied from year to year by illustrating the Fund's total
calendar-year returns. The table following the bar charts
compares each Fund's average annual returns for the periods
indicated to those of a broad-based securities market index. The
charts and table are intended to illustrate some of the risks of
investing in the Funds by showing how the Funds' performance can
vary from year to year. Past performance does not guarantee
future results.
Calendar-Year Total Returns
Short Fund
Best quarter: First quarter 1995, + 2.40%
Worst quarter: First quarter 1994, + 0.06%
More recent return information:
(January 1, 1999 - June 30,1999) to be provided
4
U.S. T-Bill 3.39% 3.88% 6.54% 5.31% 5.57% 5.58%
Short Fund 4.30% 4.14% 6.13% 6.28% 6.32% 4.77%
1993 1994 1995 1996 1997 1998
Calendar-Year Total Returns
Intermediate Fund
Best quarter: First quarter 1995, + 5.45%
Worst quarter: First quarter 1994, - 2.25%
More recent return information:
(January 1, 1999 - June 30, 1999) to be provided
5 Year/SBMI (1) 9.63% (1.42)% 16.77% 5.37% 9.26% 6.98%
Intermediate Fund 11.09% (1.67)% 16.40% 5.05% 9.00% 6.56%
1993 1994 1995 1996 1997 1998
Average Annual Total Returns
(for periods ended December 31, 1998)
Short Fund Fund
1 Year 5 Inception
Years (March 31,
1992)
The Fund 4.77 5.52 5.46
Merrill Lynch 6 Month US T-Bill 5.58 5.36 4.96
T-Bill
Intermediate Fund Fund
1 Year 5 Inception
Years (March 31,
1992)
The Fund 6.56 6.90 8.26
5 Year/SBMI (1) 6.98 7.23 8.09
(1) 5 -Year Treasury Note to 12/31/93 and Salomon Smith Barney
Mortgage Index ("SBMI") to 3/31/99. The fund changed its
investment objective 1/1/94.
Your Expenses
The information below describes the fees and expenses you may pay if you
buy and hold shares of the Funds and do not reflect any expense
reimbursements by the Adviser.
5
Short Fund Intermediate Fund
Shareholder Fees (1)
(fees paid directly from your None None
investment)
Annual Fund Operating Expenses
(expenses that are deducted
from Fund assets) 0.70% 0.70%
Management Fees (2)(3)
Other Expenses (3) 0.30% 0.36%
Total Fund Operating 1.00% 1.06%
Expenses (3)
(1)For accounts of less than $2,000, each Fund assesses an annual account
maintenance fee of $16. In addition, a transaction charge of $9 may be
imposed on redemptions by wire transfer and an account closing fee of $8
may be imposed.
(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 Fund's net assets out of its management fee.
(3)Expenses shown are before giving effect to expense limitations. The
Adviser voluntarily reimburses the Funds' expenses so that during the
fiscal year ended March 31, 1999 total fund operating expenses were 0.78%
for the Short Fund and 0.88% for the Intermediate Fund.
Examples
The examples below are intended to help you compare the cost of
investing in the Funds with the cost of investing in other mutual funds.
The examples assume that you invest $10,000 in each Fund for the time
periods indicated, that you investment earns a 5% return each year and that
the Fund's operating expenses remain the same and that the Adviser does not
reimburse the Fund any expenses. Although your actual costs may be higher
or lower, based on these assumptions your costs would be:
1 Year 3 Years 5 Years 10 Years
Short Fund $105 $328 $568 $1,258
Intermediate Fund $111 $347 $601 $1,329
Smith Breeden High Yield Bond Fund
Investment Objective
The Fund seeks high current income and capital appreciation.
Principal Investment Strategies
The Fund invests primarily in lower and unrated rated debt securities
commonly referred to as "junk bonds." At least 65% of the Fund's total
assets will be invested in these high yield debt securities rated below
investment grade by national rating agencies such as S&P and Moody's.
There is no limit on the acceptable rating of securities bought by the
Fund.
6
The Fund may also invest 35% of its total assets in equity securities,
namely common or preferred stock and warrants, of U.S. and foreign
companies. To the extent the Fund invests in stocks, the value of these
equity investments will fluctuate day to day with movements in the stock
market, as well as in response to the activities of individual companies.
The Fund may also use options, future contracts, options on futures
contracts and swaps to increase or decrease its exposure to changing
security prices, interest or currency exchange rates, or other factors that
affect security values.
Principal Investment Risks
Among the primary risks of investing in the Funds are:
Market Risk
Interest Rate Risk
Credit Risk
Prepayment Risk
Derivatives Risk
Leveraging Risk
Liquidity Risk
Foreign Investment Risk
Management Risk
Year 2000 Risk
Please see "Summary of Principal Risks and Investment Strategies" for a
discussion of these and other risks of investing in the Funds. .
Annual Performance
The Fund began operations on October 15, 1998 and therefore does not
have a full calendar year of performance to report. Since the Fund's
performance can be expected to vary from year to year there are risks of
investing in the Fund.
Your Expenses
The information below describes the fees and expenses you may pay if you
buy and hold shares of the Funds and do not reflect any expense
reimbursements by the Adviser.
Shareholder Fees (1) None
(fees paid directly from your
investment)
Annual Fund Operating Expenses
(expenses that are deducted
from Fund assets) 0.70%
Management Fees (2)(3)
Other Expenses (3) 6.16%
Total Fund Operating
Expenses (3) 6.86%
(1)For accounts of less than $2,000, the Fund assesses an annual account
maintenance fee of $16. In addition, a transaction charge of $9 may be
imposed on redemptions by wire transfer and an account closing fee of $8
may be imposed.
7
(2)Pursuant to a distribution and services plan in respect of the Fund,
the Adviser may pay annual distribution and servicing fees of up to 0.25%
of the Fund's net assets out of its management fee.
(3)Expenses shown are before giving effect to expense limitations and are
estimated had the Fund been operational for a full fiscal year. The Adviser
voluntarily reimburses the Fund's expenses so that had the Fund been
operational during the full fiscal year ended March 31, 1999 total fund
operating expenses would have been 0.98%
Examples
The examples below are intended to help you compare the cost of
investing in the Fund with the cost of investing in other mutual funds.
The examples assume that you invest $10,000 in the Fund for the time
periods indicated, that you investment earns a 5% return each year and that
the Fund's operating expenses remain the same and that the Adviser does not
reimburse any expenses. Although your actual costs may be higher or lower,
based on these assumptions your costs would be:
1 Year 3 Years 5 Years 10 Years
$720 $2,114 $3,446 $6,529
SMITH BREEDEN EQUITY FUNDS
Smith Breeden U.S. Equity Market Plus Fund
Smith Breeden Asian/Pacific Equity Market Fund
Smith Breeden European Equity Market Fund
Investment Objectives
The U.S. Equity Market Plus Fund seeks to provide a total return
exceeding the Standard & Poor's 500 Composite Stock Index (the "S&P 500
Index") without additional equity market risk.
The Asian/Pacific Equity Market Fund seeks capital appreciation through
investments in financial instruments related to the major equity markets of
Asia and the Pacific region.
The European Equity Market Fund seeks capital appreciation through
investments in securities related to the major equity markets of Europe.
Principal Investment Strategies
None of the Funds invests principally in the common stocks of the regions
or indices whose returns they are targeting. Instead, each Fund uses
futures, options and swaps to maintain its equity exposure in its
respective market. The Asian/Pacific Equity Market and European Equity
Market Funds may also employ futures and forwards on the currency markets
of their respective regions to maintain the relevant market exposure. When
futures contracts and/or swaps are, in the judgment of the Adviser,
relatively overpriced, a Fund may invest directly in the common stocks
represented by the index or in the region being tracked. In these
circumstances, the Fund will not own all issues, but will attempt to
purchase a basket of common stocks which the Adviser expects will, on
average, match the movements in the index or market being tracked.
Since futures contracts and swaps can be purchased on little or no margin,
8
under normal circumstances each Fund commits only a small percentage of its
net assets to purchasing the instruments which it uses to capture its
equity market risk. With its remaining cash, each Fund invests in a low
duration fixed income strategy substantially similar to that of the Short
Fund. The Funds' fixed income securities consist primarily of U.S.
Government Securities, including U.S. agency mortgage-backed securities,
but may also include corporate debt securities, and mortgage-backed and
other asset-backed securities of non-governmental issuers.
With these fixed-income related investments, each Fund seeks to generate
income and gains exceeding the total operating costs of the Fund. The
operating costs of the Funds include the transaction and financing costs of
entering into the futures, options and swap contracts used to replicate the
respective stock market returns. Thus, whether a Fund's total return equals
or exceeds the performance of the index or market it targets (the S&P 500
index in the case of the U.S. Equity Market Plus Fund, the Asia/Pacific
region in the case of the Asian/Pacific Equity Market Fund, the European
region in the case of the European Equity Market Fund) depends largely on
whether the total return on the Fund's fixed-income portfolio equals or
exceeds the Fund's total operating expenses. Other factors which will
impact the success of the Funds' strategies relate to how well the returns
of the futures, swaps and options chosen by the Adviser as the Fund's
investments correlate to the markets tracked. Each Fund has also applied
for an exemptive order with the Securities and Exchange Commission which
would permit the Fund to invest in the Short Fund for purposes of pursuing
its short duration fixed income strategy. There is no assurance that such
an order will be granted.
Principal Investment Risks
Among the primary risks of investing in the Funds are:
Market Risk
Interest Rate Risk
Prepayment Risk
Derivatives Risk
Foreign Investment Risk
Leveraging Risk
Liquidity Risk
Management Risk
Year 2000 Risk
Please see "Summary of Principal Risks and Investment Strategies" for a
discussion of these and other risks of investing in the Funds.
Annual Performance
The bar chart below shows how the U.S. Equity Market Plus Fund's
performance has varied from year to year by illustrating the Fund's total
calendar-year returns. The table following the bar chart compares the
Fund's average annual returns for the periods indicated to those of a broad-
based securities market index. The chart and table are intended to
illustrate some of the risks of investing in the Fund by showing how the
Fund's performance can vary from year to year. There are no charts and
tables for the Asian/Pacific Equity Market and European Equity Market Fund
because the Funds have no performance history. However, since these Funds'
performance can be expected to vary from year to year there are risks of
investing in these Fund as well. Past performance does not guarantee
future results.
9
Calendar-Year Total Returns
U.S. Equity Market Plus Fund
[Plot points for bar chart]
S&P 500 10.06% 1.32% 37.58% 22.96% 33.36% 28.58%
U.S. Equity 13.22% 1.84% 36.76% 24.36% 32.29% 26.43%
Market Plus Fund 1993 1994 1995 1996 1997 1998
Best quarter: Fourth quarter 1998, 21.07%
Worst quarter: Third quarter 1998, (10.82)%
More recent return information (January 1, 1999-June 30, 1999):
to be provided%
Average Annual Total Returns
(for periods ended December 31, 1998)
Fund
1 Year 5 Inception
Years (June 30,
1992)
U.S. Equity Market 26.43% 23.69% 21.89%
Plus Fund
S&P 500 Index* 28.58% 24.03% 21.24%
* The S&P 500 Index is a widely recognized, unmanaged index of common
stocks of the 500 largest capitalized U.S. companies. The index does
not incur expenses and cannot be purchased directly by investors.
Your Expenses
The information below describes the fees and expenses you may pay if you
buy and hold shares of the Funds.
U.S. Asian/Pa European
Equity cific Equity
Market Equity Market
Plus Market
Shareholder Fees (1) None None None
(fees paid directly from your
investment)
Annual Fund Operating
Expenses
(expenses that are deducted
from Fund assets)
Management Fees (2)(3) 0.70% 0.70% 0.70%
Other Expenses (3)(4) 0.34% 5.30% 5.30%
Total Fund Operating 1.34% 6.00% 6.00%
Expenses (3)(4)
(1)For accounts of less than $2,000, each Fund assesses an annual account
maintenance fee of $16. In addition, a transaction charge of $9 may be
imposed on redemptions by wire transfer and an account closing fee of $8
may be imposed.
10
(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 Fund's net assets out of its management fee.
(3)Expenses shown are before giving effect to expense limitations. The
Adviser voluntarily reimburses the Funds' expenses so that during the
fiscal year ended March 31, 1999 total fund operating expenses were 0.88%
for the U.S. Equity Market Plus Fund and would be expected to be 0.98% for
each of the European Equity Index and Asian/Pacific Equity Index Funds had
they been operational.
(4)Other expenses and Total Fund Operating expenses for the Asian/Pacific
Equity Market and European Equity Market Funds are based on estimated
amounts for the first fiscal year of the Funds.
Examples
The examples below are intended to help you compare the cost of
investing in the Funds with the cost of investing in other mutual funds.
The examples assume that you invest $10,000 in each Fund for the time
periods indicated, that you investment earns a 5% return each year and that
the Fund's operating expenses remain the same and that the Adviser does not
reimburse any expenses. Although your actual costs may be higher or lower,
based on these assumptions your costs would be:
1 Year 3 Years 5 Years 10 Years
U.S. Equity Market Plus $ 109 $ 341 $ 590 $1,305
Asian/Pacific Equity Market $ 630 $1,866 $3,069 $5,944
European Equity Market $ 630 $1,866 $3,069 $5,944
Smith Breeden Financial Services Fund
Investment Objective
The Fund seeks capital appreciation.
Principal Investment Strategies
To pursue its investment objective, the Fund invests at least 65% of its
total 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, although it
may also engage in other investment practices.
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.
11
The 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.
Principal Investment Risks
Among the primary risks of investing in the Funds are:
Market Risk
Concentration and Related Risk
Derivatives Risk
Foreign Investment Risk
Leveraging Risk
Liquidity Risk
Management Risk
Year 2000 Risk
Please see "Summary of Principal Risks and Investment Strategies" for a
discussion of these and other risks of investing in the Funds.
Annual Performance
The bar chart below shows the Fund's performance by illustrating the Fund's
total calendar-year returns. The table following the bar chart compares
the Fund's average annual returns for the periods indicated to those of a
broad-based securities market index. Because the Fund's performance can be
expected to vary from year to year there are risks of investing in the
Fund. Past performance does not guarantee future results.
Calendar-Year Total Returns
[Plot points for bar chart]
S&P 500 28.58%
Financial Services Fund (4.81%)
1998
Best quarter: Fourth quarter 1998, 18.18%
Worst quarter: Third quarter 1998, (27.04)%
More recent return information (January 1, 1999-June 30, 1999):
to be provided%
Average Annual Total Returns
(for periods ended December 31, 1998)
Fund
1 Year Inception
(December
22, 1997)
Fund (3.77) (4.81)
S&P 500 Index * 28.58 30.08
* The S&P 500 Index is a widely recognized, unmanaged index of common
stocks of the 500 largest capitalized U.S. companies. The index does
not incur expenses and cannot be purchased directly by investors.
12
Your Expenses
The information below describes the fees and expenses you may pay if you
buy and hold shares of the Fund.
Shareholder Fees (1) None
(fees paid directly from your
investment)
Annual Fund Operating Expenses
(expenses that are deducted
from Fund assets) 0.70%
Management Fees (2)(3)
Other Expenses (3) 2.42%
Total Fund Operating 3.12%
Expenses (3)
(1)For accounts of less than $2,000, the Fund assesses an annual account
maintenance fee of $16. In addition, a transaction charge of $9 may be
imposed on redemptions by wire transfer and an account closing fee of $8
may be imposed.
(2)Pursuant to a distribution and services plan in respect of the Fund,
the Adviser may pay annual distribution and servicing fees of up to 0.25%
of the Fund's net assets out of its management fee.
(3)Expenses shown are before giving effect to expense limitations. The
Adviser voluntarily reimburses the Fund's expenses so that during the
fiscal year ended March 31, 1999 total fund operating expenses were 1.48%
Examples
The examples below are intended to help you compare the cost of
investing in the Fund with the cost of investing in other mutual funds.
The examples assume that you invest $10,000 in the Fund for the time
periods indicated, that you investment earns a 5% return each year and that
the Fund's operating expenses remain the same and that the Adviser does not
reimburse any expenses. Although your actual costs may be higher or lower,
based on these assumptions your costs would be:
1 Year 3 Years 5 Years 10 Years
$328 $1,000 $1,695 $3,452
SUMMARY OF PRINCIPAL RISKS AND INVESTMENT STRATEGIES
Principal Risks
The value of your investment in a Fund changes with the values of that
Fund's holdings. Many factors can affect those values. The "principal
risks" identified in the fund descriptions part of this Prospectus
represent the factors that are most likely to have a material effect on a
particular Fund's portfolio as a whole. Each Fund may be subject to
additional principal risks and other risks in addition to the risks
described here. The risks of a Fund may change over time because the types
of investments made by a Fund can change over time. The following
subsection on "Characteristics and Risks of the Securities in Which the
Funds May Invest" and the Statements of Additional Information include more
important information about the Funds, their investment strategies and the
13
related risks.
Market Risk. The market price of securities held by a Fund may fall,
sometimes rapidly or unpredictably, due to changing economic, political or
market conditions, or due to the financial condition of the issuer. The
value of a security may decline due to general market conditions which are
not specifically related to a company or industry, such a real or perceived
adverse economic conditions, changes in the general outlook for corporate
earnings, changes in interest or currency rates or adverse investor
sentiment generally.
Interest Rate Risk. The market prices of a Fund's fixed-income
investments may decline due to an increase in market interest rates.
Generally, the longer the maturity or duration of a fixed-income security,
the more sensitive it is to changes in interest rates. The Short Fund (and
the fixed-income segments of the U.S. Equity Market Plus, Asian/Pacific
Equity Market and European Equity Market Funds) seek to match the duration
of a portfolio that invests exclusively in six month U.S. Treasury
securities on a constant maturity basis, and the Intermediate Fund seeks to
match the duration of a portfolio that invests in mortgage-backed
securities as weighted in the major market indices (typically ranging from
three to five years). However, each 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 six months or five
years, as the case may be, sometimes significantly longer.
Credit Risk. An issuer of securities held by the Fund may be unable to
pay principal and interest when due, or the value of the security may
suffer because investors believe the issuer is less able to pay. Lower
rated securities, while usually offering higher yields, generally have more
risk and volatility because of reduced creditworthiness and greater chance
of default.
While certain U.S. Government securities such as U.S. Treasury
obligations and GNMAs (discussed in the next section) are backed by the
full faith and credit of the U.S. Government, other fixed-income 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, while the U.S. Equity Market
Plus, European Equity Market and Asian/Pacific Equity Market Funds will
seek to minimize this risk of default by investing in securities of at
least investment grade, except that its investment in mortgage-backed
securities will be rated at least A. The High Yield Bond Fund will invest
in securities of below investment grade.
Debt obligations that are deemed investment grade carry a rating of at
least Baa from Moody's or BBB from Standard and Poor's, or a comparable
rating agency from another rating agency. Bonds rated BBB or Baa or below
(and unrated bonds of comparable quality) have speculative characteristics
and changes in economic circumstances are more likely to lead to a weakened
capacity of the issuer to make interest and principal payments. In
addition, the market for high yield bonds can be thinner and less active
than that for higher-quality debt securities. As a result, lower rated
securities held by a Fund can be less liquid, meaning that they are
difficult to purchase or sell, possibly preventing the Fund from selling
the investment at an advantageous price or time. Moreover, because these
14
less active market quotations may not always be available, the securities
will be valued in accordance with procedures established by the Board of
Trustees. Judgment plays a greater role in valuing high-yield corporate
debt securities than is the case for securities for which more external
sources for quotations and last-sale information is available. Adverse
publicity and changing investor perceptions may affect the ability of
outside pricing services to value lower-quality debt securities and a
Fund's ability to dispose of these securities.
Prepayment risk. Prepayment risk is the risk that principal will be
repaid at a different rate than anticipated, causing the return on a
security purchased to be less than expected. Mortgage-backed securities,
which represent an interest in a pool of mortgages, present this risk, as
do many asset-backed securities and high yield bonds. In general, when
market interest rates decline, many mortgages are refinanced, and mortgage-
backed securities are paid off earlier than expected, forcing a Fund to
reinvest the proceeds at current yields, which are lower than those paid by
the security that was paid off. When market interest rates increase, the
market values of mortgage-backed securities declines. At the same time,
however, mortgage refinancing slows, which lengthens the effective
maturities on these securities. As a result, the negative effect of the
rate increase on the market value of mortgage securities is usually more
pronounced than it is for other types of fixed-income securities. Asset-
backed securities can present similar risks.
Similarly, investments in high yield bonds can present the risk of
prepayment since these securities often contain redemption and call
provisions. If an issuer exercises these provisions in a declining
interest rate market, the Fund would have to replace the security with a
lower yielding security, resulting in a decreased return for investors. The
Adviser may use options to try to mitigate the prepayment risk but such a
strategy may not be successful.
Derivatives Risk. The Funds may use derivatives, which are financial
contracts whose value depends on, or is derived from, the value of an
underlying asset, interest rate or index. Using derivatives, a Fund can
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. Techniques involving derivatives 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 Asian/Pacific Equity Market, European Equity
Market, and Financial Services Funds 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.
The Funds will sometimes use derivatives as part of a strategy designed
to reduce other risks and sometimes will use derivatives for leverage,
which increases opportunities for gain but also involves greater risk. In
addition to other risks such as the credit risk of the counterparty, market
risk and liquidity risk, derivatives involve the risk of mispricing or
improper valuation and the risk that changes in the value of the derivative
may not correlate perfectly with relevant assets, rates and indices. In
addition, the Funds' use of derivatives may have the effect of accelerating
a Fund's recognition of gain.
15
The use of derivatives involves costs and may result in losses. For
example, the losses from investing in futures transactions are potentially
unlimited. In addition, 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. This means that a Fund may
not achieve, and may at times exceed, its targeted duration or the return
of the market it tracks.
The U.S. Equity Market Plus, Asian/Pacific Equity Market and European
Equity Market Funds' use of derivative instruments such as futures, swaps
and options to track the relevant index or region raises additional risks.
Each of these Fund's opportunity for gain or loss may be greater than if
the Fund invested directly in the stocks represented by the relevant market
or index because the notional value of the financial instruments utilized
may not match exactly a Fund's net assets. For example, in the U.S. Equity
Market Plus Fund, the total net notional amount of the Fund's equity swap
contracts, S&P 500 Index futures contracts, plus the market value of any
common stocks owned may be more or less than the Fund's total net assets.
(Under normal market conditions, each Fund expects that such variations in
its exposure to the relevant index or regions will be up to 5% more or less
than the Fund's net assets.) For the Asian/Pacific Equity Market and
European Equity Market Funds, there are no futures traded which match
exactly the stock market capitalization of the Asian/Pacific or European
regions. As a result, the Asian/Pacific Equity Market and European Equity
Market Funds will utilize a composite of the futures traded in these
regions. Futures contracts may not be available to trade in all countries
making up a region, or a Fund may not be able to match exactly the
weighting of a country's market capitalization in a region due to size
limitations on the notional amount of the futures being purchased. Due to
the lower correlation of the selected country or region futures with the
return of the region in total, this circumstance may magnify the "tracking
error" of a Fund's performance.
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.
A 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
16
n 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 with primary U.S. 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.
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. In addition to
margin deposits, when the Fund purchases a 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 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.
Foreign Investment Risk. Funds investing in foreign markets and
securities may experience more rapid and extreme changes in value than
Funds investing solely in U.S. companies and markets. This is because the
securities markets of many foreign countries are relatively small, with a
limited number of companies representing a small number of industries. In
addition, foreign companies are usually not subject to the same degree of
regulation as U.S. companies. These investments are also influenced by
currency risk, the risk that changes in foreign exchange rates will affect,
favorably or unfavorably, the value of a Fund's foreign securities.
Although these Funds will enter into currency futures and forwards to
maintain the same currency exposure as the markets in which they invest,
there is no guarantee that the use of such techniques will be successful.
Other risks and considerations relate to the higher transaction costs of
trading in foreign securities; lower liquidity which may result in greater
price volatility; the possibility of expropriation or confiscatory
taxation; adverse change in investment or exchange control regulation;
difficulty in obtaining a judgement from a foreign court; political
instability; and potential restrictions on the flow of international
capital.
Concentration and Related Risk. 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.
Although the Fund may buy or sell interest rate futures and options to
attempt to mitigate the effect of changing interest rates on the portfolio,
the use of these instruments in such a strategy involves the risk that the
price movements of the hedging instrument will not accurately reflect price
movements in the securities, so that the hedge will not be fully effective
or may result in losses.
In addition, the financial services companies in which the Fund invests
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 the availability and cost of capital funds, and can
fluctuate significantly when interest rates change. Credit losses resulting
17
from the financial difficulties of borrowers can negatively affect 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 harm the financial services sector and the Fund.
Liquidity Risk. Liquidity risk exists when particular investments are
difficult to sell. A Fund may not be able to sell these illiquid
investments at the best prices. Investments in derivatives, foreign
investments and securities having small market capitalization, substantial
market and/or credit risk tend to involve greater liquidity risk.
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 High Yield Bond, U.S. Equity Market Plus, Asian/Pacific Equity
Market, European Equity Market, and Financial Services Funds 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 Statements of
Additional Information, as well as equity swap contracts and reverse equity
swap contracts, are illiquid.
Year 2000 Risk Like other mutual funds (and most organizations around
the world), the Funds could be adversely affected by computer problems
related to the year 2000. These could interfere with operations of the
Funds, the Adviser and the Distributor or could impact the issuers of the
securities in which the Funds invest.
While no one knows if these problems will have any impact on the Funds or
on financial markets in general, the Adviser is taking steps to protect
fund investors. These include efforts to determine that the problem will
not directly affect the systems used by major service providers.
Whether these steps will be effective can only be known for certain in the
year 2000.
Leveraging Risk. When a Fund is borrowing money or otherwise leveraging
its portfolio, the value of an investment in that Fund will be more
volatile and all other risks will tend to be compounded. This is because
leverage tends to exaggerate the effect of any increase or decrease in the
value of a Fund's portfolio holdings. Each Fund may take on leveraging
risk by using reverse repurchase agreements, dollar rolls and other
18
borrowings, by investing collateral from loans of portfolio securities,
through the use of when-issued, delayed-delivery or forward commitment
transactions or by using other derivatives. The use of leverage may also
cause a Fund to liquidate portfolio positions when it may not be
advantageous to do so to satisfy its obligations or meet segregation
requirements.
Management Risk. Each Fund is subject to management risk because it is
an actively managed investment portfolio. Management risk is the chance
that poor security selection will cause the Fund to underperform other
funds with similar objectives. The Adviser will apply its investment
techniques and risk analyses in making investment decisions for the Funds,
but there can be no guarantee that these will produce the desired
result.
Characteristics of Certain of the Securities in which the Funds May Invest
Subject to the percentage limitations on investment to which each Fund
is subject based on their investment objective, and unless stated
otherwise, each of the Funds may invest in the following types of
securities. The Statements of Additional Information also include
information on these and other securities and financial instruments in
which the Funds may 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.
Corporate Debt Securities. All of the Funds, with the exception of the
Short and Intermediate Funds, may invest in corporate debt securities.
Corporate Debt Securities are subject to the risk of an issuer's inability
to meet principal and interest payments on the obligation (credit risk) and
may also be subject to price volatility due to such factors as interest
rate sensitivity, market perception of the credit-worthiness of the issuer
and general market liquidity. Debt securities issued by smaller and
medium sized issuers may be less actively traded than those of larger
issuers and may experience greater fluctuations in price. Smaller and
medium sized issuers may be less seasoned, have more limited product lines,
markets, financial resources and management depth, and therefore be more
susceptible to adverse market conditions than larger issuers.
Convertible Securities. All of the Funds, with the exception of the Short
and Intermediate Funds, may invest in convertible securities. A convertible
security is a fixed income equity security that may be converted into a
prescribed amount of common stock at a specified formula. A convertible
security entitles the owner to receive interest until the security matures
or is converted. Convertibles have several unique investment
characteristics such as: (a) higher yields than common stocks but lower
yields than straight debt securities; (b) lesser degree of fluctuation in
value than the underlying stock since they have fixed income
19
characteristics; and (c) potential for capital appreciation if the market
price of the underlying securities increases.
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, including residuals, stripped mortgage-backed
securities and other instruments. 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. These securities are described in detail below and in the
Statement of Additional Information.
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. Not all
securities issued by the U.S. Government or its agencies are backed by the
full faith and credit of the United States; some may be backed only by the
assets of the particular instrumentality or the ability of the agency to
borrow.
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, 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. 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
Collateralized Mortgage Backed Obligations ("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 U.S. Equity Market Plus, European Equity Market and Asian/Pacific
Equity Market Funds' investments in mortgage-backed and other asset-backed
securities will be rated at least A by Moody's or S&P.
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
10
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 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 Statements 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 Segments of the U.S. Equity Market Plus,
Asian/Pacific Equity Market, and European Equity Market Funds 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 Funds
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 Statements of Additional
Information. New financial instruments and 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.
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
21
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 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. All of
the Funds, except the Financial Services and High Yield Bond 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 and High Yield Bond Funds 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.
22
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.
Portfolio Turnover
The Adviser buys and sells securities for a Fund whenever it believes it is
appropriate to do so. The portfolio turnover rate for each Fund's previous
fiscal periods is shown in the table under the heading "Financial
Highlights".
The portfolio turnover rates reported in the "Financial Highlights" for the
Short, Intermediate, High Yield Bond and U.S. Equity Market Plus Funds for
the fiscal year ended March 31, 1999 were relatively high. In addition, the
Adviser anticipates that the portfolio turnover rate for the Asian/Pacific
Equity Market, and European Equity Market Funds will also be relatively
high. Because of their relatively frequent trading, the funds will realize
taxable capital gains frequently which must be distributed yearly to
shareholders. To the extent these gains are short-term capital gains, such
gains are generally taxed at ordinary income tax rates. If a shareholder
holds an investment in a fund in something other than a tax-deferred
account (e.g. a retirement account), the payment of any taxes will impact a
shareholder's net return from holding an investment in a Fund. Portfolio
turnover also 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. However, the
mortgage securities in which some of the Funds may 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 High Yield
Bond, U.S. Equity Market Plus, Asian/Pacific Equity Market, European Equity
Market and Financial Services Funds, in relation to any purchase of common
stocks or other equity securities.
23
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
Portfolio Manager, High Yield Bond 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, and in conjunction with David A. Tiberii, he is responsible
for the day-to-day operations of the High Yield Bond 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.
*Interested Person
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 &
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
24
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.
*Interested Person
Stephen M. Schaefer Trustee
Stephen M. Schaefer is the Tokai Bank 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 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 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
25
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.
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.
26
John B. Sprow Vice President, Smith Breeden Trust
Portfolio Manager, U.S. 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 U.S. 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.
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 marked-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
Asset/Liability Management 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.
David A. Tiberii Vice President, Smith Breeden Trust
Portfolio Manager, High Yield Bond Fund
David A. Tiberii is an Associate at Smith Breeden Associates. In
conjunction with Douglas T. Breeden, Mr. Tiberii is responsible for the day-
to-day operations of the High Yield Bond Fund. Before joining Smith
Breeden Associates, he was an engineering consultant specializing in
operational and maintenance issues at nuclear power plants and a submarine
officer in the US Navy. He received his Masters of Business Administration
with a concentration in Finance from the Fuqua School of Business, Duke
University, where he was a Fuqua Scholar. Mr. Tiberii holds a Bachelor of
Arts degree in Physics from Holy Cross College and a Chief Nuclear Engineer
certification from the US Navy.
William F. Quinn Vice President, Smith Breeden Trust
Portfolio Manager, Asian/Pacific Equity Market
and European Equity Market Funds
William F. Quinn is an Executive Vice President and a Director of Smith
Breeden Associates. He is a Senior Portfolio Manager, a member of Smith
Breeden's Portfolio Management Group (PMG), and the portfolio manager for
several discretionary accounts. Mr. Quinn is also involved in the
27
formulation and implementation of investment and risk management policies
and procedures as well as clients' strategic plans and business plans. He
has completed a number of special projects for both institutional clients
and government regulators regarding complex mortgage securities. Mr. Quinn
is primarily responsible for the day-to-day operations of the Asian/Pacific
Equity Market and European Equity Market Funds. Mr. Quinn joined Smith
Breeden after completing his Masters of Science in Management with
Concentrations in Finance, MIS and System Dynamics from the Sloan School of
Management, Massachusetts Institute of Technology. He earned a Bachelor of
Science in Management Science from the Massachusetts Institute of
Technology.
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.
St. John M. Kelliher Assistant Treasurer
St. John M. Kelliher assists in financial administration and portfolio
analysis for Smith Breeden Associates and Smith Breeden Mutual Funds. He
holds a Bachelor of Arts degree from Trinity College, Dublin, Ireland, and
a Master of Arts degree in Philosophy from the University of Illinois at
Chicago. He passed the Uniform C.P.A. examination in 1993, and currently
is a candidate for the Chartered Financial Analyst (C.F.A.) designation.
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 the fiscal year ended March 31, 1999, the
Adviser was paid an advisory fee, computed daily and payable monthly, based
on a percentage of average net assets as follows: 0.70% of each of the
Short, Intermediate, High Yield Bond, U.S. Equity Market Plus,
Asian/Pacific Equity Market, and European Equity Market Funds' and 1.50%
for 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
First Data Distributors, Inc. (the "Principal Underwriter") acts as
28
distributor for the Funds. Shares may also be sold by authorized dealers
who have entered into dealer agreements with the Principal Underwriter or
the Adviser.
Expenses
Subject to any expense waivers or reimbursements, 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 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, and a fee of $8 may be charged when an account is closed. 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.
Foreign securities, futures and options are valued at the last quoted sales
price, according to the broadest and most representative market, available
at the time a Fund is valued. If events which materially affect the value
of an investment occur after the close of the securities and futures
markets on which such securities are primarily traded, those investments
may be valued by such methods as the Board of Trustees deems in good faith
to reflect fair value.
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
29
Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving
Day, the day following Thanksgiving, Christmas Eve and Christmas Day. The
Short, Intermediate, and High Yield Bond 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."
Initial Minimum Additional
Type of Account Investment Minimum
Investment
Regular $ 1,000 $ 50
Automatic Investment Plan None $ 50
Individual Retirement Account $ 250 $ 50
Gift to Minors $ 250 $ 50
The Funds reserve the right to deduct an annual maintenance fee of $16
from accounts with a value of less than $2,000. The fee applies to each
account in each fund that is of a value of less than $2,000 and is funded
by redeeming shares. It is expected that accounts will be valued on the
second Friday in September of each year. The fee, which is payable to the
transfer agent, is designed to offset in part the relatively higher costs
of servicing smaller accounts.
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.
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
30
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 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
31
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 $1,000 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.
32
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."
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, and a fee of $8 may be charged when an
33
account is closed. 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 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 charge an $8 fee when an account is closed.
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
34
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
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.
35
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.
DIVIDENDS AND DISTRIBUTIONS
The Short, Intermediate and High Yield Bond Funds intend to pay monthly
distributions to their shareholders of net investment income. The U.S.
Equity Market Plus, Asian/Pacific Equity Market, and European Equity Market
Funds each intend 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 and High Yield Bond Funds will declare daily dividends for
36
shareholders of record. The Intermediate and High Yield Bond Funds'
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.
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. Quarterly statements will be sent to
each shareholder. Additional statements will only be sent if there is a
direct purchase or sale or if there is a cash dividend payment. Direct
purchases and sales do not include automatic investment plan purchases or
systematic withdrawal plan redemptions.
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.
37
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.
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
38
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
(generally taxed at a 20% rate in the hands of non-corporate shareholders),
regardless of how long they have held their Fund shares. Each fund provides
federal tax information to its shareholders annually about distributions
paid during the preceding year.
The use of certain synthetic instruments (including certain futures
contracts, foreign currency contracts and options) by the U.S. Equity
Market Plus, Asian/Pacific Equity Market, and European Equity Market Funds
as a means of achieving equity exposure in each Fund's respective market
will require such Funds to mark such instruments to the market annually, a
practice which will accelerate the Funds' recognition of gain or loss.
With respect to such instruments, 60% of any gain or loss recognized will
be treated as long-term capital gain or loss and 40% will be treated as
short-term capital gain or loss.
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 U.S. 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, or in certain other situations.
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 foreign, 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.
39
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 each of the Series Fund or Trust, as
the case may be, will vote together in electing the relevant trustees and
in certain other matters. Shareholders should be aware that the outcome of
the election of trustees and of certain other matters for their trust 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.
Neither the Series Fund nor the Trust is required to hold annual meetings
of its shareholders. However, shareholders of the Series Fund have the
right to call a meeting to take certain actions as provided in the
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 such actions, the Series Fund has
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
40
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, Intermediate, and High Yield Bond Funds may also advertise
current yield and distribution rate information. Current yield reflects
the income per share earned by a 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 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 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 may 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 High Yield Bond Fund's return may be
compared to the Merrill Lynch High Yield Master Index or some other high
yield bond index as published by a brokerage firm or others. The High
Yield Bond Fund's performance may also be compared to the competitive funds
average as published by Lipper Analytical Services, Inc.
The U.S. 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 U.S. 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 Asian/Pacific Equity Market Fund's
total return may be compared to the return of the Morgan Stanley Capital
International (MSCI) - Pacific (Free) Index, which consists of common
stocks of companies located in Australia, Hong Kong, Japan, Malaysia, New
Zealand, and Singapore. The European Equity Market Fund's total return may
be compared to the return of the Morgan Stanley Capital International
(MSCI) - Europe Index, which is comprised of common stocks of companies
42
located in 15 European countries (Austria, Belgium, Denmark, Finland,,
France, Germany, Ireland, Italy, the Netherlands, Norway, Portugal, Spain,
Sweden, Switzerland, and the United Kingdom). 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.
FINANCIAL HIGHLIGHTS
The financial highlights tables are intended to help you understand each
Fund's financial performance for the past 5 years or, if shorter, since the
period of the Fund's operations. Certain information reflects financial
results for a single Fund share. The total returns in the table represent
the rate that an investor would have earned or lost on an investment in the
Fund (assuming reinvestment of all dividends and distributions). This
information has been audited by Deloitte & Touche LLP, whose report, along
with each Fund's financial statements, are included in the annual report to
shareholders, which is available upon request.
42
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 April 1, 1994 through March 31, 1999, 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 Year Ended Year Ended Year Ended
March 31, March 31, March 31, March 31, March 31,
1999 1998 1997 1996 1995
<S> <C> <C> <C> <C> <C>
Net Asset Value, $9.92 $9.83 $9.74 $9.90 $9.90
Beginning of Period....
Income From Investment
Operations
Net investment income.. 0.442 0.484 0.476 0.621 0.628
Net realized and
unrealized gain (loss) 0.020 0.114 0.146 (0.148) --
on investments.........
Total from investment 0.462 0.598 0.622 0.473 0.628
operations.............
Less Distributions
Dividends from net (0.447) (0.508) (0.476) (0.621) (0.628)
investment income......
Dividends in excess of
net investment income.. -- -- (0.056) (0.012) --
Total Distributions.... (0.447) (0.508) (0.532) (0.633) (0.628)
Net Asset Value, End of $9.94 $9.92 $9.83 $9.74 $9.90
Period.................
Total Return........... 4.83% 6.24% 6.57% 4.95% 6.58%
Ratios/Supplemental Data
Net assets, end of $60,807,449 $78,427,855 $118,988,609 $221,825,136 $218,431,665
period.................
Ratio of expenses to
average net assets
Before expense 1.00% 1.00% 0.93% 0.93% 0.92%
limitation.............
After expense 0.78% 0.78% 0.78% 0.78% 0.78%
limitation.............
Ratio of net income to
average net assets
Before expense 4.56% 5.06% 4.90% 6.13% 6.18%
limitation.............
After expense 4.78% 5.28% 5.04% 6.29% 6.33%
limitation.............
Portfolio turnover 298% 626% 556% 225% 47%
rate...................
</TABLE>
Additional performance information is presented in the Short Fund's Annual
Report, which is available without charge upon request.
43
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 April 1, 1994 through March 31, 1999, 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>
Year Ended Year Ended Year Ended Year Ended Year Ended
March 31, March 31, March 31, March 31, March 31,
1999 1998 1997 1996 1995
<S> <C> <C> <C> <C> <C>
Net Asset Value, $10.00 $9.73 $10.01 $9.83 $10.01
Beginning of Period....
Income From Investment
Operations
Net investment income.. 0.525 0.590 0.599 0.660 0.664
Net realized and
unrealized gain (loss) 0.030 0.419 (0.024) 0.277 (0.049)
on investments.........
Total from investment 0.555 1.009 0.575 0.937 0.615
operations..........
Less Distributions
Dividends from net (0.515) (0.561) (0.604) (0.656) (0.664)
investment income.....
Dividends in excess of
net investment income.. ---- ---- ---- ---- (0.108)
Distributions from net
realized gains on (0.130) (0.178) (0.251) (0.101) --
investments............
Distributions in excess
of net realized gains -- -- -- -- (0.022)
on investments.........
Total Distributions.... (0.645) (0.739) (0.855) (0.757) (0.794)
Net Asset Value, End of $9.91 $10.00 $9.73 $10.01 $9.83
Period...............
Total 5.73% 10.65% 5.92% 9.69% 6.10%
Return.................
Ratios/Supplemental
Data
Net assets, end of $55,125,797 $38,641,879 $37,735,525 $36,446,940 $34,797,496
period.................
Ratio of expenses to
average net assets
Before expense 1.06% 1.13% 1.16% 1.14% 2.33%
limitation.............
After expense 0.88% 0.88% 0.88% 0.90% 0.90%
limitation.............
Ratio of net income to
average net assets
Before expense 5.08% 5.36% 5.92% 6.26% 4.77%
limitation.............
After expense 5.25% 5.61% 6.19% 6.49% 6.20%
limitation.............
44
Portfolio turnover rate 423% 583% 409% 193% 557%
rate...................
</TABLE>
Additional performance information is presented in the Intermediate Fund's
Annual Report, which is available without charge upon request.
U.S. 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 April 1, 1994 through March 31, 1999, 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 Year Ended Year Ended Year Ended
March 31, March 31, March 31, March 31, March 31,
1999 1998 1997 1996 1995
<S> <C> <C> <C> <C> <C>
Net Asset Value, $16.86 $12.56 $12.27 $10.84 $9.88
Beginning of Period....
Income From Investment
Operations
Net investment 0.686 0.591 0.592 0.615 0.568
income.................
Net realized and
unrealized gain (loss) (1.765) 4.940 1.813 2.768 1.081
on
investments............
Total from investment 2.451 5.531 2.405 3.383 1.649
operations..........
Less Distributions
Dividends from net (0.624) (0.586) (0.590) (0.583) (0.568)
investment income.....
Dividends in excess of
net investment -- -- -- -- (0.001)
income.................
Distributions from net
realized gains on (1.905) (0.645) (1.525) (1.370) (0.047)
investments............
Distributions in excess
of net realized gains -- -- -- -- (0.073)
on
investments............
Total (2.529) (1.231) (2.115) (1.953) (0.689)
Distributions..........
Net Asset Value, End of $16.78 $16.86 $12.56 $12.27 $10.84
Period...............
Total 17.17% 45.71% 21.41% 32.30% 17.18%
Return.................
Ratios/Supplemental
Data
Net assets, end of $185,584,121 $136,667,439 $13,507,377 $4,766,534 $2,107,346
period..................
45
Ratio of expenses to
average net assets
Before expense 1.04% 1.23% 2.60% 4.58% 7.75%
limitation............
After expense 0.88% 0.88% 0.88% 0.90% 0.90%
limitation.............
Ratio of net income to
average net assets
Before expense 4.45% 4.44% 3.58% 1.85% 0.59%
limitation.............
After expense 4.62% 4.79% 5.30% 5.53% 7.44%
limitation.............
Portfolio turnover 527% 424% 182% 107% 120%
rate...................
</TABLE>
Additional performance information is presented in the Fund's Annual Report,
which is available without charge upon request.
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,
1999, 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>
Year Ended Period Ended
March 31, 1999 March 31, 1998
<S> <C> <C>
Net Asset Value, Beginning of $10.06 $9.00
Period.....................................................
Income From Investment Operations
Net investment 0.006 0.017
income.....................................................
Net realized and unrealized gain (loss) on (1.082) 1.043
investments................................................
Total from investment (1.076) 1.060
operations.................................................
Less Distributions
Dividends from net investment (0.020) --
income.....................................................
Dividends in excess of net investment -- --
income.....................................................
Distributions from net realized gains on (0.063) --
investments................................................
Distributions in excess of net realized gains on -- --
investments................................................
Total -- --
Distributions..............................................
Net Asset Value, End of $8.90 $10.06
Period......................................................
46
Total (10.79%) 11.78%
Return.....................................................
Ratios/Supplemental Data
Net assets, end of $7,316,716
period..................................................... $6,842,414
Ratio of expenses to average net assets
Before expense 3.12% 3.20%*
limitation.................................................
After expense 1.48% 1.48%*
limitation.................................................
Ratio of net income to average net assets
Before expense (1.56%) (0.92%)*
limitation.................................................
After expense 0.08% 0.79%*
limitation.................................................
Portfolio turnover 105% 85%
rate.......................................................
* Annualized
</TABLE>
Additional performance information is presented in the Fund's Annual Report,
which is available without charge upon request.
HIGH YIELD BOND FUND
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
The following selected per share data and ratios cover the period from
October 15, 1998, the date the Fund commenced operations, through March 31,
1999, 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, 1999
<S> <C>
Net Asset Value, Beginning of Period................................. $9.00
Income From Investment Operations
Net investment income................................................ 0.318
Net realized and unrealized gain (loss) on investments............... (0.280)
Total from investment operations..................................... 0.038
Less Distributions
Dividends from net investment income................................. (0.318)
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.................................................. (0.318)
Net Asset Value, End of $8.72
Period...............................................................
Total 0.39%
Return...............................................................
Ratios/Supplemental Data
Net assets, end of
period............................................................... $2,121,386
47
Ratio of expenses to average net assets
Before expense 6.86%*
limitation...........................................................
After expense 0.98%*
limitation...........................................................
Ratio of net income to average net assets
Before expense 2.43%*
limitation...........................................................
After expense 8.30%*
limitation...........................................................
Portfolio turnover 12%
rate.................................................................
* Annualized
</TABLE>
Additional performance information is presented in the Fund's Annual Report,
which is available without charge upon request.
[Back Cover]
SMITH BREEDEN MUTUAL FUNDS
The Statement of Additional Information ("SAI") and annual and
semi-annual reports to shareholders for each of the Smith Breeden
Series Fund and the Smith Breeden Trust include additional
information about the Funds. The SAIs and the financial
statements included in the Funds' most recent annual report to
shareholders are incorporated by reference into (legally a part
of) this Prospectus. You may get free copies of any of these
materials, request other information about the Funds and make
shareholder inquires by calling 1-800-221-3138 of by visiting the
Funds' website (www.smithbreeden.com).
You can review, for a fee, the reports of the Funds and the SAIs
by writing to the Public Reference Section of the Securities and
Exchange Commission, Washington, D.C. 20459-60091, or by calling
the SEC at 1-800-SEC-0330. You can get copies of thus
information for free on the SEC's Internet site (www.sec.gov).
48
Part B: Information Required in
Statement of Additional Information
N-1A
Item No. Item Location in the
Registration
Statement
10. Cover Page and Cover Page and
Table of Contents Table of Contents
11. Fund History See Part A, Item 6
12. Description of the Fund Miscellaneous
and Its Investments Investment Practices
and Risks and Risk Considerations
13. Management of the Fund Trustees and Officers
14. Control Persons and Principal Holders of
Principal Holders of Securities and
Securities Controlling Persons
15. Investment Advisory Investment Advisory
and Other Services and Other Services
16. Brokerage Allocation Investment Advisory
and Other Practices and Other Services
17. Capital Stock and Additional Information
Other Securities Regarding Purchases and
Redemptions of Fund
Shares
18. Purchase, Redemption Additional Information
and Pricing of Regarding Purchases and
Securities Being Redemptions of Fund
Offered Shares
19. Taxation of the Fund Taxes
20. Underwriters Additional Information
Regarding Purchases and
Redemptions of Fund
Shares
21. Calculation of Standard Performance
Performance Data Measures
22. Financial Statements Experts; Financial
Statements
SMITH BREEDEN SERIES FUND
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
STATEMENT OF ADDITIONAL INFORMATION
JULY 31, 1999
100 Europa Drive, Suite 200
Chapel Hill, North Carolina 27514-2310
(919) 967-7221
This Statement of Additional Information contains information
pertaining to the Smith Breeden Series Fund (the "Series Fund"),
a no load open-end management investment company offering
redeemable shares of beneficial interest in two separate series,
the Smith Breeden Short Duration U.S. Government Fund (the "Short
Fund") and the Smith Breeden Intermediate Duration U.S.
Government Fund (the "Intermediate Fund"). This Statement of
Additional Information contains information which may be useful
to investors and which is not included in the Prospectus of the
Smith Breeden Mutual Funds. This Statement of Additional
Information is not a prospectus and is only authorized for
distribution when accompanied or preceded by the Prospectus of
the Smith Breeden Mutual Funds dated July 31, 1999 as may be
amended from time to time. This Statement should be read with the
Prospectus.
Contents Page
DEFINITIONS....... 2
MISCELLANEOUS INVESTMENT PRACTICES AND RISK
CONSIDERATIONS............................................ 2
INVESTMENT RESTRICTIONS. 12
TRUSTEES AND OFFICERS 14
INVESTMENT ADVISORY AND OTHER SERVICES 15
PRINCIPAL HOLDERS OF SECURITIES AND CONTROLLING PERSONS .17
POLICIES REGARDING BROKERS USED IN PORTFOLIO TRANSACTIONS 18
ADDITIONAL INFORMATION REGARDING PURCHASES
AND REDEMPTIONS OF FUND SHARES. 19
TAXES 21
STANDARD PERFORMANCE MEASURES 25
ADDITIONAL INFORMATION FOR INSTITUTIONAL INVESTORS 29
EXPERTS 29
FINANCIAL STATEMENTS 29
APPENDIX 29
1
SMITH BREEDEN SERIES FUND
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
(the "Funds")
Statement of Additional Information
DEFINITIONS
The "Series Fund" or the "Funds": Smith Breeden Series Fund
The "Adviser": Smith Breeden Associates,
Inc., the Funds' investment adviser.
The "Custodian": The Bank of New
York, the Funds' custodian.
"First Data Investor Services": First Data Investor
Services, Inc., the Funds' investor servicing agent
The "Principal Underwriter": First Data Distributors,
Inc.
MISCELLANEOUS INVESTMENT PRACTICES AND RISK CONSIDERATIONS
Investment Policies
The following supplements the information contained in the
Prospectus about the investment policies of the Short and
Intermediate Funds (the "Funds"). Terms used herein have the
same meanings as in the Prospectus. The Funds' Prospectus states
that the Funds may engage in each of the following investment
practices. However, the fact that the Funds may engage in a
particular practice does not necessarily mean that they will
actually do so.
Repurchase Agreements. A Fund may invest in repurchase
agreements. A repurchase agreement is a contract under which a
Fund acquires a security for a relatively short period (usually
not more than one week) subject to the obligation of the seller
to repurchase and the Fund to resell such security at a fixed
time and price (representing the Fund's cost plus interest). It
is the Funds' present intention to enter into repurchase
agreements only with commercial banks and registered broker-
dealers, and only with respect to obligations of the U.S.
Government or its agencies or instrumentalities. Repurchase
agreements may also be viewed as loans made by the Funds which
are collateralized by the securities subject to repurchase. The
Adviser will monitor such transactions to determine that the
value of the underlying securities is at least equal at all times
to the total amount of the repurchase obligation, including the
interest factor. If the seller defaults, a Fund could realize a
loss on the sale of the underlying security to the extent that
the proceeds of the sale including accrued interest are less than
the resale price provided in the agreement including interest.
In addition, if the seller should be involved in bankruptcy or
insolvency proceedings, a Fund may incur delay and costs in
selling the underlying security or may suffer a loss of principal
and interest if the Fund is treated as an unsecured creditor and
required to return the underlying collateral to the seller's
2
estate.
Forward Commitments. A Fund may enter into contracts to purchase
securities for a fixed price at a future date beyond customary
settlement time ("forward commitments," "when issued" and
"delayed delivery" securities) if a Fund holds until the
settlement date, in a segregated account, cash or high-grade debt
obligations in an amount sufficient to meet the purchase price,
or if a Fund enters into offsetting contracts for the forward
sale of other securities it owns. Forward commitments may be
considered securities in themselves, and involve a risk of loss
if the value of the security to be purchased declines prior to
the settlement date. Where such purchases are made through
dealers, a Fund relies on the dealer to consummate the sale. The
dealer's failure to do so may result in the loss to the Fund of
an advantageous return or price. Although a Fund will generally
enter into a forward commitment with the intention of acquiring
securities for its portfolio or for delivery pursuant to options
contracts it has entered into, the Fund may dispose of a
commitment prior to settlement if the Adviser deems it
appropriate to do so. A Fund may realize short-term profits or
losses upon the sale of forward commitments.
Securities Loans. A Fund may make secured loans of its
securities amounting to not more than 33 1/3% of its total
assets, thereby realizing additional income. The risks in
lending portfolio securities, as with other extensions of credit,
consist of possible delay in recovery of the securities or
possible loss of rights in the collateral should the borrower
fail financially. As a matter of policy, securities loans are
made to broker-dealers pursuant to agreement requiring that loans
be continuously secured by collateral in cash or short-term debt
obligations at least equal at all times to the value of the
securities on loan. The borrower pays to the Fund an amount equal
to any dividends or interest received on securities lent.
The Fund retains all or a portion of the interest received on
investment of the cash collateral, or receives a fee from the
borrower. Although voting rights, or rights to consent, with
respect to the loaned securities pass to the borrower, the Fund
retains the right to call the loans at any time on reasonable
notice, and it will do so in order that the securities may be
voted by the Fund if the holders of such securities are asked to
vote upon or consent to matters materially affecting the
investment. The Fund may also call such loans in order to sell
the securities involved.
Borrowing. A Fund may borrow from banks and enter into reverse
repurchase agreements or dollar rolls up to 33 1/3% of the value
of a Fund's total assets (computed at the time the loan is made)
in order to take advantage of investment opportunities, for
extraordinary or emergency purposes, or for the clearance of
transactions. A Fund may pledge up to 33 1/3% of its total assets
to secure these borrowings. If a Fund's asset coverage for
borrowings falls below 300%, the Fund will take prompt action to
reduce its borrowings even though it may be disadvantageous at
that time from an investment point of view. A Fund will incur
borrowing costs when it leverages, including payment of interest
and any fee necessary to maintain a line of credit, and may be
3
required to maintain a minimum average balance. If the income and
appreciation on assets acquired with borrowed funds exceed their
borrowing cost, the Fund's investment performance will increase,
whereas if the income and appreciation on assets acquired with
borrowed funds are less than their borrowing costs, investment
performance will decrease. In addition, if a Fund borrows to
invest in securities, any investment gains made on the securities
in excess of the costs of the borrowing, and any gain or loss on
hedging, will cause the net asset value of the shares to rise
faster than would otherwise be the case. On the other hand, if
the investment performance of the additional securities purchased
fails to cover their cost (including any interest paid on the
money borrowed) to the Fund, the net asset value of the Fund's
shares will decrease faster than would otherwise be the case.
This speculative characteristic is known as "leverage."
Reverse Repurchase Agreements and Dollar Roll Agreements. A Fund
may enter into reverse repurchase agreements and dollar roll
agreements with commercial banks and registered broker-dealers to
seek to enhance returns. Reverse repurchase agreements involve
sales by a Fund of portfolio assets concurrently with an
agreement by the Fund to repurchase the same assets at a later
date at a fixed price. During the reverse repurchase agreement
period, a Fund continues to receive principal and interest
payments on these securities and also has the opportunity to earn
a return on the collateral furnished by the counterparty to
secure its obligation to redeliver the securities. Dollar rolls
are transactions in which a Fund sells securities for delivery in
the current month and simultaneously contracts to repurchase
substantially similar (same type and coupon) securities on a
specified future date. During the roll period, the Fund forgoes
principal and interest paid on the securities. 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 the interest earned on the cash
proceeds of the initial sale. The Fund will establish a
segregated account with its custodian in which it will maintain
cash, U.S. Government securities or other liquid high grade debt
obligations equal in value to its obligations in respect of
reverse repurchase agreements and dollar rolls. Reverse
repurchase agreements and dollar rolls involve the risk that the
market value of the securities retained by the Fund may decline
below the price of the securities the Fund has sold but is
obligated to repurchase under the agreement. In the event the
buyer of securities under a reverse repurchase agreement or
dollar roll files for bankruptcy or becomes insolvent, the Fund's
use of the proceeds of the agreement may be restricted pending a
determination by the other party, or its trustee or receiver,
whether or not to enforce the Fund's obligation to repurchase the
securities. Reverse repurchase agreements and dollar rolls are
considered borrowings by a Fund.
Collateralized Mortgage Obligations ("CMOs"). A CMO is a
security backed by a portfolio of mortgages or mortgage-backed
securities held under an indenture. The issuer's obligation to
make interest and principal payments is secured by the underlying
portfolio of mortgages or mortgage-backed securities. CMOs are
issued with a number of classes or series, which have different
maturities representing interests in some or all of the interest
4
or principal on the underlying collateral or a combination
thereof. Payments of interest or principal on some classes or
series of CMOs may be subject to contingencies, or some classes
or series may bear some or all of the risk of default on the
underlying mortgages. CMOs of different classes are generally
retired in sequence as the underlying mortgage loans in the
mortgage pools are repaid. In the event of sufficient early
prepayments on such mortgages, the class or series of CMO first
to mature generally will be retired prior to its stated maturity.
Thus, the early retirement of a particular class or series of a
CMO held by the Funds would have the same effect as the
prepayment of mortgages underlying a mortgage-backed pass-through
security. Another type of CMO is a real estate mortgage
investment conduit ("REMIC") which qualifies for special tax
treatment under the Internal Revenue Code and invests in certain
mortgages principally secured by interests in real property and
other permitted investments.
CMOs also include securities representing the interest in any
excess cash flow and/or the value of any collateral remaining
after the issuer has applied cash flow from the underlying
mortgages or mortgage-backed securities to the payment of
principal of and interest on all other CMOs and the
administrative expenses of the issuer ("Residuals"). Residuals
have value only to the extent that income from such underlying
mortgages or mortgage-backed securities exceeds the amounts
necessary to satisfy the issuer's debt obligations represented by
all other outstanding classes or series of the CMOs. In
addition, if a CMO bears interest at an adjustable-rate, the cash
flows on the related Residual will also be extremely sensitive to
the level of the index upon which the rate adjustments are based.
As a non-fundamental policy (meaning it can be changed without
the vote of the shareholders), the Short and Intermediate Fund
will not invest in Residuals.
In reliance on an interpretation by the Securities and Exchange
Commission ("SEC"), the Fund's investments in certain qualifying
CMOs and REMICs are not subject to the 1940 Act's limitations on
acquiring interests in other investment companies. CMOs and
REMICs issued by an agency or instrumentality of the U.S.
Government are considered U.S. Government securities for the
purposes of this Prospectus.
Stripped Securities ("STRIPS"). STRIPS are usually structured
with two classes that receive different proportions of the
interest and principal distributions from a pool of underlying
assets. A common type of STRIP will have one class receiving all
of the interest from the underlying assets ("interest-only" or
"IO" class), while the other class will receive all of the
principal ("principal-only" or "PO" class). However, in some
instances, one class will receive some of the interest and most
of the principal while the other class will receive most of the
interest and the remainder of the principal. STRIPS are
unusually volatile in response to changes in interest rates. The
yield to maturity on an IO class of STRIPS is extremely sensitive
not only to changes in prevailing interest rates but also to the
rate of principal payments (including prepayments) on the
underlying assets. A rapid rate of principal prepayments may
have a measurably adverse effect on the Fund's yield to maturity
5
to the extent it invests in IOs. Conversely, POs tend to
increase in value if prepayments are greater than anticipated and
decline if prepayments are slower than anticipated. Thus, if the
underlying assets experience greater than anticipated prepayments
of principal, the Fund may fail to fully recover its initial
investment in these securities, even if the STRIPS were rated of
the highest credit quality by S&P or Moody's, respectively. The
Adviser will seek to manage these risks (and potential benefits)
by investing in a variety of such securities and by using certain
hedging techniques, as described in "Other Investment Practices
and Risk Considerations" in the Prospectus. In addition, the
secondary market for STRIPS may be less liquid than that for
other mortgage-backed or asset-backed securities, potentially
limiting the Fund's ability to buy or sell those securities at
any particular time.
The Adviser expects that interest-only STRIPS will be purchased
for their hedging characteristics. Because of their structure,
interest-only STRIPS will most likely move differently than
typical fixed income securities in relation to changes in
interest rates. For example, with increases in interest rates,
these securities will typically increase rather than decrease in
value. As a result, since they move differently to changes in
interest rates than the typical investments held by a Fund,
interest-only STRIPS can be used as hedging instruments to reduce
the variance of a Fund's net asset value from its targeted
option-adjusted duration. There can be no assurance that the use
of interest-only STRIPS will be effective as a hedging technique,
in which event, a Fund's overall performance may be less than if
the Fund had not purchased the STRIPS. STRIPS will not
constitute more than 5% of a Fund's net assets.
The determination of whether certain IO and PO STRIPS issued by
the U.S. Government and backed by fixed-rate mortgages are liquid
shall be made by the Trustees in accordance with applicable
pronouncements of the SEC. At present all other IO and PO STRIPS
are treated as illiquid securities for the purposes of the 15%
limitation on illiquid securities as a percentage of a Fund's net
assets.
In addition to STRIPS issued by the U.S. Government, its agencies
or instrumentalities, the Short and Intermediate Funds may
purchase STRIPS issued by private originators of, or investors
in, mortgage loans, including depository institutions, mortgage
banks, investment banks and special purpose subsidiaries of these
entities. However, the Short and Intermediate Funds will purchase
only STRIPS that are collateralized by mortgage-backed securities
that are issued or guaranteed by the U.S. Government or its
agencies or instrumentalities.
The Short and Intermediate Funds may invest only in stripped
mortgage-backed securities ("SMBS") which are STRIPS represented
by derivative multi-class mortgage securities. Under no
circumstances will the Short or Intermediate Funds purchase SMBS
if such purchase would cause SMBS to exceed 5% of the assets of a
Fund.
Zero Coupon Securities. The Funds may invest in "zero coupon"
securities, which are issued at a significant discount from face
6
value and pay interest only at maturity rather than at intervals
during the life of the security. Zero coupon securities tend to
be more volatile than other securities with similar stated
maturities, but which make regular payments of either principal
or interest.
A Fund is required to accrue and distribute income from zero
coupon securities on a current basis, even though it does not
receive the income currently. Thus, a Fund may have to sell
other investments to obtain cash needed to make income
distributions, which may reduce a Fund's assets and may thereby
increase its expense ratio and decrease its rate of return.
General Characteristics and Risks of Options, Futures, Swaps, and
Caps and Floors
Options. A put option gives the purchaser of the option the
right to sell and the writer the obligation, if the purchaser
exercises his right, to buy the underlying security at the
exercise price during the option period. A call option gives the
purchaser of the option the right to buy and the writer the
obligation, if the purchaser exercises his right, to sell the
underlying security at the exercise price during the option
period. Listed options are issued by the Options Clearing
Corporation ("OCC") which guarantees the performance of the
obligations of the parties to such options.
The purchaser of an option risks losing his entire investment in
a short period of time. If an option is not sold while it has
remaining value, or if during the life of an option the
underlying interest does not appreciate, in the case of a call
option, or depreciate, in the case of a put option, the purchaser
of such option may lose his entire investment. On the other
hand, given the same market conditions, if the potential
purchaser of a call option purchases the underlying interest
directly without purchasing a call option or if the potential
purchaser of a put option decides not to purchase the put option,
such a potential purchaser might have less of a loss. An option
purchaser does not have the choice of "waiting out" an unexpected
decrease or increase in the underlying instrument's price beyond
the expiration date of the option. The more that an option is
out-of-the-money and the shorter its remaining term to
expiration, the greater the risk that a purchaser of the option
will lose all or part of his investment. Further, except where
the value of the remaining life of an option may be realized in
the secondary market, for an option purchase to be profitable the
market price of the underlying interest must exceed or, as
applicable, be below the exercise price by more than the premium
and transaction costs paid in connection with the purchase of the
option and its sale or exercise.
A Fund's ability to close out its position as a purchaser of an
exchange-listed option is dependent upon the existence of a
liquid secondary market on option exchanges. Among the possible
reasons for the absence of a liquid secondary market on an
exchange are (i) insufficient trading interest in certain
options; (ii) restrictions on transactions imposed by an
exchange; (iii) trading halts, suspensions or other restrictions
imposed with respect to particular classes or series of options
7
or underlying securities; (iv) interruption of the normal
operations on an exchange; (v) inadequacy of the facilities of an
exchange or the OCC to handle current trading volume; or (vi) a
decision by one or more exchanges to discontinue the trading of
options (or a particular class or series of options), in which
event the secondary market on that exchange (or in that class or
series of options) would cease to exist, although outstanding
options on that exchange that had been listed by the OCC as a
result of trades on that exchange would generally continue to be
exercisable in accordance with their terms. OTC Options are
purchased from or sold to dealers or financial institutions which
have entered into direct agreement with a Fund. With OTC
Options, such variables as expiration date, exercise price and
premium will be agreed upon between the Fund and the transacting
dealer, without the intermediation of a third party such as the
OCC. If the transacting dealer fails to make or take delivery of
the securities underlying an option it has written, in accordance
with the terms of that option as written, the Fund would lose
the premium paid for the option as well as any anticipated
benefit of the transaction. OTC Options and their underlying
securities are considered illiquid. The Funds will engage in
OTC Option transactions only with primary United States
Government securities dealers recognized by the Federal Reserve
Bank of New York. The Adviser monitors the creditworthiness of
dealers with whom a Fund enters into OTC options transactions
under the general supervision of the Fund's Board of Trustees.
The hours of trading for options on debt securities may not
conform to the hours during which the underlying securities are
traded. To the extent that the option markets close before the
markets for the underlying securities, significant price and rate
movements can take place in the underlying markets that cannot be
reflected in the option markets.
Futures Contracts and Related Options. As a purchaser of an
interest rate futures contract, a Fund incurs an obligation to
take delivery of a specified amount of the obligation underlying
the futures contract at a specified time in the future for a
specified price or, in "cash settlement" futures contracts, to
pay to (or receive from) the seller in cash the difference
between the original price in the futures contract and the market
price of the instrument on the specified date, if the market
price is lower (or higher, as the case may be). A futures
contract sale creates an obligation by a Fund, as seller, to
deliver the specified type of financial instrument called for in
the contract at a specified future time for a specified price or,
in "cash settlement" futures contracts, to pay to (or receive
from) the buyer in cash the difference between the original price
in the futures contract and the market price of the instrument on
the specified date, if the market price is higher (or lower, as
the case may be). The potential losses from investment in futures
contracts is unlimited. Options on futures contracts are similar
to options on securities except that an option on a futures
contract gives the purchaser the right in return for the premium
paid to assume a position in a futures contract (a long position
if the option is a call and short position if the option is a
put).
Although most futures contracts call for actual delivery or
8
acceptance of securities, the contracts usually are closed out
before the settlement date without the making or taking of
delivery. A futures contract sale is closed out by effecting a
futures contract purchase for the same aggregate amount of the
specific type of security and the same delivery date. If the sale
price exceeds the offsetting purchase price, the seller would be
paid the difference and would realize a gain. If the offsetting
purchase price exceeds the sale price, the seller would pay the
difference and would realize a loss. Similarly, a futures
contract purchase is closed out by effecting a futures contract
sale for the same aggregate amount of the specific type of
security and the same delivery date. If the offsetting sale price
exceeds the purchase price, the purchaser would realize a gain,
whereas if the purchase price exceeds the offsetting sale price,
the purchaser would realize a loss. There is no assurance that
the Short or Intermediate Fund will be able to enter into a
closing transaction.
Initial margin in futures transactions is different from margin
in securities transactions in that initial margin does not
involve the borrowing of funds by a broker's client, but rather,
a good faith deposit on the futures contract which will be
returned to the Short or Intermediate Fund upon the proper
termination of the futures contract. The margin deposits made
are marked to market daily and the Funds may be required to make
subsequent deposits into the segregated account, maintained at
its Custodian for that purpose, or cash, U.S. Government
securities or other liquid highgrade debt securities, called
"variation margin", in the name of the broker, which are
reflective of price fluctuations in the futures contract.
Currently, interest rate futures contracts can be purchased on
debt securities such as U.S. Treasury Bills and Bonds, Eurodollar
instruments, U.S. Treasury Notes and GNMA Certificates.
Exchanges limit the amount by which the price of a futures
contract may move on any day. If the price moves equal the daily
limit on successive days, then it may prove impossible to
liquidate a futures position until the daily limit moves have
ceased. In the event of adverse price movements, the Funds would
continue to be required to make daily cash payments of variation
margin on open futures positions. In such situations, if the
Funds have insufficient cash, it may be disadvantageous to do so.
In addition, the Funds may be required to take or make delivery
of the instruments underlying interest rate futures contracts it
holds at a time when it is disadvantageous to do so. An
inability to close out options and futures positions could also
have an adverse impact on a Fund's ability to effectively hedge
its portfolio.
In the event of the bankruptcy of a broker through which the
Short or Intermediate Fund engages in transactions in futures or
options, either Fund could experience delays and/or losses in
liquidating open positions purchased or sold through the broker
and/or incur a loss of all or part of its margin deposits with
the broker. Transactions are entered into by the Funds only with
broker or financial institutions deemed creditworthy by the
Adviser.
The variable degree of correlation between price movements of
9
futures contracts and price movements in the position being
hedged creates the possibility that losses on the hedge may be
greater than gains in the value of a Fund's position. In
addition, futures and futures option markets may not be liquid in
all circumstances. As a result, in volatile markets, a Fund may
not be able to close out a transaction without incurring losses
substantially greater than the initial deposit. Although the
contemplated use of these contracts should tend to minimize the
risk of loss due to a decline in the value of the hedged
position, at the same time they tend to limit any potential gain
which might result from an increase in the value of such
position. The ability of the Short or Intermediate Fund to
hedge successfully will depend on the Adviser's ability to
forecast pertinent market movements, which cannot be assured.
In order to achieve its investment objective, 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 their durations as so calculated, the hedge may not be fully
effective.
A 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 securities portfolio plus or minus the unrealized gain or
loss on those open positions, adjusted for the expected
volatility relationship between the Fund and the futures
contracts based on duration calculations. If this limitation
should be exceeded at any time, the Short or Intermediate 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.
Finally, the daily deposit requirements in futures contracts
create a greater ongoing potential financial risk than do options
transactions, where the exposure is limited to the cost of the
initial premium. Losses due to hedging transactions may reduce
net asset value. Income earned by the Short or Intermediate Fund
from its hedging activities generally will be treated as capital
gains.
In accordance with regulations established by the Commodity
Futures Trading Commission, each Fund's 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.
Interest Rate and Mortgage Swaps, Caps, Floors and Collars.
Interest rate swaps involve the exchange by a Fund with another
party of their respective commitments to pay or receive interest,
for example, an exchange of floating-rate payments for fixed-rate
payments. Mortgage swaps are similar to interest rate swaps in
that they represent commitments to pay and receive interest. The
notional principal amount, however, is tied to a reference pool
10
or pools of mortgages.
The Short or Intermediate Funds will enter into interest rate
swaps only on a net basis, i.e., where the two payment streams
are netted out, with a Fund receiving or paying, as the case may
be, only the net amount of the two payments.
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 cap.
The purchase of an interest rate floor entitles the purchaser, to
the extent that a specified index falls below a predetermined
interest rate, to receive payments of interest on a notional
principal amount from the party selling such interest rate floor.
An interest rate collar combines the elements of purchasing a cap
and selling a floor. The collar protects against an interest
rate rise above the maximum amount, but gives up the benefits of
an interest rate decline below the minimum amount. There can be
no assurance that the Funds will be able to enter into interest
rate swaps, caps, floors or collars on favorable terms.
Furthermore, there can be no assurance that any of the Funds will
be able to terminate an interest rate swap or sell or offset
interest rate caps, floors or collars notwithstanding any terms
in the agreements providing for such termination.
Inasmuch as these hedging transactions are entered into for
hedging purposes, the Adviser and the Funds believe swaps, caps,
floors and collars do not constitute senior securities and,
accordingly, will not treat them as being subject to its
borrowing restrictions. The net amount of the excess, if any, of
a Fund's obligations over its entitlement with respect to each
interest rate swap will be accrued on a daily basis, and an
amount of cash or liquid securities having an aggregate net asset
value at least equal to the accrued excess will be maintained in
a segregated account by a custodian that satisfies the
requirements of the 1940 Act.
The Short and Intermediate Funds will not write interest rate
caps, floors and collars, and will not enter into any interest
rate swap, cap, floor or collar transaction unless the unsecured
commercial paper, unsecured senior debt or the claims-paying
ability of the other party is rated either AA or A-1 or better by
Standard & Poor's or Aa or P-1 or better by Moody's Investors
Service, Inc. at the time of entering into such transaction.
If there is default by the other party to such a transaction, the
Funds will have contractual remedies pursuant to the agreements
related to the transaction. There is no assurance that interest-
rate swap, cap, floor or collar counterparties will be able to
meet their obligations pursuant to their contracts, or that, in
the event of default, a Fund will succeed in pursuing contractual
remedies. The Funds thus assume the risk that one of them may be
delayed in or prevented from obtaining payments owed to it
pursuant to interest rate swaps, caps, floors or collars.
The swap, cap, floor and collar market has grown substantially in
recent years with a large number of banks and investment banking
firms acting both as principals and as agents utilizing
11
standardized documentation. As a result, this market has become
relatively liquid, although the Funds will still treat these
instruments as illiquid investments subject to the limitation on
such investments described under "Illiquid Securities" in the
Prospectus.
INVESTMENT RESTRICTIONS
The following restrictions (except as noted) have been adopted as
fundamental policies for the Funds, which means that they may not
be changed without the approval of a majority of the outstanding
shares of each of the Funds, as the case may be (as defined in
the Investment Company Act). A Fund may not (except that none of
the following investment restrictions shall prevent a Fund from
investing all of its assets (other than assets which are not
"investment securities" as defined in the Investment Company Act)
in an open-end investment company with substantially the same
investment objectives):
1. Issue senior securities, borrow money or pledge its assets,
except that the Short or Intermediate Fund may borrow from banks
or through reverse repurchase agreements or dollar rolls up to 33
1/3% of the value of its respective total assets (calculated when
the loan is made) for temporary, extraordinary or emergency
purposes and to take advantage of investment opportunities, and
may pledge up to 33 1/3% of the value of its total assets to
secure such borrowings. For purposes of this restriction, the
purchase or sale of securities on a "when issued" or "delayed
delivery" basis, the purchase and sale of futures contracts, the
entry into reverse repurchase agreements and dollar roll
transactions, short sales, interest rate swaps, mortgage swaps,
over-the-counter options, and collateral arrangements with
respect thereto are not deemed to be a pledge of assets and none
of such transactions or arrangements nor obligations of the Funds
to Trustees pursuant to deferred compensation arrangements are
deemed to be the issuance of a senior security.
2. Act as underwriter except to the extent that, in connection
with the disposition of portfolio securities, it may be deemed to
be an underwriter under certain federal securities laws.
3. Purchase any security (other than obligations of the U.S.
Government, its agencies and instrumentalities) if as a result:
(i) with respect to 75% of its total assets more than 5% of the
Short or Intermediate Fund's total assets (determined at the time
of investment) would then be invested in securities of a single
issuer, or (ii) 25% or more of a Fund's total assets (determined
at the time of investment) would be invested in one or more
issuers having their principal business activities in the same
industry.
4. Purchase the securities of any issuer which would result in
owning more than 10% of any class of the outstanding voting
securities of such issuer.
5. Purchase any security, other than Mortgage-Backed
Securities, or obligations of the U.S. Government, its
agencies or instrumentalities, if as a result the Short or
12
Intermediate Fund would have invested more than 5% of its
respective total assets in securities of issuers (including
predecessors) having a record of less than three years of
continuous operation; except for investments in regulated
investment companies with the same objective.
6. Acquire, lease or hold real estate. (Does not preclude
investments in securities collateralized by real estate or
interests therein.)
7. Purchase or sell commodities or commodity contracts except
for hedging purposes.
8. Invest in interests in oil, gas or other mineral exploration
or development program.
9. Invest in companies for the purpose of exercising control or
management.
10. Purchase securities of other investment companies, except to
the extent permitted by the Investment Company Act.
11. Make loans of money or property to any person, except
through loans of portfolio securities to Qualified Institutions,
the purchase of debt obligations in which the Short or
Intermediate Fund may invest consistently with its investment
objectives and policies and investment limitations or the
investment in repurchase agreements with Qualified Institutions.
The Short or Intermediate Fund will not lend portfolio securities
if, as a result, the aggregate of such loans exceeds 33 1/3% of
the value of a Fund's respective total assets (including such
loans).
12. Purchase securities on margin (though the Short or
Intermediate Fund may obtain such short-term credits as may be
necessary for the clearance of transactions); provided that the
deposit or payment by a Fund of initial or variation margin in
connection with options or futures contracts is not considered
the purchase of a security on margin.
13. Make short sales of securities or maintain a short position
if, when added together, more than 25% of the value of the Short
or Intermediate Fund's net assets would be (i) deposited as
collateral for the obligation to replace securities borrowed to
effect short sales, and (ii) allocated to segregated accounts in
connection with short sales. Short sales "against-the box" are
not subject to this limitation.
Whenever any fundamental investment policy or investment
restriction states a maximum percentage of assets, it is intended
that if the percentage limitation is met at the time the
investment is made, a later change in percentage resulting from
changing total or net asset values will not be considered a
violation of such policy. However, in the event that the asset
coverage for borrowings falls below 300%, the Funds will take
prompt action to reduce its borrowings as required by applicable
laws.
In order to change any of the foregoing restrictions, which are
13
fundamental policies, approval must be obtained by shareholders
of the Short or Intermediate Fund, as the case may be. Such
approval requires the affirmative vote of the lesser of (i) 67%
or more of the voting securities present at a meeting if the
holders of more than 50% of voting securities are represented at
that meeting or (ii) more than 50% of the outstanding voting
securities of either the Short or Intermediate Fund.
In addition, as non-fundamental policies, a Fund may not:
(a) sell over-the-counter options which it does not own;
(b) sell options on futures contracts which options it does not
own; or
(c) invest in residual interests in a REMIC or a CMO.
Other Policies
There are no restrictions or limitations on investments in
obligations of the United States, or of corporations chartered by
Congress as federal government instrumentalities. The underlying
assets of the Short or Intermediate Fund may be retained in cash,
including cash equivalents which are Treasury bills, short-term
bank obligations such as certificates of deposit, bankers'
acceptances and repurchase agreements. However, it is intended
that only so much of the underlying assets of the Short or
Intermediate Fund be retained in cash as is deemed desirable or
expedient under then-existing market conditions. As noted in the
Prospectus, a Fund may invest up to 15% of its respective total
net assets in illiquid securities.
TRUSTEES AND OFFICERS
The Board of Trustees has the responsibility for the overall
management of the Series Fund and each of the Funds, including
general supervision and review of the Funds' investment
activities. The Trustees, in turn, elect the officers who are
responsible for administering the day-to-day operations of the
Funds. Trustees and officers of the Series Fund are identified in
the Prospectus.
All of the Trustees are Trustees of all the other Funds
managed by the Adviser and each independent Trustee receives fees
for his or her services. The Trustees do not receive pension or
retirement benefits from the Funds. The table below shows the
fees paid by each of the Funds of the Smith Breeden Series Fund
separately to each independent Director for the fiscal year ended
March 31, 1999, and the total fees paid by the entire Fund
complex for the fiscal year ended March 31, 1999. There are five
other Funds in the complex besides the Short Duration U.S.
Government Fund and the Intermediate Duration U.S. Government
Fund.
14
Total Total Total
Compensation Compensation Compensation
Director Paid by Paid by Paid by Smith
Short Fund Intermediate Breeden Fund
Fund Complex
Stephen M. $ 0.00 $ 35,000.00 $ 70,000.00
Schaefer
Myron S. $ 70,000.00 $ $ 70,000.00
Scholes 0.00
William F. $ 0.00 $ $ 70,000.00
Sharpe 0.00
The Series Fund's Declaration of Trust provides that it will
indemnify its Trustees and officers against liabilities and
expenses incurred in connection with litigation in which they may
be involved because of their offices with the Series Fund, unless
it is determined that they had acted with willful misfeasance,
bad faith, gross negligence or reckless disregard of the duties
involved in their offices, or had not acted in good faith in the
reasonable belief that their actions were in the best interests
of the Series Fund or the Funds.
INVESTMENT ADVISORY AND OTHER SERVICES
The investment manager of each of the Funds is Smith Breeden
Associates, Inc. (the "Adviser"). The table in the Prospectus
indicates which officers and Trustees are affiliated persons of
the Adviser.
Pursuant to an Investment Advisory Agreement with each of the
Funds (the "Advisory Agreement"), the Adviser provides investment
research and portfolio management services, including the
selection of securities to purchase, hold or sell, and the
selection of brokers and dealers through whom portfolio
transactions are executed. The Adviser's activities are subject
to the review and supervision of the Board of Trustees to whom
the Adviser renders periodic reports of both Funds' investment
activities. The Adviser, at its own expense, furnishes the Funds
with office space and office furnishings, facilities and
equipment required for managing the business affairs of the
Funds; maintains all internal bookkeeping, clerical, secretarial
and administrative personnel and services; carries fidelity
insurance on its own officers and directors for the protection of
the Funds; and provides certain telephone and other mechanical
services. Except for the expense limitation in place through
August 1, 1999, each of the Funds bears all expenses related to
its operation not borne by the Adviser, as discussed in the
Prospectus.
Each Advisory Agreement is in effect until August 1, 1999.
Thereafter, it may continue in effect for successive periods not
exceeding one year, providing such continuance is specifically
approved at least annually by a vote of the Funds' Board of
Trustees or by a vote of the holders of a majority of each of the
Funds' outstanding voting securities, and in either event by a
majority of the Fund's Trustees who are not parties to the
Agreement or interested persons of any such party (other than as
15
Trustees of the Fund), cast in person at a meeting called for
that purpose. Each Advisory Agreement may be terminated without
penalty at any time by each Fund, or by the Adviser on sixty
days' written notice and will automatically terminate in the
event of its assignment as defined in the Investment Company Act.
The Advisory Agreement provides that the Adviser will not be
liable for any error of judgment or for any loss suffered by
either Fund in connection with matters to which the Advisory
Agreement relates, except a loss resulting from willful
misfeasance, bad faith gross negligence or reckless disregard of
duty.
As compensation for the services rendered to each of the Funds by
the Adviser under the terms of the Advisory Agreement, and the
assumption by the Adviser of the related expenses, each Fund pays
the Adviser a fee, computed daily and payable monthly, at an
annual rate equal to 0.70% of the respective Fund's average daily
net asset value. Advisory fees paid by the Funds for the past
three fiscal years are as follows:
Advisory Fee Advisory Fee Paid by
Fiscal Year Ended Paid by Intermediate Fund
Short Fund
March 31, 1999 $ 508,343 $ 355,620
March 31, 1998 $ 727,735 $ 271,230
March 31, 1997 $ 1,417,921 $ 259,767
The following chart details the reimbursements the Adviser made
to the Funds for each of the last three fiscal years, under
expense limitation provisions:
Amount Amount Reimbursed
Fiscal Year Ended Reimbursed by Adviser to
by Adviser to Intermediate Fund
Short Fund
March 31, 1999 $ 155,616 $ 83,434
March 31, 1998 $ 231,365 $ 97,835
March 31, 1997 $ 301,998 $ 101,379
Under the terms of its Advisory agreement with each of the Funds,
the Adviser also provides certain administrative services. First
Data Investor Services, Inc. is the shareholder servicing,
accounting, transfer and dividend paying agent. Each of the
Funds pays its own expenses, including, but not limited to
auditing, legal, tax preparation and consulting, insurance,
custodial, accounting, shareholder servicing and shareholder
report expenses. Fees paid to First Data Investor Services are
determined by contract as approved by the Trustees.
Bank of New York, 48 Wall Street, New York, NY, 10286 acts as
custodian of the securities and other assets of each of the
Funds. A custodian's responsibilities include generally
safeguarding and controlling a Fund's cash and securities,
handling the receipt and delivery of securities, and collecting
interest and dividends on a Fund's investments. The custodian
does not participate in decisions relating to the purchase and
sale of portfolio securities.
16
Deloitte & Touche, 117 Campus Drive, Princeton, New Jersey 08540,
are the Funds' independent auditors, providing audit services,
tax return preparation and other tax consulting services, and
assistance and consultation in connection with the review of
various Securities and Exchange Commission filings. Ropes &
Gray, One International Place, Boston, Massachusetts, 02110-2624,
are legal counsel to the Series Fund and each of the Funds.
PRINCIPAL HOLDERS OF SECURITIES AND CONTROLLING PERSONS
Listed below are the names and addresses of those shareholders
who, to the Short Fund's best knowledge, as of April 30, 1999,
owned 5% or more of the shares of the Fund.
Charles Schwab & Co.
For the Beneficial Ownership of Its Accountholders
101 Montgomery Street
San Francisco, CA 94104 39.66%
Webster Financial
PO BOX 191
Waterbury, CT 06720 6.90%
Pacific Mutual Door Company
1525 West 31st Street
Kansas City, MO 64108 6.90%
Redland Insurance Company
535 West Broadway
Council Bluffs, IA 51503 6.28%
Harris Regional Hospital
59 Hospital Road
Sylva, NC 28779 5.11%
The Officers and Trustees of the Short Fund together as a group
owned less than 1.00% of the shares of the Short Duration Fund as
of April 30, 1999.
Listed below are the names and addresses of those shareholders,
who as of April 30, 1999, to the best knowledge of the
Intermediate Fund, owned 5% or more of shares of the Fund.
Charles Schwab & Co.
For the Beneficial Ownership of Its Accountholders
101 Montgomery Street
San Francisco, CA 94104 52.61%
Webster Bank
145 Bank Street
Webster Plaza
Waterbury, CT 06720 29.93%
The Officers and Trustees of the Intermediate Fund together as a
group owned less than 1.00% of the shares of the Fund as of April
30, 1999.
17
Potential Conflicts of Interest
Principals of the Adviser as individuals own approximately 70% of
the common stock of Harrington Financial Group, the holding
company for Harrington Bank, FSB (the "Bank"). The Bank invests
in assets of the same types as those to be held by the Funds.
Douglas T. Breeden, in combination with immediate family members,
controls over 75% of the common stock of Community First
Financial Group, Inc. ("CFFG"), the holding company for certain
banks and thrifts to which the Adviser renders certain Investment
Advisory Services. CFFG and its subsidiaries invest in assets of
the same types as those to be held by the Funds.
The Adviser may also manage advisory accounts with investment
objectives similar to or the same as those of the Short or
Intermediate Fund, or different from both Funds, but trading in
the same type of securities and instruments. Portfolio decisions
and results of both Funds' investments may differ from those of
such accounts managed by the Adviser. When two or more accounts
managed by the Adviser seek to purchase or sell the same assets,
the assets actually purchased or sold may be allocated among the
accounts on a basis determined by the Adviser in its good faith
discretion to be equitable. In some cases, this system may
adversely affect the size or the price of the position obtainable
for the Short or Intermediate Fund.
POLICIES REGARDING BROKERS USED IN PORTFOLIO TRANSACTIONS
Under the Advisory Agreement, the selection of brokers and
dealers to execute transactions on behalf of a Fund is made by
the Adviser in accordance with criteria set forth in the Advisory
Agreement and any directions which the Board of Trustees may
give. However, each of the Funds does not anticipate that it will
incur a significant amount of brokerage expense because brokerage
commissions are not normally incurred on investments in Mortgage
Securities, which are generally traded on a "net" basis; that is,
in principal amounts without the addition or deduction of
brokerage commissions. The following table details the brokerage
commissions paid by the Funds for the last three fiscal years:
Brokerage Brokerage
Fiscal Year Ended Commissions Commissions
Paid By Short Fund Paid By Intermediate
Fund
March 31, 1999 $ 16,929 $ 5,999
March 31, 1998 $ 25,408 $ 2,038
March 31, 1997 $ 51,367 $ 4,203
When placing a portfolio transaction, the Adviser attempts to
obtain the best net price and execution of the transaction. On
portfolio transactions that are done on a securities exchange,
the amount of commission paid by the Short or Intermediate Fund
is negotiated between the Adviser and the broker executing the
transaction. The Adviser seeks to obtain the lowest commission
rate available from brokers that are felt to be capable of
efficient execution of the transactions. The determination and
18
evaluation of the reasonableness of the brokerage commissions
paid in connection with portfolio transactions are based to a
large degree on the professional opinions of the persons
responsible for the placement and review of such transactions.
These opinions are formed on the basis of, among other things,
the experience of these individuals in the securities industry
and information available to them concerning the level of
commissions being paid by other institutional investors of
comparable size.
Securities may be purchased directly from issuers or from
underwriters. Where possible, purchase and sale transactions will
be effected through dealers (including banks) which specialize in
the types of securities which the Funds will be holding, unless
better executions are available elsewhere. Dealers and
underwriters usually act as principals for their own account.
Purchases from underwriters will include a concession paid by the
issuer to the underwriter, and purchases from dealers will
include the spread between the bid and the asked price. No broker
or dealer affiliated with the Funds or with the Adviser may
purchase securities from, or sell securities to, the Funds.
When it is felt that several brokers or dealers are equally able
to provide the best net price and execution, the Adviser may
decide to execute transactions through brokers or dealers who
provide quotations and other services to the Short or
Intermediate Fund, specifically including the quotations
necessary to determine each of the Fund's net assets, in such
amount of total brokerage as may reasonably be required in light
of such services, and through brokers and dealers who supply
statistical and other data to both Funds in such amount of total
brokerage as may reasonably be required.
The Adviser conducts extensive proprietary fixed income research
with emphasis on mortgage-backed securities. The Adviser is not
dependent on any broker for such research and analysis and, thus
is able to transact business with brokers regardless of the
brokers' research capabilities or provision of such research to
brokerage customers. The Adviser uses multiple electronic
quotation services for trading and pricing purposes. The Adviser
pays for these services directly out of its advisory fees. The
Adviser is not involved in any soft dollar arrangements. The
Adviser does utilize broker pricing guidance for certain assets
not consistently available through electronic quotation services.
ADDITIONAL INFORMATION REGARDING PURCHASES AND REDEMPTIONS OF
FUND SHARES
All checks, drafts, wires and other payment mediums used for
purchasing or redeeming shares of either of the Funds must be
denominated in U.S. Dollars. Each Fund reserves the right, in
its sole discretion, to either (a) reject any order for the
purchase or sale of shares denominated in any other currency, or
(b) to honor the transaction or make adjustments to shareholder's
account for the transaction as of a date and with a foreign
currency exchange factor determined by the drawee bank. Dividend
checks which are returned to a Fund marked "unable to forward" by
the postal service will be deemed to be a request to change the
19
dividend option and the proceeds will be reinvested in additional
shares at the current net asset value until new instructions are
received.
Redemptions in Kind
The Funds have committed themselves to pay in cash all requests
for redemption by any shareholder of record, limited in amount,
however, during any 90-day period to the lesser of $250,000 or 1%
of the value of either Fund's net assets at the beginning of such
period. Such commitment is irrevocable without the prior approval
of the Securities and Exchange Commission. In the case of
requests for redemption in excess of such amounts, the Trustees
reserve the right to make payments in whole or in part in
securities or other assets of either of the Funds in case of an
emergency, or if the payment of such redemption in cash would be
detrimental to the existing shareholders of either of the Funds.
In such circumstances, the securities distributed would be valued
at the price used to compute the Short or Intermediate Fund's net
assets. Should the Short or Intermediate Fund do so, a
shareholder may incur brokerage fees or other transaction costs
in converting the securities to cash.
Principal Underwriter
First Data Distributors, Inc. (the "Principal Underwriter"),
4400 Computer Drive, Westborough, MA, 01581, is the principal
underwriter for the Funds and will act on a best efforts basis.
First Data Distributors, Inc. is registered as a broker-dealer
under the Securities Exchange Act of 1934 and is a member of the
National Association of Securities Dealers, Inc. The offering of
the Funds' shares is continuous.
The underwriting agreement with the Principal Underwriter
provides that each Fund will pay all fees and expenses in
connection with: registering and qualifying its shares under the
various state "blue sky" laws; preparing, setting in type,
printing, and mailing its prospectuses and reports to
shareholders; and issuing its shares, including expenses of
confirming purchase orders. (See the description of the
Distribution Plan in the Prospectus). The Principal Underwriter
acts as the agent of both the Funds in connection with the sale
of their shares in all states in which the shares are qualified
and in which the Principal Underwriter is qualified as a broker-
dealer. Under the underwriting agreement, the Principal
Underwriter may accept orders for either Fund's shares at the
offering price. The Principal Underwriter may enter into
agreements with other broker-dealers for the sale of Short or
Intermediate Fund shares by them.
The Principal Underwriter is paid approximately $15,000 in
total by the Adviser for its services to the two Funds. In
addition, for the year March 31, 1999, the Principal Underwriter
received no sales charges or commissions.
Calculation of Net Asset Value
As noted in the Prospectus, the Funds will generally calculate
their net asset value as of the close of trading each Monday
20
through Friday that the Adviser and Transfer Agent are open for
business and sufficient trading takes place to impact the value
of the Short or Intermediate Fund assets. As of the date of this
Statement, current holiday schedules indicate that the net asset
value will not be calculated on: New Year's Day, Presidents' Day,
Dr. Martin Luther King Day Jr. Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Columbus Day, Veteran's Day,
Thanksgiving Day, the day following Thanksgiving, Christmas Eve,
and Christmas Day.
Reinvestment Date
The dividend reinvestment date is the date on which the
additional shares are purchased for the investor who has his
dividends reinvested. This date will vary from month to month
and is not necessarily the same date as the record date or the
payable date for cash dividends.
Ownership and Authority Disputes
In the event of disputes involving multiple claims of ownership
or authority to control a shareholder's account, each Fund has
the right (but no obligation) to (a) require the written
agreement of all persons deemed by the Fund to have a potential
property interest in the account, prior to executing instructions
regarding the account; (b) interplead disputed funds or account
with a court of competent jurisdiction, or (c) surrender
ownership of all or a portion of the account to the Internal
Revenue Service in response to a Notice of Levy.
TAXES
Taxation of the Funds
For federal income tax purposes, each of the Funds will be
treated as a separate corporation. Each of the Funds intends to
qualify each year and elects to be treated as regulated
investment companies ("RICs") for federal income tax purposes. To
so qualify, the Funds must, among other things: (i) derive at
least 90% of their gross income for each taxable year from
dividends, interest, payments with respect to loans of securities
and gains from the sale or other disposition of securities or
certain other related income; and (ii) diversify their holdings
so that at the end of each quarter of the taxable year (A) at
least 50% of the value of each of the Fund's assets would be
represented by cash, U.S. Government securities, securities of
other RICs, and other securities which, with respect to any one
issuer, do not represent more than 5% of the value of each of the
Fund's assets nor more than 10% of the voting securities of such
issuer and (B) not more than 25% of the value of each of the
Fund's assets are invested in the securities of any one issuer
(other than U.S. Government securities or the securities of other
RICs).
If the Funds qualify as RICs and distribute to their shareholders
at least 90% of their net investment income (including tax-exempt
interest and net short-term capital gain but not net capital
gain, which is the excess of net long-term capital gains over net
21
short term capital losses), then the Funds will not be subject to
federal income tax on the income so distributed. However, the
Funds will be subject to corporate income tax on any
undistributed income. In addition, either of the Funds would be
subject to a nondeductible 4% excise tax on the amount by which
the income it distributed in any calendar year would be less
than a minimum distribution amount. The minimum distribution
amount required to avoid the excise tax for a calendar year
equals the sum of (i) 98% of a Fund's ordinary income (excluding
tax-exempt interest income) for such calendar year; (ii) 98% of
the excess of capital gains over capital losses for the one year
period ending on October 31 of each year; and (iii) 100% of the
undistributed ordinary income and gains from prior years. For
purposes of the excise tax, any income or capital gains retained
by, and taxed in the hands of, either of the Funds will be
treated as having been distributed.
Both Funds intend to distribute sufficient income so as to avoid
corporate income tax and excise tax. The Short Fund may be
subject to a 4% excise tax to the extent that the amount of
ordinary income distributed during the calendar year is less than
98% of the ordinary income (excluding tax-exempt interest income)
for the year. The Short Fund will endeavor to pay dividends in
such a manner that an excise tax will not be incurred. The Short
Fund also may elect to retain all or a portion of its net capital
gain, as described under "Taxation of Shareholders Distributions"
below.
Any capital losses resulting from the disposition of securities
can be used only to offset capital gains and cannot be used to
reduce a Fund's ordinary income. Such capital losses may be
carried forward for eight years. If any capital losses have not
been utilized at the time a Fund terminates, such capital losses
will become unusable.
Taxation of Shareholders
Distributions. In general, all distributions to shareholders
attributable to the Short or Intermediate Fund's net investment
income (including any tax-exempt interest income distributed)
will be taxable as ordinary dividend income whether paid in cash
or in additional shares.
To the extent either of the Funds does realize net capital gains,
it intends to distribute such gains at least annually and
designate them as capital gain dividends. Capital gain dividends
are taxable as capital gains, whether paid in cash or in
additional shares, regardless of how long the shares have been
held. The Short or Intermediate Fund may elect to retain net
capital gains and pay corporate income tax thereon. In such
event, the Short or Intermediate Fund would most likely make an
election that would require each shareholder of record on the
last day of the Fund's taxable year to include in income for tax
purposes his proportionate share of the Fund's undistributed net
capital gain. If such an election is made, each shareholder would
be entitled to credit his proportionate share of the tax paid by
the Fund against his federal income tax liabilities and to claim
refunds to the extent that the credit exceeds such liabilities.
In addition, the shareholder would be entitled to increase the
22
basis of his shares for federal tax purposes by an amount equal
to 66% of his proportionate share of the undistributed net
capital gain.
Shareholders receiving distributions in the form of additional
shares will be treated for federal income tax purposes as
receiving an equivalent amount of cash. In general, the basis of
such shares will equal the amount of cash that the shareholder
would have received if he had elected to receive distributions in
cash.
Liquidating distributions which, in the aggregate, exceed a
shareholder's basis in shares will be treated as gain from the
sale of shares. If a shareholder receives, in the aggregate,
liquidating distributions which are less than such basis, such
shareholder will recognize a loss to that extent. Dividends and
other distributions by either the Short or Intermediate Fund are
generally taxable to the shareholders at the time the dividend or
distribution is made.
If a shareholder purchases shares at a cost that reflects an
anticipated dividend, such dividend will be taxable even though
it represents economically a return of part of the purchase
price. Investors should consider the tax implications of buying
shares shortly prior to a distribution.
Sale or Redemption of Shares. The sale, exchange, or redemption
of Fund shares may give rise to a gain or loss. In general, any
gain or loss realized upon a taxable disposition of shares will
be treated as long-term capital gain or loss if the shares have
been held for more than one year. Otherwise the gain or loss on
the sale, exchange or redemption of Fund shares generally will be
treated as short-term capital gain or loss. In addition, any
loss (not already disallowed as provided in the next sentence)
realized upon a taxable disposition of shares held for six months
or less will be treated as long-term, rather than short-term, to
the extent of any long-term capital gain distributions received
by the shareholder with respect to the shares. All or a portion
of any loss realized upon a taxable disposition of Fund shares
will be disallowed if other Fund shares are purchased within 30
days before or after the disposition. In such a case, the basis
of the newly purchased shares will be adjusted to reflect the
disallowed loss.
Tax-Exempt Investors. If a shareholder that is a benefit plan
investor (e.g., an individual retirement account, pension plan
401(k) plan, or Keogh plan) or charitable organization (a "Tax
Exempt Investor") incurs debt to finance the acquisition of its
shares, a portion of the income received by the Tax-Exempt
Investor with respect to its shares would constitute unrelated
business taxable income ("UBTI"). In that case, the UBTI portion
of the Tax Exempt Investor's income from its investment in the
Short or Intermediate Fund for the year would equal the total
income recognized by the Tax-Exempt Investor in that year
multiplied by the ratio of the Tax-Exempt Investor's average
acquisition debt balance to the average tax basis of its shares
for the year. A Tax Exempt Investor is generally subject to
federal income tax to the extent that its UBTI for a taxable year
exceeds its annual $1,000 exclusion.
23
Tax Consequences of Certain Fund Investments
Hedging Transactions. Each of the Funds intends to engage in
various hedging transactions. Under various provisions of the
Code, the result of such investments and transactions may be to
change the character of recognized gains and losses, accelerate
the recognition of certain gains and losses, and defer the
recognition of certain losses. For example, the tax treatment of
futures contracts entered into by a Fund as well as listed
nonequity options written or purchased by a Fund on U.S.
exchanges (including options on debt securities and options on
futures contracts) will be governed by section 1256 of the Code.
Absent a tax election for "mixed straddles" (described below),
each such position held by a Fund on the last business day of
each taxable year will be marked to market (i.e., treated as if
it were closed out), and all resulting gain or loss will be
treated as 60% long term capital gain or loss and 40% short-term
capital gain or loss, with subsequent adjustments made to any
gain or loss realized upon an actual disposition of such
positions (currently, the 60% long-term portion will be treated
as if held for more than 12 months). When a Fund holds an option
or contract governed by section 1256 which substantially
diminishes the Fund's risk of loss with respect to another
position of its Portfolio not governed by section 1256 (as might
occur in some hedging transactions), that combination of
positions generally will be a "mixed straddle" that is subject to
the straddles rules of section 1092 of the Code. The application
of Section 1092 might result in deferral of losses, adjustments
in the holding periods of a Fund's securities and conversion of
short term capital losses into long-term capital losses. Either
Fund may make certain tax elections for its "mixed straddles"
that could alter certain effects of section 1256 or section 1092.
Tax Implications of Certain Investments. Certain of a Fund's
investments, including investments in stripped securities, will
create taxable income in excess of the cash they generate. In
such cases, a Fund may be required to sell assets (including when
it is not advantageous to do so) to generate the cash necessary
to distribute to its shareholders all of its income and gains and
therefore to eliminate any tax liability at the Fund level.
The character of the Short or Intermediate Fund's taxable income
will, in most cases, be determined on the basis of reports made
to the Funds by the issuers of the securities in which they
invest. The tax treatment of certain securities in which a Fund
may invest is not free from doubt and it is possible that an IRS
examination of the issuers of such securities could result in
adjustments to the income of a Fund. The foregoing discussion is
a general summary of certain of the current federal income tax
laws regarding both Funds and investors in the shares.
THE TAX DISCUSSION SET FORTH ABOVE IS A SUMMARY INCLUDED FOR
GENERAL INFORMATION PURPOSES ONLY. EACH SHAREHOLDER IS ADVISED TO
CONSULT ITS OWN TAX ADVISER WITH RESPECT TO THE SPECIFIC TAX
CONSEQUENCES TO IT OF AN INVESTMENT IN A FUND, INCLUDING THE
EFFECT AND APPLICABILITY OF STATE, LOCAL, FOREIGN, AND OTHER TAX
LAWS AND THE POSSIBLE EFFECTS OF CHANGES IN FEDERAL OR OTHER TAX
LAWS. THIS DISCUSSION IS NOT INTENDED AS A SUBSTITUTE FOR CAREFUL
TAX PLANNING.
24
STANDARD PERFORMANCE MEASURES
Performance
As noted in the Prospectus, a Fund may from time to time quote
various performance figures to illustrate its past performance.
It may occasionally cite statistics to reflect its volatility or
risk.
Performance quotations by investment companies are subject to
rules adopted by the Securities and Exchange Commission ("SEC").
These rules require the use of standardized performance
quotations, or alternatively, that every non-standardized
performance quotation furnished by a Fund be accompanied by
certain standardized performance information computed as required
by the SEC. Current yield and average annual compounded total
return quotations used by a Fund are based on the standardized
methods of computing performance mandated by the SEC. An
explanation of those and other methods used by a Fund to compute
or express performance follows.
Total Return
The average annual total return is determined by finding the
average annual compounded rates of return over one, five, and ten
year periods (or for the life of a Fund, if shorter) that would
equate an initial hypothetical $1000 investment to its ending
redeemable value. The calculation assumes no sales charge is
deducted from the initial $1000 purchase order, capital gains and
all income dividends are reinvested at net asset value on the
reinvestment dates during the period. The quotation assumes the
account was completely redeemed at the end of each one, five and
ten year period and the deduction of all applicable charges and
fees.
A Fund's average annual compounded rate of return is determined
by reference to a hypothetical $1000 investment, according to the
following formula:
P(1+T)n = ERV
where:
P = a hypothetical initial payment of $1000
T = average annual total return
n = number of years
ERV = ending redeemable value of a
hypothetical $1000 payment made at the beginning
of the 1, 5, or 10 year periods at the end of
said 1, 5, or 10 year periods (or fractional
portion thereof).
As discussed in the Prospectus, a Fund may quote total rates of
return in addition to its average annual total return. Such
quotations are computed in the same manner as a Fund's average
annual compounded rate, except that such quotations will be based
on a Fund's actual aggregate return for a specified period as
opposed to its average return over certain periods.
Yield
25
Current yield reflects the income per share earned by a Fund's
portfolio investments. Current yield is determined by dividing
the net investment income per share earned during a 30 day base
period by the offering price or net asset value per share, as the
case may be, on the last day of the period and analyzing the
result, according to the following formula:
Yield = 2 [(a-b + 1)6 -1]
cd
where:
a = dividends and interest earned during the
period.
b = expenses accrued for the period (net of
reimbursements).
c = the average daily
number of shares outstanding during the
period that were entitled to receive
dividends.
d = the maximum offering
price or net asset value per share, as
the case may be, on the last day of the
period.
The following table shows the average annual total return for
the periods stated, and yield for the Funds for the 30-day period
ended March 31, 1999.
Average Annual Total Return
One Year Five Years Inception 30-Day
Yield
Short Fund 4.83% 5.83% 5.50% 5.50%
Intermediate 5.73% 7.59% 8.10% 5.34%
Fund
The investment results of the Funds, like all others, fluctuate
over time. Thus, performance figures should not be considered to
represent what an investment may earn in the future or what the
Short or Intermediate Fund's yield or total return may be for any
future period.
Current Distribution Rate
Yield, which is calculated according to a formula prescribed by
the SEC, is not indicative of the amounts which will be paid to a
Fund's shareholders. Amounts paid to shareholders are reflected
in the quoted "current distribution rate." The current
distribution rate is computed by dividing the total amount of
dividends, excluding long-term capital gains, per share paid by a
Fund during the past twelve months by its current net asset
value. Under certain circumstances, such as when there has been a
change in the amount of dividend payout, or a fundamental change
in investment policies, it might be appropriate to annualize the
dividends paid over the period such policies were in effect,
rather than using the dividends during the past twelve months.
The current distribution rate differs from the current yield
computation because it may include distributions to shareholders
from sources other than dividends and interest, such as short-
term capital gains and net equalization credits and is calculated
26
over a different period of time.
Volatility
Occasionally statistics may be used to specify a Fund's
volatility or risk. Measures of volatility or risk are generally
used to compare fund net asset value or performance relative to a
market index. One measure of volatility is beta. The ratio of
the expected excess return on a Fund to the expected excess
return on the market index is called beta. Equity funds commonly
use the S&P 500 as their market index. A beta of more than 1.00
indicates volatility greater than the market, and a beta of less
that 1.00 indicates volatility less than the market. Another
measure of volatility or risk is standard deviation. Standard
deviation is used to measure variability of net asset value or
total return around an average, over a specified period of time.
The premise is that greater volatility connotes greater risk
undertaken in achieving performance.
A statistic often used by sophisticated institutional investors
when comparing the relative performance of portfolios is the
Sharpe Ratio. This statistic is a Fund's excess return (relative
to T-Bills) divided by the standard deviation of its returns.
Comparisons and Advertisements
To help investors better evaluate how an investment in a Fund
might satisfy their objective, advertisements regarding either of
the Funds may discuss various measures of a Fund's performance as
reported by various financial publications. Advertisements may
also compare performance (as calculated above) to performance as
reported by other investments, indices, and averages. The
following publications, indices, and averages may be used:
a) Lipper-Mutual Fund Performance Analysis, Lipper-Fixed Income
Analysis, and Lipper-Mutual Fund Indices - measures total return
and average current yield for the mutual fund industry and rank
individual mutual fund performance over specified time periods
assuming reinvestment of all distributions, exclusive of sales
charges.
b) CDA Mutual Fund Report, published by CDA Investment
Technologies, Inc. - analyzes price, current yield, risk, total
return, and average rate of return (average annual compounded
growth rate) over specified time periods for the mutual fund
industry.
c) Mutual Fund Source book, published by Morningstar, Inc. -
analyzes price, yield, risk, and total return for equity and
fixed income funds.
d) Financial publications: Barron's, Business Week, Changing
Times, Financial World, Forbes, Fortune, and Money magazines -
rate fund performance over specified time periods.
e) Consumer Price Index (or Cost Of Living Index), published by
the U.S. Bureau of Labor Statistics - a statistical measure of
change, over time, in the price of goods and services, in major
expenditure groups.
27
f) Stocks, Bonds, Bills, and Inflation, published by Ibbotson
Associates - a historical measure of yield, price, and total
return for common and small company stock, long-term government
bonds, treasury bills, and inflation.
g) Savings and Loan Historical Interest Rates - as published in
the U.S. Savings & Loan League Fact Book.
h) Salomon Brothers Broad Bond Index - measures yield, price,
and total return for Treasury, Agency, Corporate, and
Mortgage bonds. All issues mature in one year or more and
have at least $50 million outstanding, with the exception of
mortgages. The entry criteria for mortgage issues is $200
million for each coupon.
i) Salomon Brothers Mortgage Index - measures only the mortgage
component of the Salomon Brothers Broad Bond Index.
j) Salomon Brothers Composite High Yield Index or its component
indices - measures yield, price and total return for Long-
Term High Yield Index, Intermediate Term High Yield Index,
and Long-Term Utility High Yield Index.
k) Lehman Brothers Aggregate Bond Index or its component
indices - measures yield, price and total return for Treasury,
Agency, Corporate, Mortgage, and Yankee bonds.
l) Lehman Brothers Government/Corporate Bond Index.
m) Standard & Poor's Bond Indices - measure yield and price of
Corporate, Municipal, and Government bonds.
n) Other taxable investments including certificates of deposit
(CD's), money market deposit accounts (MMDA's), checking
accounts, savings accounts, money market mutual funds,
repurchase agreements, and government securities.
o) Historical data supplied by the research departments of
Lehman Brothers, First Boston Corporation, Morgan Stanley,
Salomon Brothers, Merrill Lynch, Goldman Sachs, Prudential
Securities and Donaldson Lufkin and Jenrette.
p) Donoghues's Money Fund Report - industry averages for 7-day
annualized and compounded yields of taxable, taxfree and
government money funds.
q) Total returns and yields for Treasury Securities and fixed
income indices as published by Ryan Laboratories or other
suppliers.
In assessing such comparisons of performance, an investor should
keep in mind that the composition of the investments in the
reported indices and averages is not identical, and in some cases
is very different, to a Fund's portfolio, that the averages are
generally unmanaged and that the items included in the
calculations of such averages may not be identical to the formula
used by a Fund to calculate its figures. In addition, there can
be no assurance that a Fund will continue its performance as
compared to such other averages.
28
Shareholders should note that the investment results of the Short
or Intermediate Fund will fluctuate over time, and any
presentation of a Fund's current yield or total return for any
period should not be considered as a representation of what an
investment may earn or what a shareholder's yield or total return
may be in any future period.
Shareholders should also note that although the Funds believe
that there are substantial benefits to be realized by investing
in its shares, such investments also involve certain risks. (See
"Investment Objectives and Policies of the Fund Risks of Mortgage
Securities" in the Funds' Prospectus).
ADDITIONAL INFORMATION FOR INSTITUTIONAL INVESTORS
As the investments permitted to the Funds are primarily in
mortgage securities issued or guaranteed by the U.S. Government
or its agencies and instrumentalities, the shares of either the
Short or Intermediate Fund may be eligible for investment by
federally chartered credit unions, federally chartered thrifts,
and national banks. Either of the Funds may be a permissible
investment for certain state chartered institutions as well,
including state and local government authorities and agencies.
Any financial institution or agency considering an investment in
either of the Funds should refer to the applicable laws and
regulations governing its operations in order to determine if a
Fund is a permissible investment.
EXPERTS
The annual financial statements of both the Short and
Intermediate Funds and related notes thereto attached to this
Statement of Additional Information have been so attached in
reliance upon the report of Deloitte & Touche LLP, independent
auditors, given in authority of said firm as experts in auditing
and accounting.
FINANCIAL STATEMENTS
The audited annual financial statements of the Funds are attached
and follow the Appendix.
APPENDIX
Description of Moody's Investors Service, Inc.'s corporate bond
ratings:
Aaa - Bonds which are rated Aaa are judged to be of the best
quality. They carry the smallest degree of investment
risk and are generally referred to as "gilt edged."
Interest payments are protected by a large or
exceptionally stable margin and principal is secure.
While the various protective elements are likely to
change, such changes as can be visualized are most
unlikely to impair the fundamentally strong position of
such issues.
29
Aa - Bonds which are rated Aa are judged to be of high
quality by all standards. Together with the Aaa group
they comprise what are generally known as high grade
bonds. They are rated lower than the best bonds because
margins of protection may not be as large as in Aaa
securities, or fluctuation of protective elements may
be of greater amplitude,or there may be other elements
present which make the long-term risks appear somewhat
larger than in Aaa securities.
A - Bonds which are rated A possess many favorable
investment attributes and are to be considered as upper
medium grade obligations. Factors giving security to
principal and interest are considered adequate but
elements may be present which suggest a susceptibility
to impairment sometime in the future.
Baa - Bonds which are rated Baa are considered as medium
grade obligations, i.e., they are neither highly
protected nor poorly secured. Interest payments and
principal security appear adequate for the present, but
certain protective elements may be lacking or may be
characteristically unreliable over any great length of
time. Such bonds lack outstanding investment
characteristics and have speculative characteristics as
well.
Ba - Bonds which are rated Ba are judged to have
predominantly speculative elements; their future cannot
be considered as well assured. Often the protection of
interest and principal payments may be very moderate
and thereby not well safeguarded during both good and
bad times over the future. Uncertainty of position
characterizes bonds in this class.
B - Bonds which are rated B generally lack characteristics of
the desirable investment. Assurance of interest and
principal payments or of maintenance of other terms of
the contract over any long period of time may be small.
Caa - Bonds which are rated Caa are of poor standing. Such
issues may be in default, or there may be present
elements of danger with respect to principal or interest.
Ca - Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in
default or have other marked shortcomings.
Description of Standard & Poor's Corporation's corporate bond
ratings:
AAA - Bonds rated AAA are given the highest rating assigned by
Standard & Poor's to a debt obligation,
which indicates an extremely strong capacity to pay
principal and interest.
30
AA - Bonds rated AA also qualify as high-quality debt
obligations. Capacity to pay principal and interest is
very strong, and in the majority of instances they
differ from AAA issues only in small degree.
A - Bonds rated A have a strong capacity to pay principal
and interest, although they are somewhat more
susceptible to the adverse effects of changes in
circumstances and economic conditions.
BBB - Bonds rated BBB are regarded as having an adequate
capacity to pay principal and interest. Whereas they
normally exhibit protection parameters, adverse
economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay principal
and interest for bonds in this capacity than for bonds
in the A category.
BB, B,
CCC, CC - Bonds rated BB, B, CCC and CC are regarded,
on balance, predominantly speculative with respect to
the issuer's capacity to pay interest and repay
principal in accordance with the terms of the
obligations. BB indicates the lowest degree of
speculation and CC the highest degree of speculation.
While such bonds will likely have some quality and
protective characteristics, these are outweighed by
large uncertainties or major risk exposures to adverse
conditions.
SMITH BREEDEN SERIES FUND
Smith Breeden Short Duration U.S. Government Fund
Smith Breeden Intermediate Duration U.S. Government Fund
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
PERFORMANCE REVIEW
The Smith Breeden Short Duration U.S. Government Fund returned 4.83% in
the year ending March 31, 1999. The Fund's benchmark, six-month U.S. Treasury
Bill, returned 5.29% over the same period as measured by Merrill Lynch. The
Fund's return exceeded the average twelve month yield on money-market funds of
4.73%1. The Graph below shows the Fund's return versus both its benchmark and
the average return of the mutual funds in Morningstar's Ultrashort Bond Fund
category.
[GRAPHIC APPEARS HERE WITH THE FOLLOWING PLOT POINTS:]
CHANGE IN VALUE OF A $10,000 INVESTMENT
<TABLE>
<CAPTION>
3/92 9/92 3/93 9/93 3/94 9/94 3/95 9/95 3/96 9/96 3/97 9/97 3/98 9/98 3/99
---- ----- ---- ----- ---- ----- ---- ----- ---- ----- ---- ----- ---- ----- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Smith Breeden Short
Duration U.S. Gov't
Fund(1) 10,000 10,363 10,567 10,831 10,956 11,222 11,676 11,967 12,254 12,652 13,059 13,490 13,874 14,202 14,544
Morningstar Avg.
Ultrashort Bond 10,000 10,342 10,554 10,798 10,930 11,088 11,404 11,778 12,120 12,467 12,823 13,426 13,604 13,985 14,312
6 Month U.S. T-Bill 10,000 10,258 10,427 10,595 10,753 10,966 11,291 11,643 11,964 12,282 12,611 12,978 13,326 13,721 14,029
- ------------
(1) Fund Returns are net 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.
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS FOR
PERIODS
ENDING MARCH 31, 1999
--------------------------------------
SINCE INCEPTION FINAL VALUE OF
1 YEAR 5 YEARS (3/31/92) $10,000 INVESTMENT
---------- --------- ----------------- -------------------
<S> <C> <C> <C> <C>
Smith Breeden Short Duration U.S. Govt Fund 4.83% 5.83% 5.50% $14,544
Six Month T-Bill ........................... 5.29% 5.46% 4.95% 14,029
Morningstar Avg. Ultrashort Bond Fund ...... 5.20% 5.54% 5.25% 14,312
</TABLE>
For the year ending March 31, 1999, the best performing fixed income
investments were those with the best credit and liquidity characteristics.
Although the Short Duration Fund has low credit risk and excellent liquidity,
the Fund's return did not exceed the return of the six-month T-Bill for the
year. In general, U.S. Treasury securities were the best performing fixed
income securities in 1998. The main factor that constrained the returns of the
Short Duration Fund was the cost of the prepayment option in the mortgage
securities that comprise most of the Fund's assets. This prepayment option is
more costly to the investor in volatile markets such as those of the last year.
Over longer periods of time, the yield advantage of mortgage securities over
Treasury securities has historically compensated for this prepayment risk.
The second half of 1998 was a difficult period for mortgage securities.
During that period the Fund returned 1.99%, while the six-month T-Bill return
was 2.73%. The markets have been much more favorable so far in 1999. In the
first quarter, the Fund returned 1.52%, 0.41% more than the six-month T-Bill.
- ---------
1 SOURCE: THE WALL STREET JOURNAL
<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS MARCH 31, 1999
<TABLE>
<CAPTION>
MARKET
FACE AMOUNT SECURITY VALUE
- --------------- --------------------------------------------------------------------------- ---------------
<S> <C> <C>
U.S. GOVERNMENT & AGENCY OBLIGATIONS -- 151.7%
FREDDIE MAC -- 11.2%
Fixed-rate (1)
$ 2,600,000 6.00% 15 Year, due date to be announced ................................... $ 2,582,633
3,997,053 8.50%, due 5/1/25 to 12/1/25 .............................................. 4,198,517
Discount Notes ............................................................
25,000 4.87%, due 9/3/99 (2), (3) ................................................ 24,504
------------
6,805,654
------------
FANNIE MAE -- 100.7%
Interest-only strip (1)
893,940 9.00%, due 7/25/21 ........................................................ 206,679
Fixed-rate (1)
10,000,000 6.00% 15 Year, due date to be announced ................................... 9,909,766
25,839,904 6.00%, due 11/1/13 to 3/1/29 .............................................. 25,317,569
4,100,000 6.50%, due 4/1/29 ......................................................... 4,079,500
4,000,000 7.00%, due 5/1/11 to 10/1/11 .............................................. 4,086,832
9,000,000 7.00% 30 Year, due date to be announced ................................... 9,125,157
1,333,755 7.043%, 30 Year, due 12/1/06 .............................................. 1,397,540
Delegated Underwriting Servicing (DUS) (1)
4,855,146 6.01%, due 12/1/08 ........................................................ 4,841,559
1,363,351 6.04%, due 10/1/08 ........................................................ 1,355,040
857,988 7.033%, due 6/1/07 ........................................................ 899,955
Discount Notes
40,000 4.96%, due 3/22/00 (2), (3) ............................................... 38,159
------------
61,257,756
------------
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION -- 39.3%
Adjustable-rate (1)
3,008,525 6.625%, due 7/20/17 to 9/20/22 ............................................ 3,068,702
1,340,122 6.875%, due 3/20/21 to 4/20/24 ............................................ 1,366,283
Fixed-rate (1)
18,426,871 7.00%, due 9/15/27 to 10/15/28 ............................................ 18,720,924
684,020 9.50%, due 7/15/09 to 4/15/25 ............................................. 737,635
------------
23,893,544
------------
U.S. TREASURY NOTES -- 0.5%
120,000 5.875% due 7/31/99 (3) .................................................... 120,488
170,000 6.375% due 5/15/99 (3) .................................................... 170,345
------------
290,833
------------
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(COST $92,187,983)......................................................... 92,247,787
------------
NOTIONAL
AMOUNT
-----------
THREE MONTH LIBOR INTEREST RATE SWAP CONTRACTS -- (2.0%)
$20,000,000 Contract dated 8/31/93 with Salomon Swapco, Expires 8/30/00,
pay rate 5.34% ............................................................ (8,094)
20,000,000 Contract dated 5/15/95 with Salomon Swapco, Expires 5/15/05,
pay rate 6.951% ........................................................... (1,218,116)
------------
TOTAL THREE MONTH LIBOR INTEREST RATE SWAP CONTRACTS ...................... (1,226,210)
------------
THREE MONTH LIBOR INTEREST RATE CAP CONTRACTS -- 0.3%
50,000,000 Contract with Salomon Swapco, expires 4/23/03, Strike rate 7.50% .......... 213,500
------------
TOTAL THREE MONTH LIBOR INTEREST RATE CAP CONTRACTS
(COST $1,336,030).......................................................... 213,500
------------
TOTAL INVESTMENTS -- 150.0% (COST $93,524,013)............................. 91,235,077
------------
</TABLE>
<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS (CONTINUED) MARCH 31, 1999
<TABLE>
<CAPTION>
MARKET
FACE AMOUNT SECURITY VALUE
- --------------- ------------------------------------------------------------ ----------------
<S> <C> <C>
REVERSE REPURCHASE AGREEMENTS -- (8.2%)
$ (5,000,000) Freddie Mac 5.55% due 4/5/99 dated 3/29/99 (4) ............. $ (5,000,000)
-------------
(5,000,000)
-------------
FORWARD SALES -- (25.6%)
(16,000,000) Fannie Mae 6.00%, due date to be announced (5) ............. (15,546,250)
-------------
(15,546,250)
-------------
LIABILITIES LESS CASH AND OTHER ASSETS -- (16.2%) .......... (9,881,378)
-------------
NET ASSETS -- 100.0% ....................................... $ 60,807,449
=============
</TABLE>
- ---------
(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. Adjustable-rate mortgages have coupon rates that adjust
periodically. The interest rate shown is the rate in effect at March 31,
1999. The adjusted rate is determined by adding a spread to a specified
index.
(2) The interest rate shown for discount notes is the discount rate paid at the
time of purchase by the fund.
(3) Security is held as collateral by Carr Futures, Inc.
(4) Reverse repurchase agreement is collateralized by $4,344,000 face of GNMA
7.0% due 10/15/27 and $1,750,000 face of GNMA 7.0% due 6/15/28.
(5) The forward sale position represents the unsettled sale of securities held
by the Fund.
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES MARCH 31, 1999
<TABLE>
<S> <C>
ASSETS
Investments at market value (identified cost $93,524,013) (Note 1)....................... $ 91,235,077
Cash .................................................................................... 513,419
Restricted cash held to cover checkwriting privilege .................................... 6,489
Receivables:
Variation margin on futures contracts (Note 2) ........................................ 50,019
Subscriptions ......................................................................... 22,917
Interest .............................................................................. 446,698
Securities sold ....................................................................... 30,165,367
Other assets ............................................................................ 24,207
-------------
TOTAL ASSETS .......................................................................... 122,464,193
-------------
LIABILITIES
Reverse repurchase agreement (proceeds $5,000,000) (Note 1).............................. 5,000,000
Forward sales at market value (proceeds $15,520,000)..................................... 15,546,250
Payables:
Redemptions ........................................................................... 641,861
Securities purchased .................................................................. 40,317,051
Swap and other interest (Note 2) ...................................................... 57,776
Due to Advisor (Note 3) ................................................................. 45,881
Accrued expenses ........................................................................ 47,925
-------------
TOTAL LIABILITIES ..................................................................... 61,656,744
-------------
NET ASSETS
(Applicable to outstanding shares of 6,120,026 unlimited number of shares of beneficial
interest authorized; no stated par) ................................................... $ 60,807,449
=============
Net asset value, offering price and redemption price per share ($60,807,449 / 6,120,026). $ 9.94
=============
SOURCE OF NET ASSETS
Paid in capital ......................................................................... $ 65,331,014
Overdistributed net investment income ................................................... (463,285)
Accumulated net realized loss on investments and futures contracts ...................... (1,628,551)
Net unrealized depreciation of investments, interest rate swaps, interest rate caps and
forward sales ......................................................................... (2,315,186)
Net unrealized depreciation of futures contracts... ..................................... (116,543)
-------------
NET ASSETS ............................................................................ $ 60,807,449
=============
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1999
<TABLE>
<S> <C>
INVESTMENT INCOME
Interest and discount earned, net of premium amortization and interest expense ($202,305)
(Note 1) .............................................................................. $ 4,036,991
EXPENSES
Advisory fees (Note 3) .................................................................. 508,343
Accounting and pricing services fees .................................................... 46,826
Custodian fees .......................................................................... 23,868
Audit and tax preparation fees .......................................................... 21,757
Legal fees .............................................................................. 17,825
Transfer agent fees ..................................................................... 27,529
Registration fees ....................................................................... 12,417
Trustees fees and expenses .............................................................. 45,794
Insurance ............................................................................... 9,647
Other ................................................................................... 8,048
------------
TOTAL EXPENSES BEFORE REIMBURSEMENT ................................................... 722,054
Expenses reimbursed by Advisor (Note 3) ............................................... (155,616)
------------
NET EXPENSES .......................................................................... 566,438
------------
NET INVESTMENT INCOME ................................................................. 3,470,553
------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS
Net realized gain on investments and futures contracts .................................. 1,074,357
Change in unrealized depreciation of investments, interest rate swaps, interest rate
caps, and futures contracts ............................................................. (1,229,582)
------------
Net realized and unrealized loss on investments and futures contracts ................... (155,225)
------------
Net increase in net assets resulting from operations .................................... $ 3,315,328
============
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
MARCH 31, 1999 MARCH 31, 1998
---------------- ---------------
<S> <C> <C>
OPERATIONS
Net investment income ............................................................ $ 3,470,553 $ 5,485,507
Net realized gain on investments ................................................. 1,074,357 2,886,352
Change in unrealized appreciation (depreciation) of investments, interest rate
swaps, interest rate caps and futures contracts ................................ (1,229,582) (2,022,049)
------------- -------------
Net increase in net assets resulting from operations ............................. 3,315,328 6,349,810
------------- -------------
DISTRIBUTIONS TO SHAREHOLDERS
Dividends from net investment income ............................................. (3,302,565) (5,439,867)
------------- -------------
Total distributions .............................................................. (3,302,565) (5,439,867)
------------- -------------
CAPITAL SHARE TRANSACTIONS
Shares sold ...................................................................... 45,691,681 46,118,603
Shares issued on reinvestment of distributions ................................... 1,845,880 2,600,980
Shares redeemed .................................................................. (65,170,730) (90,190,280)
------------- -------------
Decrease in net assets resulting from capital share transactions (a) ............. (17,633,169) (41,470,697)
------------- -------------
TOTAL INCREASE (DECREASE) IN NET ASSETS ........................................ (17,620,406) (40,560,754)
NET ASSETS
Beginning of period .............................................................. 78,427,855 118,988,609
------------- -------------
End of period .................................................................... $ 60,807,449 $ 78,427,855
============= =============
(a) Transactions in capital shares were as follows:
Shares sold ...................................................................... 4,622,012 4,669,660
Shares issued on reinvestment of distributions ................................... 186,844 264,390
Shares redeemed .................................................................. (6,593,289) (9,136,010)
------------- -------------
Net decrease ..................................................................... (1,784,433) (4,201,960)
Beginning balance ................................................................ 7,904,459 12,106,419
------------- -------------
Ending balance ................................................................... 6,120,026 7,904,459
============= =============
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
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.
<TABLE>
<CAPTION>
YEAR YEAR YEAR YEAR YEAR
ENDED ENDED ENDED ENDED ENDED
MARCH 31, 1999 MARCH 31, 1998 MARCH 31, 1997 MARCH 31, 1996 MARCH 31, 1995
---------------- ---------------- ---------------- ---------------- ---------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF
PERIOD ........................... $ 9.92 $ 9.83 $ 9.74 $ 9.90 $ 9.90
---------- ---------- ----------- ----------- ------------
INCOME FROM INVESTMENT
OPERATIONS
Net investment income ............ 0.442 0.484 0.476 0.621 0.628
Net realized and unrealized
gain (loss) on investments ..... 0.020 0.114 0.146 (0.148) --
----------- ----------- ------------ ------------ ------------
Total from investment
operations ..................... 0.462 0.598 0.622 0.473 0.628
----------- ----------- ------------ ------------ ------------
LESS DISTRIBUTIONS
Dividends from net
investment income .............. (0.447) (0.508) (0.476) (0.621) (0.628)
Dividends in excess of
investment income .............. -- -- (0.056) (0.012) --
----------- ----------- ------------ ------------ ------------
Total distributions ............ (0.447) (0.508) (0.532) (0.633) (0.628)
----------- ----------- ------------ ------------ ------------
NET ASSET VALUE, END OF
PERIOD ........................... $ 9.94 $ 9.92 $ 9.83 $ 9.74 $ 9.90
----------- ----------- ------------ ------------ ------------
TOTAL RETURN ...................... 4.83% 6.24% 6.57% 4.95% 6.58%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period ........ $60,807,449 $78,427,855 $118,988,609 $221,825,136 $218,431,665
Ratio of net expenses to
average net assets (1) ......... 0.78% 0.78% 0.78% 0.78% 0.78%
Ratio of net investment
income to average net
assets ......................... 4.78% 5.28% 5.04% 6.29% 6.33%
Portfolio turnover rate .......... 298% 626% 556% 225% 47%
Ratio of expenses to average
net assets before
reimbursement of
expenses by the
Advisor (1) .................... 1.00% 1.00% 0.93% 0.93% 0.92%
Ratio of net investment
income to average net
assets before
reimbursement of
expenses by the Advisor ........ 4.56% 5.06% 4.90% 6.13% 6.18%
</TABLE>
- ---------
(1) 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.
<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 statement of assets and liabilities,
including the schedule of investments, of the Smith Breeden Short Duration U.S.
Government Fund of the Smith Breeden Series Fund (the "Fund") as of March 31,
1999, and the related statement of operations for the year then ended, the
statements of changes in net assets for each of the years in the two-year
period then ended and the financial highlights for 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, 1999 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, 1999, 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 14, 1999
<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
PERFORMANCE REVIEW
The Smith Breeden Intermediate Duration U.S. Government Fund returned
5.73% in the year ending March 31, 1999. The Salomon-Smith Barney Mortgage
Index, the Fund's benchmark, returned 6.33%, marginally under the 6.53% return
of the five-year Treasury Note. The average Government Mortgage Fund, as
tracked by Morningstar, returned 5.22% over the same period.
[GRAPHIC APPEARS HERE WITH THE FOLLOWING PLOT POINTS:]
CHANGE IN VALUE OF A $10,000 INVESTMENT
<TABLE>
<CAPTION>
3/92 9/92 3/93 9/93 3/94 9/94 3/95 9/95 3/96 9/96 3/97 9/97 3/98 9/98 3/99
---- ----- ---- ----- ---- ----- ---- ----- ---- ----- ---- ----- ---- ----- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Smith Breeden
Intermediate
Duration U.S. Gov't
Fund(1) 10,000 10,954 11,493 12,255 11,967 11,982 12,695 13,610 13,925 14,330 14,748 15,682 16,318 16,864 17,252
Morningstar Avg.
Gov't Bond
Mortgage 10,000 10,748 11,141 11,533 11,270 11,161 11,692 12,512 12,812 13,089 13,429 14,277 14,807 15,486 15,579
5yr/SBMI (2) 10,000 11,037 11,428 11,988 11,678 11,708 12,380 13,284 13,681 14,065 14,486 15,446 16,066 16,768 17,082
- ------------
(1) Fund Returns are net fees and sales charges. Index returns are market returns without deduction of fees or rebalancing
transaction costs.
(2) 5-Year Treasury Note to 12/31/93 and the Salomon-Smith Barney Mortgage Index ("SBMI") to 3/31/99. The fund changed its
investment objective 1/1/94.
Past performance is no guarantee of future results.
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS FOR
PERIODS ENDING MARCH 31, 1999
--------------------------------------
SINCE INCEPTION FINAL VALUE OF
1 YEAR 5 YEARS (3/31/92) $10,000 INVESTMENT
---------- --------- ----------------- -------------------
<S> <C> <C> <C> <C>
Smith Breeden Intermediate Dur. U.S. Govt. Fund ... 5.73% 7.59% 8.10% $17,252
SBMI/5-Year U.S. Treasury (2) ..................... 6.33% 7.90% 7.95% 17,082
Morningstar Avg. Government Mortgage Fund ......... 5.22% 6.69% 6.54% 15,579
</TABLE>
The Intermediate Fund aims to match closely the interest-rate and
prepayment risk of the Salomon-Smith Barney Mortgage Index. This index is
representative of the universe of fixed-rate Government agency mortgages, and
has a duration ranging from about two to four years, depending on the overall
level of interest rates.
The Intermediate Fund was invested 60% in fixed-rate mortgages and 40% in
adjustable-rate mortgages (ARMs) at the end of June 1998. In the third quarter,
the Fund added AAA-rated commercial mortgage-backed securities to its holdings.
Commercial mortgage-backed securities (MBS) suffered in the flight-to quality
in the August to October period, and consequently the Fund underperformed its
benchmark by about 0.9% in the third quarter. Commercial MBS performed
exceedingly well in the fourth quarter, and the fund outperformed it's
benchmark by 0.5% in this period. Mortgage securities in general performed very
well compared to other bond classes in the first quarter of 1999, and the Fund
returned 0.9% in this period, in line with the benchmark Salomon Index return
of 1.0%. By contrast, the five-year Note lost 1.3% in this period due to rising
interest rates. The Fund reduced its ARM holdings in the third and fourth
quarters to about 13% of net assets, as ARMs became richly priced relative to
other mortgage securities.
<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS MARCH 31, 1999
<TABLE>
<CAPTION>
MARKET
FACE AMOUNT SECURITY VALUE
- --------------- ------------------------------------------------------------------------ ---------------
<S> <C> <C>
U.S. GOVERNMENT & AGENCY OBLIGATIONS -- 103.6%
FREDDIE MAC -- 30.7% (1)
Fixed-rate
$ 4,982,385 6.00%, due 1/1/29 ...................................................... $ 4,846,209
10,000,000 6.50% 30 Year, due date to be announced ................................ 9,942,578
2,095,828 7.50%, due date 11/1/27 to 1/1/28 ...................................... 2,151,975
------------
16,940,762
------------
FANNIE MAE -- 41.3% (1)
Fixed-rate
9,874,418 6.00%, due 1/1/14 to 3/1/29 ............................................ 9,635,778
7,217,482 6.50%, due 6/1/13 to 11/1/28 ........................................... 7,243,554
730,663 6.98%, due 6/1/07 ...................................................... 763,645
5,000,001 7.00%, due 12/1/07 to 3/1/08 ........................................... 5,108,541
------------
22,751,518
------------
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION -- 31.2% (1)
Fixed-rate
7,121,230 7.00%, due 3/15/26 to 1/15/28 .......................................... 7,234,877
4,299,359 7.50%, due 9/15/28 ..................................................... 4,428,551
Adjustable-rate
2,433,341 5.50%, due 6/20/28 ..................................................... 2,466,308
411,811 6.125%, due 11/20/17 to 12/20/17 ....................................... 419,430
1,005,599 6.625%, due 8/20/17 to 8/20/18 ......................................... 1,025,628
1,598,569 6.875%, due 3/20/16 to 4/20/22 ......................................... 1,629,276
------------
17,204,070
------------
U.S. TREASURY NOTES -- 0.4%
175,000 5.875%, due 7/31/99 (2) ................................................ 175,711
40,000 6.375%, due 5/15/99 (2) ................................................ 40,081
------------
215,792
------------
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS (COST $57,223,788)........... 57,112,142
------------
COMMERCIAL MORTGAGE-BACKED SECURITIES -- 16.4% (1)
2,000,000 First Union-Lehman Brothers-Bank of America Commercial Mortage Trust
6.56%, due 11/18/08 .................................................... 2,025,333
2,000,000 GMAC Commercial Mortgage Securities 6.42%, due 8/15/08 ................. 2,006,854
5,000,000 Nomura Asset Securities Corporation Commercial Mortgage Trust 6.59%, due
3/17/28 ................................................................ 5,017,872
------------
TOTAL COMMERCIAL MORTGAGE-BACKED SECURITIES
(COST $9,149,637)....................................................... 9,050,059
------------
TOTAL INVESTMENTS (COST $66,373,425)--120.0%............................ 66,162,201
------------
FORWARD SALES -- (14.1%)
(8,000,000) Fannie Mae 6.00%, due date to be announced (3) ......................... (7,773,125)
------------
(7,773,125)
------------
LIABILITIES LESS CASH AND OTHER ASSETS -- (5.9%) ....................... (3,263,279)
------------
NET ASSETS -- 100.0% ................................................... $ 55,125,797
============
</TABLE>
- ---------
(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. Adjustable-rate mortgages have coupon rates that adjust
periodically. The interest rate shown is the rate in effect at March 31,
1999. The adjusted rate is determined by adding a spread to a specified
index.
(2) Security is held as collateral by Carr Futures, Inc.
(3) The forward sale position represents the unsettled sale of securities held
by the Fund.
<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES MARCH 31, 1999
<TABLE>
<S> <C>
ASSETS
Investments at market value (identified cost $66,373,425) (Note 1)....................... $ 66,162,201
Receivables:
Variation margin on futures contracts (Note 2) ........................................ 17,063
Subscriptions ......................................................................... 63,068
Interest .............................................................................. 328,063
Securities sold ....................................................................... 17,778,394
Prepaid expenses ...................................................................... 5,547
------------
TOTAL ASSETS ......................................................................... 84,354,336
------------
LIABILITIES
Bank overdraft .......................................................................... 1,402,577
Forward sales at market value (proceeds $7,760,000)...................................... 7,773,125
Payables:
Securities purchased .................................................................. 19,911,736
Redemptions ........................................................................... 65,098
Distributions ......................................................................... 8,417
Due to Advisor (Note 3) ................................................................. 33,945
Accrued expenses ........................................................................ 33,641
------------
TOTAL LIABILITIES .................................................................... 29,228,539
------------
NET ASSETS
(Applicable to outstanding shares of 5,559,865; unlimited number of shares of beneficial
interest authorized; no stated par) ................................................... $ 55,125,797
============
Net asset value, offering price and redemption price per share ($55,125,797 / 5,559,865). $ 9.91
============
SOURCE OF NET ASSETS
Paid in capital ......................................................................... $ 55,613,189
Overdistribution of net investment income ............................................... (134,448)
Accumulated net realized loss on investments and futures contracts ...................... (205,949)
Net unrealized depreciation of investments and forward sales ............................ (224,349)
Net unrealized appreciation of futures contracts ........................................ 77,354
------------
NET ASSETS ........................................................................... $ 55,125,797
============
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1999
<TABLE>
<S> <C>
INVESTMENT INCOME
Interest and discount earned, net of premium amortization and interest expense ($20,002)
(Note 1) .............................................................................. $3,077,235
EXPENSES
Advisory fees (Note 3) ................................................................. 355,620
Accounting and pricing services fees ................................................... 40,922
Custodian fees ......................................................................... 20,350
Audit & tax preparation fees ........................................................... 14,402
Legal fees ............................................................................. 10,381
Transfer agent fees .................................................................... 28,175
Registration fees ...................................................................... 21,002
Trustees fees and expenses ............................................................. 29,452
Insurance .............................................................................. 4,722
Other .................................................................................. 5,474
----------
TOTAL EXPENSES BEFORE REIMBURSEMENT ................................................... 530,500
Expenses reimbursed by Advisor (Note 3) ............................................... (83,434)
----------
NET EXPENSES .......................................................................... 447,066
----------
NET INVESTMENT INCOME ................................................................. 2,630,169
----------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS
Net realized gain on investments and futures contracts ................................. 247,095
Change in unrealized depreciation of investments and futures contracts ................. (209,534)
----------
Net realized and unrealized gain on investments and futures contracts .................. 37,561
----------
Net increase in net assets resulting from operations ................................... $2,667,730
==========
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
MARCH 31, 1999 MARCH 31, 1998
---------------- ---------------
<S> <C> <C>
OPERATIONS
Net investment income .................................................... $ 2,630,169 $ 2,175,424
Net realized gain on investments ......................................... 247,095 1,835,038
Change in unrealized depreciation of investments ......................... (209,534) (73,907)
------------- -------------
Net increase in net assets resulting from operations ..................... 2,667,730 3,936,555
------------- -------------
DISTRIBUTIONS TO SHAREHOLDERS
Dividends from net investment income ..................................... (2,630,169) (2,175,424)
Dividends in excess of net investment income ............................. -- (10,140)
Distributions from net realized gains on investments ..................... (576,411) (880,968)
------------- -------------
Total distributions ...................................................... (3,206,580) (3,066,532)
------------- -------------
CAPITAL SHARE TRANSACTIONS
Shares sold .............................................................. 45,066,774 34,884,833
Shares issued on reinvestment of distributions ........................... 3,096,717 1,570,705
Shares redeemed .......................................................... (31,140,723) (36,419,207)
------------- -------------
Increase in net assets resulting from capital share transactions (a) ..... 17,022,768 36,331
------------- -------------
TOTAL INCREASE IN NET ASSETS ........................................... 16,483,918 906,354
NET ASSETS
Beginning of period ...................................................... 38,641,879 37,735,525
------------- -------------
End of period ............................................................ $ 55,125,797 $ 38,641,879
============= =============
(a) Transactions in capital shares were as follows:
Shares sold .............................................................. 4,529,253 3,494,156
Shares issued on reinvestment of distributions ........................... 311,881 157,456
Shares redeemed .......................................................... (3,146,761) (3,664,130)
------------- -------------
Net increase (decrease) .................................................. 1,694,373 (12,518)
Beginning balance ........................................................ 3,865,492 3,878,010
------------- -------------
Ending balance ........................................................... 5,559,865 3,865,492
============= =============
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
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.
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED
MARCH 31, 1999 MARCH 31, 1998 MARCH 31, 1997 MARCH 31, 1996 MARCH 31, 1995
---------------- ---------------- ---------------- ---------------- ---------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF
PERIOD ............................ $ 10.00 $ 9.73 $ 10.01 $ 9.83 $ 10.01
---------- ---------- ---------- ---------- ----------
INCOME FROM INVESTMENT
OPERATIONS
Net investment income ............. 0.525 0.590 0.599 0.660 0.664
Net realized and unrealized
(loss) gain on investments ...... 0.030 0.419 ( 0.024) 0.277 ( 0.049)
----------- ----------- ----------- ----------- -----------
Total from investment
operations ...................... 0.555 1.009 0.575 0.937 0.615
----------- ----------- ----------- ----------- -----------
LESS DISTRIBUTIONS
Dividends from net investment
income .......................... ( 0.515) ( 0.561) ( 0.604) ( 0.656) ( 0.664)
Dividends in excess of net
investment income ............... -- -- -- -- ( 0.108)
Distributions from net realized
gains on investments ............ ( 0.130) ( 0.178) ( 0.251) ( 0.101) --
Distributions in excess of net
realized gains on
investments ..................... -- -- -- -- ( 0.022)
----------- ----------- ----------- ----------- -----------
Total distributions ............. ( 0.645) ( 0.739) ( 0.855) ( 0.757) ( 0.794)
----------- ----------- ----------- ----------- -----------
NET ASSET VALUE, END OF PERIOD ..... $ 9.91 $ 10.00 $ 9.73 $ 10.01 $ 9.83
----------- ----------- ----------- ----------- -----------
TOTAL RETURN ....................... 5.73% 10.65% 5.92% 9.69% 6.10%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period ......... $55,125,797 $38,641,879 $37,735,525 $36,446,940 $34,797,496
Ratio of net expenses to
average net assets (1) .......... 0.88% 0.88% 0.89% 0.90% 0.90%
Ratio of net investment income
to average net assets ........... 5.25% 5.61% 6.19% 6.49% 6.20%
Portfolio turnover rate ........... 423% 583% 409% 193% 557%
Ratio of expenses to average
net assets before
reimbursement of expenses
by the Advisor (1) .............. 1.06% 1.13% 1.16% 1.14% 2.33%
Ratio of net investment income
to average net assets before
reimbursement of expenses
by the Advisor .................. 5.08% 5.36% 5.92% 6.26% 4.77%
</TABLE>
- ---------
(1) 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.
<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 statement of assets and liabilities,
including the schedule of investments, of the Smith Breeden Intermediate
Duration U.S. Government Fund of the Smith Breeden Series Fund (the "Fund") as
of March 31, 1999, and the related statement of operations for the year then
ended, the statements of changes in net assets for each of the years in the
two-year period then ended and the financial highlights for 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, 1999 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, 1999, 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 14, 1999
<PAGE>
SMITH BREEDEN MUTUAL FUNDS
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Breeden Series Fund and the Smith Breeden Trust (the "Trusts") are
open-end, diversified management investment companies registered under the
Investment Company Act of 1940, as amended. The Smith Breeden Series Fund
offers shares in two series: the Smith Breeden Short Duration U.S. Government
Fund (the "Short Fund") and the Smith Breeden Intermediate Duration U.S.
Government Fund (the "Intermediate Fund"). The Smith Breeden Trust offers
shares in three series: the Smith Breeden U.S. Equity Market Plus Fund (the
"U.S. Equity Fund", formerly the Smith Breeden Equity Market Plus Fund), the
Smith Breeden High Yield Bond Fund (the "High Yield Fund"), and the Smith
Breeden Financial Services Fund (the "Financial Services Fund"). The following
is a summary of accounting policies consistently followed by the Short Fund,
the Intermediate Fund, the High Yield Fund, the U.S. Equity Fund and the
Financial Services Fund (collectively, the "Funds").
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: Each Fund may enter into repurchase agreements 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 Funds' Board of Trustees. In a repurchase agreement, a
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
Funds' 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 at least 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, a
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 AND REVERSE 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. When a Fund invests in a dollar roll, it 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.
A reverse dollar roll is agreement to buy securities for delivery in the
current month and to sell substantially similar (same type and coupon)
securities on a specified future date, typically at a lower price. During the
roll period, the fund receives the principal and interest on the securities
purchased in compensation for the cash invested in the transaction.
E. DISTRIBUTIONS AND TAXES: Dividends to shareholders are recorded on the
ex-dividend date. Each Fund intends to continue to qualify for and elect the
special tax treatment afforded to regulated investment companies under
Subchapter M of the Internal Revenue Code, thereby relieving the Funds of
Federal income taxes. To so qualify, the Funds intend to distribute
substantially all net investment income and net realized capital gains, if any,
less any available capital loss carryforward. The following table summarized
the available capital loss carryforwards for each Fund.
<PAGE>
SMITH BREEDEN MUTUAL FUNDS
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES -- CONTINUED
<TABLE>
<CAPTION>
CAPITAL LOSS CAPITAL LOSS CAPITAL LOSS
CARRYFORWARD CARRYFORWARD CARRYFORWARD
FUND EXPIRES 3/31/2004 EXPIRES 3/31/2005 EXPIRES 3/31/2007
- ---------------------------------- ------------------- ------------------- ------------------
<S> <C> <C> <C>
Short Duration Fund ........ $658,505 $829,556 $ 0
Intermediate Duration Fund . 0 0 126,641
U.S. Equity Fund ........... 0 0 0
Financial Services Fund .... 0 0 196,832
High Yield Bond Fund ....... 0 0 0
</TABLE>
F. SECURITIES TRANSACTIONS, INVESTMENT INCOME AND OPERATING 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 fixed-income securities purchased are
amortized over the life of the respective securities. Dividend income is
recorded on the ex-dividend 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 Trusts are
generally allocated among the funds comprising the Trusts based on the ratio of
net assets of each Fund to the combined net assets of each Trust. Other
expenses are charged to each Fund on a specific identification basis.
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. FUTURES CONTRACTS HELD OR ISSUED FOR PURPOSES OTHER THAN TRADING: The Short
Fund, Intermediate Fund, and U.S. Equity Fund use interest-rate futures
contracts for risk management purposes in order to reduce fluctuations in the
Funds' net asset values relative to the Funds' targeted option-adjusted
durations. The Financial Services Fund uses S&P 500 futures contracts for risk
management purposes in order to manage the Fund's equity market risk relative
to its benchmark. 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 Funds recognize 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.
<PAGE>
SMITH BREEDEN MUTUAL FUNDS
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. FINANCIAL INSTRUMENTS -- CONTINUED
The Short Fund had the following open futures contracts as of March 31, 1999:
<TABLE>
<CAPTION>
NUMBER OF EXPIRATION UNREALIZED
TYPE CONTRACTS POSITION MONTH GAIN/(LOSS)
- ---------------------------- ----------- ---------- ----------------- --------------
<S> <C> <C> <C> <C>
5 Year Treasury ............ 43 Short June, 1999 $ 7,791
10 Year Treasury ........... 113 Short June, 1999 53,226
3 Month Eurodollar ......... 31 Short June, 1999 (1,140)
3 Month Eurodollar ......... 55 Short September, 1999 (9,898)
3 Month Eurodollar ......... 12 Long December, 1999 (6,054)
3 Month Eurodollar ......... 12 Long March, 2000 (10,004)
3 Month Eurodollar ......... 12 Long June, 2000 (10,891)
3 Month Eurodollar ......... 12 Long September, 2000 (11,429)
3 Month Eurodollar ......... 12 Long December, 2000 (10,541)
3 Month Eurodollar ......... 12 Long March, 2001 (11,429)
3 Month Eurodollar ......... 12 Long June, 2001 (11,729)
3 Month Eurodollar ......... 62 Long September, 2001 94,284
3 Month Eurodollar ......... 12 Long December, 2001 (10,529)
3 Month Eurodollar ......... 12 Long March, 2002 (11,980)
3 Month Eurodollar ......... 12 Long June, 2002 (12,305)
3 Month Eurodollar ......... 12 Long September, 2002 (12,342)
3 Month Eurodollar ......... 12 Long December, 2002 (10,804)
3 Month Eurodollar ......... 12 Long March, 2003 (12,241)
3 Month Eurodollar ......... 12 Long June, 2003 (12,316)
3 Month Eurodollar ......... 12 Long September, 2003 (12,316)
3 Month Eurodollar ......... 12 Long December, 2003 (10,841)
3 Month Eurodollar ......... 12 Long March, 2004 (11,804)
3 Month Eurodollar ......... 12 Long June, 2004 (11,879)
3 Month Eurodollar ......... 12 Long September, 2004 (12,079)
3 Month Eurodollar ......... 12 Long December, 2004 (10,854)
3 Month Eurodollar ......... 12 Long March, 2005 (11,579)
3 Month Eurodollar ......... 12 Long June, 2005 (11,654)
3 Month Eurodollar ......... 12 Long September, 2005 (11,479)
3 Month Eurodollar ......... 4 Long December, 2005 (1,168)
3 Month Eurodollar ......... 2 Long March, 2006 (559)
---------
Total ($ 116,543)
=========
</TABLE>
The Intermediate Fund had the following open futures contracts as of March 31,
1999:
<TABLE>
<CAPTION>
NUMBER OF EXPIRATION UNREALIZED
TYPE CONTRACTS POSITION MONTH GAIN/(LOSS)
- -------------------------- ----------- ---------- --------------- ------------
<S> <C> <C> <C> <C>
5 Year Treasury .......... 32 Long June, 1999 ($ 10,246)
10 Year Treasury ......... 82 Short June, 1999 87,600
--------
Total $ 77,354
========
</TABLE>
<PAGE>
SMITH BREEDEN MUTUAL FUNDS
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. FINANCIAL INSTRUMENTS -- CONTINUED
The U.S. Equity Fund had the following open interest-rate futures contracts as
of March 31, 1999:
<TABLE>
<CAPTION>
NUMBER OF EXPIRATION UNREALIZED
TYPE CONTRACTS POSITION MONTH GAIN/(LOSS)
- ---------------------------- ----------- ---------- ----------------- --------------
<S> <C> <C> <C> <C>
5 Year Treasury ............ 126 Short June, 1999 $ 18,527
10 Year Treasury ........... 81 Short June, 1999 60,409
3 Month Eurodollar ......... 185 Long June, 1999 31,543
3 Month Eurodollar ......... 166 Short September, 1999 (214,510)
3 Month Eurodollar ......... 18 Short December, 1999 7,819
3 Month Eurodollar ......... 55 Short March, 2000 (31,048)
3 Month Eurodollar ......... 18 Short June, 2000 15,032
3 Month Eurodollar ......... 127 Short September, 2000 (164,284)
3 Month Eurodollar ......... 18 Short December, 2000 14,007
3 Month Eurodollar ......... 49 Short March, 2001 (3,208)
3 Month Eurodollar ......... 18 Short June, 2001 15,132
3 Month Eurodollar ......... 123 Short September, 2001 (148,704)
3 Month Eurodollar ......... 18 Short December, 2001 12,769
3 Month Eurodollar ......... 48 Short March, 2002 3,059
3 Month Eurodollar ......... 18 Short June, 2002 15,494
3 Month Eurodollar ......... 117 Short September, 2002 (35,589)
3 Month Eurodollar ......... 18 Short December, 2002 13,369
3 Month Eurodollar ......... 62 Short March, 2003 (3,129)
3 Month Eurodollar ......... 18 Short June, 2003 15,544
3 Month Eurodollar ......... 102 Short September, 2003 35,204
3 Month Eurodollar ......... 16 Short December, 2003 10,803
3 Month Eurodollar ......... 65 Short March, 2004 9,645
3 Month Eurodollar ......... 16 Short June, 2004 12,803
3 Month Eurodollar ......... 16 Short September, 2004 13,103
3 Month Eurodollar ......... 16 Short December, 2004 11,678
3 Month Eurodollar ......... 135 Short March, 2005 26,768
3 Month Eurodollar ......... 16 Short June, 2005 13,003
3 Month Eurodollar ......... 13 Short September, 2005 11,167
3 Month Eurodollar ......... 4 Short December, 2005 2,007
3 Month Eurodollar ......... 78 Short March, 2006 18,424
3 Month Eurodollar ......... 24 Short March, 2007 8,292
---------
Total ($ 204,874)
=========
</TABLE>
The Financial Services Fund had the following open futures contracts on the S&P
500 Index as of March 31, 1999:
<TABLE>
<CAPTION>
NUMBER OF UNREALIZED
TYPE CONTRACTS POSITION EXPIRATION MONTH GAIN/(LOSS)
- ----------------- ----------- ---------- ------------------ ------------
<S> <C> <C> <C> <C>
S&P 500 ......... 7 Short June, 1999 ($ 57,627)
--------
Total ($ 57,627)
========
</TABLE>
Futures transactions involve costs and may result in losses. The effective use
of futures depends on the Funds' ability to close futures positions at times
when the Funds' 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 Funds, of the
futures contract themselves, and of the securities that are the subject of a
hedge.
<PAGE>
SMITH BREEDEN MUTUAL FUNDS
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. FINANCIAL INSTRUMENTS -- CONTINUED
B. DERIVATIVE FINANCIAL INSTRUMENTS HELD OR ISSUED FOR TRADING PURPOSES: The
U.S. Equity Fund invests in futures contracts on the S&P 500 Index whose
returns are expected to track movements in the S&P 500 Index.
The U.S. Equity Fund had the following open futures contracts on the S&P 500
Index as of March 31, 1999:
<TABLE>
<CAPTION>
NUMBER OF EXPIRATION UNREALIZED
TYPE CONTRACTS POSITION MONTH GAIN/(LOSS)
- ------------------- ----------- ---------- ------------ ------------
<S> <C> <C> <C> <C>
S&P 500 ......... 580 Long June, 1999 $1,787,863
----------
Total $1,787,863
==========
</TABLE>
C. ASSETS PLEDGED TO COVER MARGIN REQUIREMENTS FOR OPEN FUTURES POSITIONS: The
aggregate market value of assets pledged to cover margin requirements for the
open futures positions at March 31, 1999 was:
<TABLE>
<CAPTION>
FUND ASSETS PLEDGED
- ------------------------------- ---------------
<S> <C>
Short Fund .................. $ 353,496
Intermediate Fund ........... 215,792
U.S. Equity Fund ............ 11,246,155
Financial Services Fund ..... 115,500
</TABLE>
E. INTEREST-RATE SWAP CONTRACTS: The Funds may use interest-rate swap contracts
to help manage interest-rate risk. 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 Funds 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 or better by Standard & Poor's Corporation, or Aa or P-1 or
better by Moody's Investors Service, Inc. (or is otherwise acceptable to either
agency) at the time of entering into such a transaction. If the counterparty to
the swap transaction defaults, the Funds 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 Funds will succeed in pursuing contractual remedies. The Funds may thus
assume the risk that payments owed the Funds under a swap contract will be
delayed, or not received at all. Should interest rates move unexpectedly, the
Funds may not achieve the anticipated benefits of the interest-rate swaps, and
may realize a loss. The Funds recognize gains and losses under interest-rate
swap contracts as realized gains or losses on investments upon sale of the swap
contracts.
As of March 31, 1999, the Short Fund had two open interest-rate swap contracts.
In each of the contracts, the Short Fund has agreed to pay a fixed rate and
receive a floating rate. The Short 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 Short Fund receiving or paying, as the case may be, only the net
amount of the two payments. The floating rate on the contracts resets quarterly
and is the three-month London Inter-Bank Offered Rate ("LIBOR"). The Short
Fund's interest payable on the interest-rate swap contracts as of March 31,
1999 was $57,776. No collateral is required under these contracts.
F. INTEREST-RATE CAP CONTRACTS: The purchase of an interest-rate cap entitles
the purchaser, to the extent that a specified index exceeds a predetermined
interest rate, to receive payments of interest on a notional principal amount
from the party selling such interest rate caps. The Short Fund had one
interest-rate cap contract open at March 31, 1999.
<PAGE>
SMITH BREEDEN MUTUAL FUNDS
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. FINANCIAL INSTRUMENTS -- CONTINUED
G. OPTIONS ON INTEREST-RATE SWAP CONTRACTS: The Funds may enter into
over-the-counter transactions swapping interest rates, or purchase options to
enter into such contracts. Purchased options on interest-rate swap contracts
("swaptions") give the right, but not the obligation, to enter into a swap
contract with the counterparty which has written the option on a date, at an
interest rate, and with a notional amount as specified in the swaption
agreement.
As of March 31, 1999, the U.S. Equity Fund had two open swaptions. In each of
the contracts, the Fund has paid a sum of money, called a premium, to the
counterparty, in return for the swaptions. These swaptions may be exercised by
entering into a swap contract with the counterparty only on the date specified
in each contract. If the swaptions are exercised, the Fund will enter into a
swap either to pay a specified fixed interest rate in return for receiving a
floating rate, or receive a fixed rate in return for paying a floating rate,
based on the respective contracts, or both. The floating rate on the swap
contracts as specified in the swaption agreements resets quarterly and is the
three-month London Inter-Bank Offered Rate ("LIBOR"). If the counterparty to
the swaption transaction defaults, the Fund will be limited to contractual
remedies pursuant to the agreements governing the transaction. There is no
assurance that the interest rate swap or swaption contract counterparty will be
able to meet its obligation under the 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 swaption, or swap contracts should the swaptions
be exercised. Should interest rates move unexpectedly, the Fund may not achieve
the anticipated benefits of the swaptions, and may realize a loss. The Fund
recognizes gains and losses under swaptions as realized gains or losses on
investments upon sale or expiration of the contracts.
3. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES
Smith Breeden Associates, Inc. (the "Advisor"), a registered Investment
Advisor, provides the Funds with investment management services. As
compensation for these services, the Funds pay the Advisor a fee computed daily
and payable monthly at a fixed annual rate based on the Funds' average daily
net assets.
The Advisor has voluntarily agreed to reimburse normal business expenses of the
Funds through August 1, 1999 so that total direct and indirect operating
expenses do not exceed the percentages listed below of each fund's 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 to these levels until August 1, 1999. The table below lists the fees
received by the Advisor and the expenses reimbursed by the Advisor to each Fund
during the year ending March 31, 1999.
<TABLE>
<CAPTION>
NET EXPENSE FEES RECEIVED EXPENSES REIMBURSED
FUND RATIO BY ADVISOR BY ADVISOR
- ------------------------------- ------------- --------------- --------------------
<S> <C> <C> <C>
Short Fund .............. 0.78% $ 508,343 $ 155,616
Intermediate Fund ....... 0.88% 355,620 83,434
U.S. Equity Fund ........ 0.88% 1,090,372 251,051
Financial Services Fund . 1.48% 107,863 117,431
High Yield Bond Fund .... 0.98% 6,058 50,547
</TABLE>
The Funds have 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 Funds, 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, which
may come out of the advisory fee, to dealers and other persons at the annual
rate of up to 0.25% of each 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.
<PAGE>
SMITH BREEDEN MUTUAL FUNDS
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES -- CONTINUED
Certain officers and trustees of the Fund are also officers and directors of
the Advisor.
4. INVESTMENT TRANSACTIONS
During the year ended March 31, 1999 purchases and proceeds from sales of
securities, other than short-term investments, aggregated:
<TABLE>
<CAPTION>
PURCHASES OF PROCEEDS FROM
FUND SECURITIES SALES OF SECURITIES
- ------------------------------- ---------------- --------------------
<S> <C> <C>
Short Fund .................. $ 257,690,659 $ 254,290,486
Intermediate Fund ........... 259,809,711 229,277,078
U.S. Equity Fund ............ 875,819,709 790,168,109
Financial Services Fund ..... 11,055,264 8,877,443
High Yield Bond Fund ........ 2,398,197 213,563
</TABLE>
The cost of securities held for Federal tax purposes, and the net unrealized
appreciation (depreciation) of investments, short sales and futures contracts
is as follows:
<TABLE>
<CAPTION>
COST OF SECURITIES NET UNREALIZED
FOR FEDERAL TAX GROSS UNREALIZED GROSS UNREALIZED APPRECIATION
FUND PURPOSES APPRECIATION DEPRECIATION (DEPRECIATION)
- ------------------------------ -------------------- ------------------ ------------------ -----------------
<S> <C> <C> <C> <C>
Short Fund .................. $ 93,524,013 $ 1,102,601 ($ 3,534,330) ($ 2,431,729)
Intermediate Fund ........... 66,373,425 213,025 (360,020) (146,995)
U.S. Equity Fund ............ 246,631,334 2,443,797 (1,376,620) 1,067,177
Financial Services Fund ..... 8,654,885 503,012 (462,793) 40,219
High Yield Bond Fund ........ 2,195,739 46,929 (121,573) (74,644)
</TABLE>
5. CREDIT FACILITY
The High Yield Bond Fund and the Financial Services Funds have available
unsecured lines of credit from Bank of New York, the Funds' custodian. Total
borrowing allowed under the lines of credit is limited to the lesser of:
a) The amount of the line of credit;
b) 33 1/3% of the amount by which each Fund's total assets exceed each Fund's
total liabilities at the time a borrowing request is made;
c) The maximum amount the Funds are permitted to borrow under the Investment
Company Act of 1940, as amended; or
d) The maximum amount the Bank of New York is permitted to loan to the Funds
under regulations promulgated by the Board of Governors of the Federal Reserve
System.
The Financial Services Fund pays a fee of 0.15% per annum, and the High Yield
Fund pays a fee of 0.25% per annum on the total line of credit, whether used or
unused. In addition, the Financial Services Fund pays interest at a rate per
annum equal to the overnight Federal Funds Rate plus 1%, and the High Yield
Fund pays interest at a rate per annum equal to the overnight Federal Funds
Rate plus 1 1/4%, on amounts borrowed under the lines of credit. The total
amount of the line of credit is $2,500,000 for the Financial Services Fund and
$1,000,000 for the High Yield Bond Fund. As of March 31, 1999, the Financial
Services Fund had borrowed $2,125,000 and the High Yield Bond Fund had borrowed
$60,000 under the Funds' respective lines of credit.
SMITH BREEDEN SERIES FUND
FORM N-1A
PART C. OTHER INFORMATION
Item 23. Exhibits.
(a) Declaration of Trust: Incorporated by Reference
(b) By-Laws: Incorporated by Reference
(c) Instruments Defining Rights of Security Holders:
Incorporated by Reference
(d) Form of Investment Advisory Agreement
for Smith Breeden Series Fund: Incorporated by
Reference
(e) Form of Underwriting or Distribution
Agreement
(f) Bonus, Profit Sharing, Pension and Other
Similar Arrangements: Not Applicable
(g) Custodian Agreement: Incorporated by Reference
(h) Other Material Contracts:
Shareholder Services Agreement: Incorporated by
Reference
Accounting Services Agreement: Incorporated by
Reference
(i) Legal Opinion: Incorporated by Reference to
Pre-Effective Amendment No. 1 filed on
November 26, 1991.
(j) Other Opinions:
Independent Auditors' Consent
(k) Financial Statements Omitted from Item 22:
Not Applicable
(l) Initial Capital Agreements: Incorporated by
Reference
(m) Form of Rule 12b-1 Plan for Smith Breeden
Series Fund: Incorporated by Reference
(n) Financial Data Schedule: Not Applicable
(o) Rule 18f-3 Multi-Class Plan: Not Applicable
Item 24. Persons Controlled by or under Common Control
with Registrant.
As of 4/30/99, there were no persons controlled by
or under common control with the Smith Breeden Short
Duration U.S. Government Fund. Webster Financial of
Waterbury, Connecticut may be deemed to control the
Smith Breeden Intermediate Duration U.S. Government Fund
by virtue of owning 29.93% of the outstanding shares of
the Fund as of 4/30/99.
Item 25. Indemnification.
Reference is made to Article IV, Sections 4.2 and 4.3 of
Registrant's Declaration of Trust (Exhibit 1(a)) with
respect to indemnification of the Trustees and officers of
Registrant against liabilities which may be incurred by
them in such capacities.
Insofar as indemnification for liability arising under the
Securities Act of 1933, as amended (the "Act"), may be
permitted to directors, officers and controlling persons
of the Registrant pursuant to the foregoing provisions, or
otherwise, the Registrant has been advised that, in the
opinion of the Securities and Exchange Commission ("SEC"),
such indemnification is against public policy as expressed
in the Act, and is, therefore, unenforceable. In the
event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of
expenses incurred or paid by a trustee, an officer or a
controlling person of the Registrant in the successful
defense of any action, suit or proceeding) is asserted by
such trustee, officer or controlling person in connection
with the securities being registered, the Registrant will,
unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such
indemnification by it is against public policy as
expressed in the Act and will be governed by the final
adjudication of such issue.
Each disinterested Trustee has entered into an indemnity
agreement with the Adviser whereby the Adviser indemnifies
each disinterested Trustee against defense costs in
connection with a civil claim which involves the Trustee
by virtue of his position with the Fund.
Item 26. Business and Other Connections of Adviser.
Smith Breeden Associates, Inc. (the "Adviser") acts as
investment adviser to financial institution, insurance,
pension, charitable foundation clients and other registered
investment companies. For a description of the officers
and directors of the Adviser and their business
affiliations, see "Management of the Fund" in the
Prospectus contained within this Registration Statement.
Item 27. Principal Underwriters
(a) First Data Distributors, Inc. ("FDDI"), the
principal underwriter for the Registrant's
securities, currently acts as principal underwriter
for the following entities:
BT Insurance Funds Trust
CT&T Funds
First Choice Funds Trust
Forward Funds, Inc.
The Galaxy Fund
Galaxy Fund II
The Galaxy VIP Fund
The Govett Funds, Inc.
IAA Trust Asset Allocation Fund, Inc.
IAA Trust Growth Fund, Inc.
IAA Trust Taxable Fixed Income Series Fund, Inc.
IAA Trust Tax Exempt Bond Fund, Inc.
IBJ Funds Trust
ICM Series Trust
Light Index Funds, Inc.
LKCM Funds
Matthews International Funds
McM Funds
Metropolitan West Funds
Panorama Trust
The Potomac Funds
Rembrandt Funds
RWB/WPG U.S. Large Stock Fund
Smith Breeden Series Fund
Smith Breeden Trust
The Sports Funds Trust
The Stratton Funds, Inc.
Stratton Growth Fund, Inc.
Stratton Monthly Dividend REIT Shares, Inc.
Tomorrow Funds Retirement Trust
Trainer, Wortham First Mutual Funds
Undiscovered Managers Funds
Weiss, Peck & Greer Funds Trust
Weiss, Peck & Greer International Fund
Wilshire Target Funds, Inc.
WorldWide Index Funds
WPG Growth Fund
WPG Growth and Income Fund
WPG Tudor Fund
(b) The table below sets forth certain information as
to the Underwriter's Directors, Officers and
Control Persons:
NAME AND PRINCIPAL POSITION AND OFFICES POSITION AND
BUSINESS ADDRESS WITH UNDERWRITER OFFICES WITH
REGISTRANT
Robert Guillocheau Director None
4400 Computer Drive
Westborough, MA 01581
Francis Koudelka President & Chief None
4400 Computer Drive Executive Officer
Westborough, MA 01581
Jack Kutner Director None
4400 Computer Drive
Westborough, MA 01581
Scott Hacker Vice President, None
4400 Computer Drive Treasurer & Chief
Westborough, MA 01581 Compliance Officer
Bruno DiStefano Vice President None
4400 Computer Drive
Westborough, MA 01581
Sue Moscaritolo Vice President None
4400 Computer Drive
Westborough, MA 01581
Bernard Rothman Vice President None
4400 Computer Drive
Westborough, MA 01581
Christine Ritch Chief Legal Officer None
4400 Computer Drive and Clerk
Westborough, MA 01581
Bradley Stearns Assistant Clerk None
4400 Computer Drive
Westborough, MA 01581
(c) Not Applicable.
Item 28. Locations of Accounts and Records.
The accounts, books or other documents required to be
maintained by Section 31(a) of the Investment Company Act
of 1940 and the Rules thereunder will be kept by the
Registrant at the following offices.
(1) First Data Investor Services, Inc., 3200 Horizon
Drive, P. O. Box 61503, King of Prussia, PA
19406-0903
(2) Smith Breeden Associates, Inc., 100 Europa Drive,
Suite 200, Chapel Hill, NC 27514
Item 29. Management Services.
There are no management-related service contracts not
discussed in Part A or Part B.
Item 30. Undertakings.
(a) The Registrant previously has undertaken to
promptly call a meeting of shareholders for the purpose
of voting upon the question of removal of any trustee or
trustees when requested in writing to do so by the record
holders of not less than 10 percent of the Registrant's
outstanding shares and to assist its shareholders in
accordance with the requirements of Section 16(c) of the
Investment Company Act of 1940 relating to shareholder
communications.
(b) The registrant hereby undertakes to furnish to
each person to whom a prospectus is delivered a copy of
the Registrant's latest annual report to shareholders
upon request and without charge.
SIGNATURES
Pursuant to the requirements of the Securities Act of
1933, as amended, and the Investment Company Act of 1940,
as amended, the Registrant certifies that it meets all of
the requirements for effectiveness of this Registration
Statement pursuant to Rule 485 (a) under the Securities Act
of 1933 and has duly caused this Amendment to the
Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of
Chapel Hill, and the State of North Carolina, on the 28th
day of May, 1999.
SMITH BREEDEN SERIES FUND
By
Michael J. Giarla
President
Pursuant to the requirements of the Securities Act of 1933,
this Amendment to the Registration Statement has been
signed below by the following persons in the capacities
and on the dates indicated.
SIGNATURE TITLE DATE
Michael J. Giarla President, Principal May 28, 1999
Executive Officer,
and Trustee
Douglas T. Breeden* Trustee May 28, 1999
Stephen M. Schaefer* Trustee May 28, 1999
Myron S. Scholes* Trustee May 28, 1999
William F. Sharpe* Trustee May 28, 1999
Marianthe S. Mewkill Principal Financial May 28, 1999
and Accounting Officer
* By Marianthe S. Mewkill, Attorney-in-Fact pursuant to
power-of-attorney filed previously.
CONSENT OF INDEPENDENT AUDITORS
Smith Breeden Series Fund:
We consent to the use in Post-Effective Amendment No. 18 to
Registration Statement No. 33-43089 of our reports dated May 14,
1999 relating to the Smith Breeden Short Duration U.S. Government
Fund and Smith Breeden Intermediate Duration U.S. Government Fund
of Smith Breeden Series Fund appearing in the Statement of
Additional Information, which is a part of such Registration
Statement and to the references to us under the captions
"Experts" appearing in the Statement of Additional Information
and "Financial Highlights" appearing in the Prospectus, which
also is a part of such Registration Statement.
DELOITTE & TOUCHE LLP
Princeton, New Jersey
May 28, 1999
This Agreement, dated as of January 1, 1999, is made by and
between Smith Breeden Series Fund, a Massachusetts business trust
(the "Fund") operating as an open-end management investment company
registered under the Investment Company Act of 1940, as amended (the
"Act"), Smith Breeden Associates, Inc. (the "Company"), a registered
investment advisor duly organized and existing as a corporation under
the laws of the state of Kansas, and First Data Distributors, Inc.
("FDDI"), a corporation duly organized and existing under the laws of
the Commonwealth of Massachusetts (collectively, the "Parties").
WITNESSETH THAT:
WHEREAS, the Fund is authorized to issue separate series of
shares representing interests in separate investment portfolios (the
"Series"), which Series are identified on Schedule "C" attached
hereto, and which Schedule "C" may be amended from time to time by
mutual agreement among the Parties; and
WHEREAS, the Company has been appointed investment advisor to
the Fund; and
WHEREAS, FDDI is a broker-dealer registered with the U.S.
Securities and Exchange Commission (the "SEC") and a member in good
standing of the National Association of Securities Dealers, Inc. (the
"NASD"); and
WHEREAS, the Parties are desirous of entering into an agreement
providing for the distribution by FDDI of the shares of the Fund (the
"Shares").
NOW, THEREFORE, in consideration of the premises and mutual
covenants contained herein, and in exchange of good and valuable
consideration, the sufficiency and receipt of which is hereby
acknowledged, the Parties hereto, intending to be legally bound, do
hereby agree as follows:
1. Appointment
The Fund hereby appoints FDDI as its principal agent for the
distribution of the Shares, and FDDI hereby accepts such
appointment under the terms of this Agreement. The Fund agrees
that it will not sell any Shares to any person except to fill
orders for the Shares received through FDDI, provided, however,
that the foregoing exclusive right shall not apply to: (a)
Shares issued or sold in connection with the merger or
consolidation of any other investment company with the Fund or
the acquisition by purchase or otherwise of all or
substantially all of the assets of any investment company or
substantially all of the outstanding shares of any such company
by the Fund; (b) Shares which may be offered by the Fund to its
stockholders for reinvestment of cash distributed from capital
gains or net investment income of the Fund; or (c) Shares which
may be issued to shareholders of other funds who exercise any
exchange privilege set forth in the Fund's Prospectus.
Notwithstanding any other provision hereof, the Fund may
terminate, suspend, or withdraw the offering of the Shares
whenever, in their sole discretion, they deem such action to be
1
desirable.
2. Sale and Repurchase of Shares
(a) FDDI is hereby granted the right, as agent for the Fund,
to sell Shares to the public against orders received at
the public offering price as defined in the Fund's
Prospectus and Statement of Additional Information.
(b) FDDI will also have the right to take, as agent for the
Fund, all actions which, in FDDI's judgment, and subject
to the Fund's reasonable approval, are necessary to carry
into effect the distribution of the Shares.
(c) FDDI will act as agent for the Fund in connection with
the repurchase of Shares by the Fund upon the terms set
forth in the Fund's Prospectus and Statement of
Additional Information.
(d) The net asset value of the Shares shall be determined in
the manner provided in the then current Prospectus and
Statement of Additional Information relating to the
Shares, and when determined shall be applicable to all
transactions as provided in the Prospectus. The net
asset value of the Shares shall be calculated by the Fund
or by another entity on behalf of the Fund. FDDI shall
have no duty to inquire into, or liability for, the
accuracy of the net asset value per Share as calculated.
(e) On every sale, FDDI shall promptly pay to the Fund the
applicable net asset value of the Shares.
(f) Upon receipt of purchase instructions, FDDI will transmit
such instructions to the Fund or its transfer agent for
registration of the Shares purchased.
(g) Nothing in this Agreement shall prevent FDDI or any
affiliated person (as defined in the Act) of FDDI from
acting as underwriter for any other person, firm or
corporation (including other investment companies), or in
any way limit or restrict FDDI or such affiliated person
from buying, selling or trading any securities for its or
their own account or for the account of others for whom
it or they may be acting, provided, however, that FDDI
expressly agrees that it will not for its own account
purchase any Shares of the Fund except for investment
purposes, and that it will not for its own account
dispose of any such Shares except by redemption of such
Shares with the Fund, and that it will not undertake in
any activities which, in its judgment, will adversely
affect the performance of its obligations to the Fund
under this Agreement.
3. Rules of Sale of Shares
FDDI does not agree to sell any specific number of Shares and
serves only in the capacity of Statutory Underwriter. The Fund
reserves the right to terminate, suspend or withdraw the sale
of its Shares for any reason deemed adequate by it, and the
2
Fund reserves the right to refuse at any time or times to sell
any of its Shares to any person for any reason deemed adequate
by it.
4. Rules of NASD, etc.
(a) FDDI will conform to the Conduct Rules of the NASD and
the securities laws of any jurisdiction in which it
directly or indirectly sells any Shares.
(b) FDDI will require each dealer with whom FDDI has a
selling agreement to conform to the applicable provisions
of the Prospectus, with respect to the public offering
price of the Shares, and FDDI shall not cause the Fund to
withhold the placing of purchase orders so as to make a
profit thereby.
(c) The Fund and the Company agree to furnish FDDI sufficient
copies of any and all: agreements, plans, communications
with the public or other materials which the Fund or the
Company intend to use in connection with any sales of
Shares, in adequate time for FDDI to file and clear such
materials with the proper authorities before they are put
in use. FDDI and the Fund or the Company may agree that
any such material does not need to be filed subsequent to
distribution. In addition, the Fund and the Company
agree not to use any such materials until so filed and
cleared for use, if required, by appropriate authorities
as well as by FDDI.
(d) FDDI, at its own expense, will qualify as a dealer or
broker, or otherwise, under all applicable state or
federal laws required in order that the Shares may be
sold in such states as may be mutually agreed upon by the
Parties.
(e) FDDI shall remain registered with the SEC and a member of
the NASD for the term of this Agreement.
(f) FDDI shall not, in connection with any sale or
solicitation of a sale of the Shares, make or authorize
any representative, service organization, broker or
dealer to make any representations concerning the Shares,
except those contained in the Prospectus offering the
Shares and in communications with the public or sales
materials approved by FDDI as information supplemental to
such Prospectus. Copies of the Prospectus will be
supplied by the Fund or the Company to FDDI in reasonable
quantities upon request.
(g) FDDI shall only be authorized to make representations in
respect of the Fund consistent with the then current
Prospectus, Statement of Additional Information, and
other written information provided by the Fund or its
agents to be used explicitly with respect to the sale of
Shares.
3
5. Records to be Supplied by the Fund
The Fund shall furnish to FDDI copies of all information,
financial statements and other papers which FDDI may reasonably
request for use in connection with the underwriting of the
Shares including, but not limited to, one certified copy of all
financial statements prepared for the Fund by its independent
public accountants.
6. Expenses
(a) The Fund will bear the following expenses:
(i) preparation, setting in type, and printing of
sufficient copies of the Prospectus and Statement
of Additional Information for distribution to
shareholders, and the cost of distribution of same
to the shareholders;
(ii) preparation, printing and distribution of reports
and other communications to shareholders;
(iii) registration of the Shares under the federal
securities laws;
(iv) qualification of the Shares for sale in the
jurisdictions as directed by the Fund;
(v) maintaining facilities for the issue and transfer
of the Shares;
(vi) supplying information, prices and other data to be
furnished by the Fund under this Agreement; and
(vii) any original issue taxes or transfer taxes
applicable to the sale or delivery of the Shares or
certificates therefor.
(b) The Company will pay all other expenses incident to the
sale and distribution of the Shares sold hereunder.
(c) FDDI agrees to pay all of its own expenses in performing
its obligations hereunder.
7. Term and Compensation
(a) The term of this Agreement shall commence on the date on
hereinabove first written (the "Effective Date").
(b) This Agreement shall remain in effect for one (1) year
from the Effective Date. This Agreement shall continue
thereafter for periods not exceeding one (1) year, if
approved at least annually (i) by a vote of a majority of
the outstanding voting securities of each Series, or (ii)
by a vote of a majority of the Board Members of the Fund
who are not parties to this Agreement (other than as
Board Members of the Fund) or interested persons of any
such party, cast in person at a meeting called for the
4
purpose of voting on such approval.
(c) Fees payable to FDDI shall be paid by the Company as set
forth in Schedule "B" attached and shall be fixed for the
one (1) year period commencing on the Effective Date of
this Agreement. Thereafter, the fee schedule will be
subject to annual review and adjustment.
(d) This Agreement (i) may be terminated at any time without
the payment of any penalty, either by a vote of the
Trustees of the Fund or by a vote of a majority of the
outstanding voting securities of each Series with respect
to such Series, on sixty (60) days' written notice to
FDDI; and (ii) may be terminated by FDDI on sixty (60)
days' written notice to the Fund with respect to any
Series.
(e) This Agreement shall automatically terminate in the event
of its assignment, as defined in the Act.
8. Indemnification of FDDI by the Company and the Fund
FDDI is responsible for its own conduct and the employment,
control, and conduct of its agents and employees and for injury
to such agents or employees or to others caused by it, its
agents or employees. Notwithstanding the above, the Company
and the Fund will indemnify and hold FDDI harmless for the
actions of the Company's employees registered with the NASD as
registered representatives of FDDI, and the Company hereby
undertakes to maintain compliance with all NASD and SEC rules
and regulations concerning any activities of such employees.
FDDI shall have the right, in its reasonable discretion, to
refuse to register any individual as its representative.
9. Liability of FDDI
(a) FDDI, its directors, officers, employees, shareholders
and agents shall not be liable for any error of judgment
or mistake of law or for any loss suffered by the Fund in
connection with the performance of this Agreement, except
a loss resulting from a breach of FDDI's obligations
pursuant to Section 4 of this Agreement (Rules of NASD),
a breach of fiduciary duty with respect to the receipt of
compensation for services or a loss resulting from
willful misfeasance, bad faith or gross negligence on the
part of FDDI in the performance of its obligations and
duties or by reason of its reckless disregard of its
obligations and duties under this Agreement. FDDI agrees
to indemnify and hold harmless the Fund and each person
who has been, is, or may hereafter be a Trustee, officer,
or employee of the Fund against expenses reasonably
incurred by any of them in connection with any claim or
in connection with any action, suit, or proceeding to
which any of them may be a party, which arises out of or
is alleged to arise out of any misrepresentation or
omission to state a material fact, or out of any alleged
misrepresentation or omission to state a material fact,
on the part of FDDI or any agent of employee of FDDI or
any of the persons for whose acts FDDI is responsible or
5
is alleged to be responsible unless such
misrepresentation or omission was made in reliance upon
written information furnished to FDDI by the Fund. FDDI
also agrees to indemnify and hold harmless the Fund and
each such person in connection with any claim or in
connection with any action, suit, or proceeding which
arises out of or is alleged to arise out of FDDI's
failure to exercise reasonable care and diligence with
respect to its services rendered in connection with the
purchase and sale of Shares. The foregoing rights of
indemnification shall be in addition to any other rights
to which the Fund or any such person shall be entitled to
as a matter of law.
(b) The Fund agrees to indemnify and hold harmless FDDI
against any and all liability, loss, damages, costs or
expenses (including reasonable counsel fees) which FDDI
may incur or be required to pay hereafter, in connection
with any action, suit or other proceeding, whether civil
or criminal, before any court or administrative or
legislative body, in which FDDI may be involved as a
party or otherwise or with which FDDI may be threatened,
by reason of the offer or sale of the Fund's Shares by
persons other than FDDI or its representatives, prior to
the execution of this Agreement. If a claim is made
against FDDI as to which FDDI may seek indemnity under
the Section, FDDI shall notify the Fund promptly after
any written assertion of such claim threatening to
institute an action or proceeding with respect thereto
and shall notify the Fund promptly of any action
commenced against FDDI within 10 days time after FDDI
shall have been served with a summons or other legal
process, giving information as to the nature and basis of
the claim. Failure to notify the Fund shall not,
however, relieve the Fund from any liability which it may
have on account of the indemnity under this Section 9(b)
if the Fund has not been prejudiced in any material
respect by such failure. The Fund shall have the sole
right to control the settlement of any such action, suit
or proceeding subject to FDDI approval, which shall not
be unreasonably withheld. FDDI shall have the right to
participate in the defense of an action or proceeding and
to retain its own counsel, and the reasonable fees and
expenses of such counsel shall be borne by the Fund
(which shall pay such fees, costs and expenses at least
quarterly) if:
(i) FDDI has received an opinion of counsel
stating that the use of counsel chosen by the
Fund to represent FDDI would present such
counsel with a conflict of interest:
(ii) the defendants in, or targets of, any such
action or proceeding include both FDDI and
the Fund, and legal counsel to FDDI shall
have reasonably concluded that there are
legal defenses available to it which are
different from or additional to those
available to the trust or which may be
6
adverse to or inconsistent with defenses
available to the Fund (in which case the Fund
shall not have the right to direct the
defense of such action on behalf of FDDI); or
(iii) the Fund shall authorize FDDI to employ
separate counsel at the expense of the Fund.
(c) Any person, even though also a director, officer,
employee, shareholder or agent of FDDI who may be or
become an officer, director, trustee, employee or agent
of the Fund, shall be deemed, when rendering services to
the Fund or acting on any business of the Fund (other
than services or business in connection with FDDI's
duties hereunder), to be rendering such services to or
acting solely for the Fund and not as a director,
officer, employee, shareholder or agent, or one under the
control or direction of FDDI even though receiving a
salary from FDDI.
(d) The Fund agrees to indemnify and hold harmless FDDI, and
each person who controls FDDI within the meaning of
Section 15 of the Securities Act of 1933, as amended (the
"Securities Act"), or Section 20 of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"),
against any and all losses, claims, damages and
liabilities, joint or several (including any reasonable
investigative, legal and other expenses incurred in
connection therewith) to which they, or any of them, may
become subject under the Act, the Securities Act, the
Exchange Act or other federal or state law or
regulations, at common law or otherwise insofar as such
losses, claims, damages or liabilities (or actions, suits
or proceedings in respect thereof) arise out of or are
based upon any untrue statement or alleged untrue
statement of a material fact contained in a Prospectus,
Statement of Additional Information, supplement thereto,
sales literature (or other written information) prepared
by the Fund and furnished by the Fund to FDDI for FDDI's
use hereunder, disseminated by the trust or which arise
out of or are based upon any omission or alleged omission
to state therein a material fact required to be stated
therein or necessary to make the statements therein not
misleading.
Such indemnity shall not, however, inure to the benefit
of FDDI (or any person controlling FDDI) on account of
any losses, claims, damages or liabilities (or actions,
suits or proceedings in respect thereof) arising from the
sale of the Shares of the Fund to any person by FDDI (i)
if such untrue statement or omission or alleged untrue
statement or omission was made in the Prospectus,
Statement of Additional Information, or supplement, sales
or other literature, in reliance upon and in conformity
with information furnished in writing to the Fund by FDDI
specifically for use therein or (ii) if such losses,
claims, damages or liabilities arise out of or are based
upon an untrue statement or omission or alleged untrue
statement or omission found in any Prospectus, Statement
7
of Additional Information, supplement, sales or other
literature, subsequently corrected, but negligently
distributed by FDDI and a copy of the corrected
Prospectus was not delivered to such person at or before
the confirmation of the sale to such person
(e) FDDI shall not be responsible for any damages,
consequential or otherwise, which the Company or the Fund
may experience, due to the disruption of the distribution
of Shares caused by any action or inaction of any
registered representative or affiliate of FDDI or of FDDI
itself.
(f) Notwithstanding anything in this Agreement to the
contrary, in no event shall any party to this Agreement,
its affiliates or any of its or their directors,
trustees, officers, employees, agents or subcontractors
be liable for consequential damages.
10. Amendments
No provision of this Agreement may be amended or modified in
any manner whatsoever, except by a written agreement properly
authorized and executed by the Parties.
11. Section Headings
Section and paragraph headings are for convenience only and
shall not be construed as part of this Agreement.
12. Reports
FDDI shall prepare reports for the Board of the Fund, on a
quarterly basis, showing such information as, from time to
time, shall be reasonably requested by the Board.
13. Severability
If any part, term or provision of this Agreement is held by any
court to be illegal, in conflict with any law or otherwise
invalid, the remaining portion or portions shall be considered
severable and not affected, and the rights and obligations of
the Parties shall be construed and enforced as if the Agreement
did not contain the particular part, term or provision held to
be illegal or invalid provided that the basic agreement is not
thereby substantially impaired.
14. Governing Law
This Agreement shall be governed by the laws of the
Commonwealth of Massachusetts and the exclusive venue of any
action arising under this Agreement shall be the City of
Boston, Commonwealth of Massachusetts.
15. Authority to Execute
The Parties represent and warrant to each other that the
execution and delivery of this Agreement by the undersigned
officer of each Party has been duly and validly authorized;
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and, when duly executed, this Agreement will constitute a valid
and legally binding and enforceable obligation of each Party.
IN WITNESS WHEREOF, the Parties hereto have caused this Agreement to
be signed by their duly authorized officer, of the day and year first
above written.
FIRST DATA DISTRIBUTORS, INC.
_____________________________
By:
Title:
SMITH BREEDEN SERIES FUND
_____________________________
By:
Title:
SMITH BREEDEN ASSOCIATES, INC.
_____________________________
By:
Title:
SCHEDULE A
UNDERWRITER SERVICES
1. Underwriter services include:
A) Preparation and execution of Underwriter and 12b-1 Plan
Agreements
? Monitoring accruals
? Monitoring expenses
? Disbursements for expenses and tail commissions
B) Quarterly 12b-1 Reports to Board
C) Literature review, recommendations and submission to the
NASD
D) Initial NASD Licensing and Transfers of Registered
Representatives
? U-4 Form and Fingerprinting Submission to NASD
? Supplying Series 6 and 63 written study material
? Registration for Exam Preparation classes
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? Renewals and Termination of Representatives
E) Written supervisory procedures and manuals for Registered
Representatives
F) Ongoing compliance updates for Representatives regarding
sales practices, written correspondence and other
communications with the public.
G) NASD Continuing Education Requirement
SCHEDULE B
FEE SCHEDULE
This Fee Schedule is fixed for a period of one (1) year from the
Effective Date as that term is defined in the Agreement.
1. Statutory Underwriter Services
A) The Fund agrees to pay FDDI $15,000 for the services
performed under this Agreement.
B) FDDI agrees to register certain employees of the Company
as its representatives as follows:
Up to 10 States $2,000 per Representative per
Year
All 50 States $4,000 per Representative
per Year
SCHEDULE C
IDENTIFICATION OF SERIES
Below are listed the Series and Classes of Shares to which services
under this Agreement are to be performed as of the Effective Date of
this Agreement:
Smith Breeden Short Duration U.S. Government Fund
Smith Breeden Intermediate Duration U.S. Government Fund
This Schedule "C" may be amended from time to time by agreement of
the Parties.
Dated: January 1, 1999
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