PROSPECTUS/FEBRUARY 2, 2000
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SMITH BREEDEN
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M U T U A L F U N D S
- Short Duration U.S. Government Fund
- Intermediate Duration U.S. Government Fund
- U.S. Equity Market Plus Fund
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SUMMARY INFORMATION
This Prospectus describes three no load mutual funds offering you a choice of
investments to help fulfill your asset allocation needs:
o Smith Breeden Short Duration U.S. Government Fund
o Smith Breeden Intermediate Duration U.S. Government Fund
o Smith Breeden U.S. Equity Market Plus 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").
TABLE OF CONTENTS
<TABLE>
<CAPTION>
<S> <C>
SMITH BREEDEN BOND FUNDS .................................................. 1
SMITH BREEDEN EQUITY FUND ................................................. 5
SUMMARY OF PRINCIPAL RISKS AND INVESTMENT STRATEGIES ...................... 9
CHARACTERISTICS AND RISKS OF THE SECURITIES IN WHICH THE FUNDS MAY INVEST . 11
MANAGEMENT OF THE FUNDS ................................................... 14
PRICING OF FUND SHARES .................................................... 18
HOW TO PURCHASE SHARES .................................................... 18
HOW TO EXCHANGE SHARES .................................................... 21
HOW TO REDEEM SHARES ...................................................... 21
DIVIDENDS AND DISTRIBUTIONS ............................................... 24
SHAREHOLDER REPORTS AND INFORMATION ....................................... 24
RETIREMENT PLANS .......................................................... 25
SERVICE AND DISTRIBUTION PLANS ............................................ 25
TAXES ..................................................................... 25
CAPITAL STRUCTURE ......................................................... 26
TRANSFER AND DIVIDEND DISBURSING AGENT, CUSTODIAN AND INDEPENDENT AUDITORS 26
FUND PERFORMANCE .......................................................... 27
FINANCIAL HIGHLIGHTS ...................................................... 28
</TABLE>
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.
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SMITH BREEDEN BOND FUNDS
Smith Breeden Short Duration U.S. Government Fund
Smith Breeden Intermediate Duration U.S. Government Fund
Investment Objectives
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o 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.
o 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
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o 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.
o 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 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 Short and Intermediate Funds will not purchase a put or call option on U.S.
Government Securities or mortgage-backed securities if, as a result of such
purchase, more than 10% of its total assets would be invested in such options.
The Short and Intermediate Funds will engage in OTC option transactions only
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.
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:
o Securities issued directly or guaranteed by the U.S. Government or its
agencies or instrumentalities.
o 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.
o Securities fully collateralized by assets in either of the above classes.
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o 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.
o Hedge instruments and stripped Mortgage-Backed Securities, which may only be
used for risk management purposes.
Principal Investment Risks
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An investor could lose money by investing in these Funds. Other primary risks
of investing in the Funds are:
o Basis Risk
o Credit Risk
o Derivatives Risk
o Interest Rate and Maturity Risk
o Leveraging Risk
o Liquidity Risk
o Management Risk
o Market Risk
o Prepayment Risk
o 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.
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Annual Performance
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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.
[BAR GRAPH APPEARS HERE WITH THE FOLLOWING PLOT POINTS]
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) 1.68%
1993 1994 1995 1996 1997 1998
4.30% 4.14% 6.13% 6.28% 6.32% 4.77%
Short Fund
[BAR GRAPH APPEARS HERE WITH THE FOLLOWING PLOT POINTS]
CALANDAR-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) .01%
1993 1994 1995 1996 1997 1998
11.09% (1.67)% 16.40% 5.05% 9.00% 6.56%
Intermediate Fund
AVERAGE ANNUAL TOTAL RETURNS
(for periods ended December 31, 1998)
<TABLE>
<CAPTION>
Fund Inception
Short Fund 1 Year 5 Years (March 31, 1992)
- --------------------------------- ---------- --------- -----------------
<S> <C> <C> <C>
Short Fund 4.77% 5.52% 5.46%
- --------------------------------- ---- ---- ----
Merrill Lynch 6 Month US T-Bill 5.58% 5.37% 4.97%
- --------------------------------- ---- ---- ----
</TABLE>
<TABLE>
<CAPTION>
Fund Inception
Intermediate Fund 1 Year 5 Years (March 31, 1992)
- ------------------------------------------------- ---------- --------- -----------------
<S> <C> <C> <C>
Intermediate Fund 6.56% 6.91% 8.26%
- ------------------------------------------------- ---- ---- ----
Salomon Smith Barney Mortgage Index ("SBMI")(1) 6.99% 7.23% 7.58%
- ------------------------------------------------- ---- ---- ----
</TABLE>
(1) The fund changed its investment objective 1/1/94. Prior to 1/1/1994, the
Fund's objective was to provide a return in excess of the five year U.S.
Treasury Note.
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Your Expenses
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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.
<TABLE>
<CAPTION>
Short Fund Intermediate Fund
<S> <C> <C>
Shareholder Fees(1) (fees paid directly from your investment)
Annual Maintenance Fee for accounts less than $2,000 $ 16 $ 16
Account Closing Fee $ 8 $ 8
- -------------------------------------------------------------- ------- -------
Annual Fund Operating Expenses
(expenses that are deducted from Fund assets)
Management Fees(2)(3) 0.70% 0.70%
- -------------------------------------------------------------- ------- -------
Other Expenses(3) 0.30% 0.36%
12b-1 Fee(2) None None
- -------------------------------------------------------------- ------- -------
Total Fund Operating Expenses(3) 1.00% 1.06%
- -------------------------------------------------------------- ------- -------
</TABLE>
(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 your
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:
<TABLE>
<CAPTION>
1 Year 3 Years 5 Years 10 Years
-------- --------- --------- ---------
<S> <C> <C> <C> <C>
Short Fund $105 $328 $568 $1,258
Intermediate Fund $111 $347 $601 $1,329
</TABLE>
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SMITH BREEDEN EQUITY FUND
Smith Breeden U.S. Equity Market Plus Fund
Investment Objectives
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o 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.
Principal Investment Strategies
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The Fund does not invest principally in the common stocks that make up the S&P
500 Index or any other index. Instead, the Fund invests primarily in an
actively managed short duration fixed income portfolio and maintains positions
in S&P 500 futures, options and similar instruments. The equity index futures
and options positions are designed to produce an exposure to the S&P 500 Index
similar to that which would be achieved if all the Fund's assets were invested
directly in the stocks comprising the S&P 500 Index. The Fund's investment
strategy is designed to produce a total return with a low tracking error
relative to the S&P 500 Index.
The Fund's fixed income securities will 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. The Fund will employ hedging
techniques, with instruments such as interest rate futures, options, floors,
caps and swaps, designed to reduce the interest-rate risk of its fixed-income
portfolio. The Fund will manage its fixed income portfolio effective duration
to a target of one year or less. The Fund may also engage in loans of portfolio
securities and dollar rolls to enhance income and total return.
The 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.
The Fund's equity market positions are designed to produce a return similar to
that which would be achieved if all the Fund's assets were invested directly in
the stocks comprising the S&P 500 Index in proportion to their respective
weightings in the S&P 500 Index. The Fund's exposure to the S&P 500 Index will
be maintained primarily with futures, options, and swaps. When futures
contracts are purchased, only a small percentage of the notional value of the
contract must be posted as margin. No margin is generally required when
entering into a swap or option contract. The Fund therefore commits only a
small percentage of its net assets to purchasing the instruments that it uses
to obtain its equity market exposure. With the remainder of its assets, the
Fund will invest in an actively managed short duration fixed income portfolio.
The Fund's success in achieving its performance objective depends largely on
whether the total return on the Fund's fixed-income portfolio equals or exceeds
a short term interest rate plus the Fund's total operating expenses. The
operating expenses of the Fund include the transaction and financing costs of
entering into the futures, options and swap contracts used for interest rate
risk management and for S&P 500 Index replication. Other factors which will
impact the success of the Fund's strategies relate to how well the returns of
the equity index futures, swaps and options track the S&P 500 Index.
Principal Investment Risks
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An investor could lose money by investing in this Fund. The Fund should be
invested in by individuals seeking the return of the stock market, specifically
that of the S&P 500 Index. Although the Fund invests in bonds, it is not a
"bond" fund and should not be invested in by someone seeking a fixed income
return. The movements in the S&P 500 Index can be very volatile from day-to-day
and a person who invests in the Equity Market Plus Fund should be aware that
significant losses can be sustained in one day, as well as over time.
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The U.S. Equity Market Plus Fund's use of derivative instruments such as
futures, swaps and options to track the market index raises additional risks.
The Fund's opportunity for gain or loss may be greater than if the Fund
invested directly in the stocks represented by the market index because the
notional value of the financial instruments utilized may not match exactly the
Fund's net assets. For example, 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, the Fund expects that such variations
in its exposure to the index will be up to 5% more or less than the Fund's net
assets.)
Other primary risks of investing in the Fund are:
o Basis Risk
o Credit Risk
o Derivatives Risk
o Interest Rate and Maturity Risk
o Leveraging Risk
o Liquidity Risk
o Management Risk
o Market Risk
o Prepayment Risk
o 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.
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Annual Performance
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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. Past performance does not guarantee future results.
[BAR GRAPH APPEARS HERE WITH THE FOLLOWING PLOT POINTS]
CALENDAR-YEAR TOTAL RETURNS
U.S. EQUITY MARKET PLUS FUND
BEST QUARTER: Fourth quarter 1998, 21.07%
WORST QUARTER: Third quarter 1998, 10.82%
MORE RECENT RETURN INFORMATION: (January 1, 1999 - June 30, 1999) 12.09%
1993 1994 1995 1996 1997 1998
13.22% 1.84% 36.76% 24.36% 32.29% 26.43%
AVERAGE ANNUAL TOTAL RETURNS
(for periods ended December 31, 1998)
<TABLE>
<CAPTION>
Fund Inception
1 Year 5 Years (June 30, 1992)
----------- ----------- ----------------
<S> <C> <C> <C>
U.S. Equity Market Plus Fund 26.43% 23.71% 21.89%
- ------------------------------ ----- ----- -----
S&P 500 Index* 28.58% 24.03% 21.24%
- ------------------------------ ----- ----- -----
</TABLE>
* 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
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The information below describes the fees and expenses you may pay if you buy
and hold shares of the Fund.
<TABLE>
<CAPTION>
U.S. Equity
Market Plus
<S> <C>
Shareholder Fees(1) (fees paid directly from
your investment)
Annual Maintenance Fee for accounts less than $2,000 $ 16
Account Closing Fee $ 8
- ------------------------------------------------------ -------
Annual Fund Operating Expenses
(expenses that are deducted from Fund assets) 0.70%
Management Fees(2)(3)
- ------------------------------------------------------
Other Expenses(3) 0.34%
12b-1 Fee(2) None
- ------------------------------------------------------ -------
Total Fund Operating Expenses(3) 1.04%
- ------------------------------------------------------ -------
</TABLE>
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(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 each 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 0.88%.
Examples
The example below is intended to help you compare the cost of investing in the
Fund with the cost of investing in other mutual funds. The example assumes that
you invest $10,000 in the Fund for the time periods indicated, that your
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:
<TABLE>
<CAPTION>
1 Year 3 Years 5 Years 10 Years
-------- --------- --------- ---------
<S> <C> <C> <C> <C>
U.S. Equity Market Plus $109 $341 $590 $1,305
</TABLE>
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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 each 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 related risks.
Basis Risk. Basis risk is the risk that changes in the value of a hedge
transaction will not completely offset changes in the value of the assets and
liabilities being hedged. Basis risk may occur in many ways. For example, a
hedge transaction may rise in value by $100 in response to higher interest
rates. At the same time, the security being hedged could decline in value by
$102 in response to the same market factor -- higher interest rates -- and
other factors unique to those assets including credit risks that might be
reflected in the assets' value. The hedge would therefore not fully cover the
loss in value of the security caused by higher rates since a $2 differential
would exist between the gain in value on the hedge and the assets' loss in
value. The $2 differential reflects basis risk. Basis risk can manifest itself
in other ways; for example when a small change in interest rates occurs. In
that context, both the hedge transaction and the hedged assets could decline in
value, although by different amounts, following an interest rate change. This
means that a Fund may not achieve, and may at times exceed, its targeted
duration or the return of the market it tracks.
Credit Risk. An issuer of securities 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
credit risk by investing in securities of the highest credit quality, while the
U.S. Equity Market Plus Fund will seek to minimize credit risk by investing in
securities of at least investment grade, except that its investment in
mortgage-backed securities will be rated at least A. 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.
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, 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 swap
agreements. Any or all of these techniques may be used at one time. 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 use of derivatives involves costs and may result in losses. For
example, the losses from investing in futures transactions are potentially
unlimited.
The use of options and futures strategies 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. In
addition to other risks such as the credit risk of the counterparty, market
risk, liquidity risk, and basis risk, derivatives involve the
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risk of mispricing or improper valuation. In addition, the Funds' use of
derivatives may also have the effect of accelerating a Fund's recognition of
gain.
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.
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.
Interest Rate and Maturity 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 seeks 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). The Equity Market Plus Fund seeks a duration of one year or less.
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 significantly longer than its duration objective.
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 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.
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, 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 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
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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.
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.
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 as 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.
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.
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.
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.
CHARACTERISTICS AND RISKS 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.
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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 Short and Intermediate 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 Fund's 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 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 "Summary of Principal Risks and
Investment Strategies" and the Statements of Additional Information.
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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 portfolio of the U.S. Equity Market Plus Fund may also invest in
adjustable-rate securities backed by assets other than mortgage pools.
Although the rate adjustment feature may act as a buffer to reduce large
changes in the value of adjustable-rate securities, these securities are still
subject to changes in value based on changes in market interest rates or
changes in the issuer's creditworthiness. Because the interest rate is reset
only periodically, changes in the interest rate on adjustable-rate securities
may lag changes in prevailing market interest rates. Also, some adjustable-rate
securities (or the underlying mortgages or other underlying loans or
receivables) are subject to caps or floors that limit the maximum change in
interest rate during a specified period or over the life of the security.
Because of the resetting of interest rates, adjustable-rate securities are less
likely than non-adjustable-rate securities of comparable quality and maturity
to increase significantly in value when market interest rates fall.
Adjustable-rate securities are also subject to the prepayment risks associated
generally with mortgage-backed securities.
Securities Lending, Repurchase Agreements and Forward Commitments. The Funds
may lend portfolio securities to broker-dealers and may enter into repurchase
agreements. These transactions must be fully collateralized at all times but
involve some risk to the Funds if the other party should default on its
obligations and a Fund is delayed in or prevented from recovering the
collateral. None of the Funds will lend portfolio securities if, as a result,
the aggregate of such loans exceeds 33 1/3% of the total asset value (including
such loans). The Funds will only enter into repurchase agreements with or lend
securities to (i) member banks of the Federal Reserve System having total
assets in excess of $500 million and (ii) securities dealers, provided such
banks or dealers meet the creditworthiness standards established by the Board
of Trustees ("Qualified Institutions"). The Adviser will monitor the continued
creditworthiness of Qualified Institutions, subject to the oversight of the
Board of Trustees.
The Funds may also purchase securities for future delivery, which may increase
overall investment exposure and involves a risk of loss if the value of the
securities declines prior to the settlement date. At the time a Fund enters
into a transaction on a when-issued or forward commitment basis, a segregated
account consisting of liquid securities equal to at least 100% of the value of
the when-issued or forward commitment securities will be established and
maintained with the Funds' custodian. Subject to this requirement, the Funds
may purchase securities on such basis without limit. Settlements in the
ordinary course, which may be substantially more than three business days for
mortgage-backed securities, are not treated as when-issued or forward
commitment transactions, and are not subject to the foregoing limitations,
although some of the risks described above may exist.
Reverse Repurchase Agreements, Dollar Roll Agreements and Borrowing. The Funds
may enter into reverse repurchase agreements or dollar roll agreements with
commercial banks and registered broker-dealers in amounts up to 33 1/3% of
their assets. The Short and Intermediate Funds may only enter into these
transactions with commercial banks and registered broker-dealers which are also
Qualified Institutions. The Statement of Additional Information for each Trust
contains a more detailed explanation of these practices. Reverse repurchase
agreements and dollar rolls are considered borrowings by a Fund and require
segregation of assets with a Fund's custodian in an amount equal to the Fund's
obligations pending completion of such transactions. Each Fund may also borrow
money from banks in an amount up to 33 1/3% of a Fund's total assets to realize
investment opportunities, for extraordinary or emergency purposes, or for the
clearance of transactions. Borrowing from banks usually involves certain
transaction and ongoing costs and may require 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
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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. While
a short sale may act as effective hedge to reduce the market or interest rate
risk of a portfolio, it may also result in losses which can reduce the
portfolio's total return.
When a Fund makes a short sale, it must borrow the security sold short and
deliver it to the broker-dealer through which it made the short sale as
collateral for its obligation to deliver the security upon completion of the
transaction. A Fund may have to pay a fee to borrow particular securities, and
is often obligated to relinquish any payments received on such borrowed
securities.
Until a Fund replaces a borrowed security, it will maintain daily a segregated
account with its custodian into which it will deposit liquid securities such
that the amount deposited in the account plus any amount deposited with the
broker as collateral will equal the current value of the security sold short.
Depending on arrangements made with the broker, a Fund may not receive any
payments (including interest) on collateral deposited with the broker. If the
price of the security sold short increases between the time of the short sale
and the time a Fund replaces the borrowed security, the Fund will incur a loss;
conversely, if the price declines, the Fund will realize a gain. Although a
Fund's gain is limited to the amount at which it sold the security short, its
potential loss is limited only by the maximum attainable price of the security
less the price at which the security was sold.
A Fund will not make a short sale if, after giving effect to such sale, the
market value of all securities sold exceeds 25% of the value of the Fund's
total net assets. A Fund may also effect short sales where the Fund owns, or
has the right to acquire at no additional cost, the identical security (a
technique known as a short sale "against the box"). Such transactions might
accelerate the recognition of gain. See "Taxes" in the relevant Statement of
Additional Information.
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
each of the Funds for the fiscal year ended March 31, 1999 were 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. High portfolio turnover could adversely impact a Fund's
performance. However, the mortgage securities in which 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 U.S. Equity Market
Plus Fund, in relation to any purchase of common stocks or other equity
securities.
MANAGEMENT OF THE FUNDS
Its Board of Trustees manages the business affairs of the Funds. Each of the
Funds has entered into an investment advisory agreement with Smith Breeden
Associates, Inc., 100 Europa Drive, Chapel Hill, North Carolina, 27514 (the
"Investment Advisory Agreements"). Pursuant to such investment advisory
agreements, the Adviser furnishes continuous investment advisory services to
each of the Funds.
Trustees and Officers
The following is a listing of the Trustees and officers of the Series Fund and
Trust, the legal entities that have issued shares in the Funds. Unless
otherwise indicated, all of the named individuals serve in their capacities for
both the Series Fund and Trust.
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Douglas T. Breeden* Trustee and Chairman
Dr. Breeden, aged 49, the Chairman of the Board of Smith Breeden Associates,
co-founded the firm in 1982. 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. The address for Dr. Breeden is the same as that of the Funds at 100
Europa Drive, Chapel Hill, North Carolina, 27514.
Michael J. Giarla* Trustee and President
Mr. Giarla, aged 41, is Chief Operating Officer, President and Director of
Smith Breeden Associates. 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 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. The address for Mr. Giarla is the same as
that of the Funds at 100 Europa Drive, Chapel Hill, North Carolina, 27514.
Stephen M. Schaefer Trustee
Stephen M. Schaefer, aged 52, 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. The address for Dr. Schaefer
is the same as that of the Funds at 100 Europa Drive, Chapel Hill, North
Carolina, 27514.
Myron S. Scholes Trustee
Myron S. Scholes, aged 58, is the Frank E. Buck Professor of Finance Emeritus
at the Graduate School of Business at Stanford University (since 1983). He is a
consultant to the Robert M. Bass organization. He is a member of the
Econometric Society. Professor Scholes was formerly a limited partner and
principal of Long Term Capital Management (1993-1998). He 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.
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* Interested Person
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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). The address for Dr.
Scholes is the same as that of the Funds at 100 Europa Drive, Chapel Hill,
North Carolina, 27514.
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, aged 65, is the STANCO 25 Professor of Finance at Stanford
University's Graduate School of Business. He is best known as one of the
developers of the Capital Asset Pricing Model, including the beta and alpha
concepts used in risk analysis and performance measurement. He developed the
widely used binomial method for the valuation of options and other contingent
claims. He also developed the computer algorithm used in many asset allocation
procedures, a procedure for estimating the style of an investment manager from
its historic returns, and the Sharpe ratio for measuring investment
performance. Dr. Sharpe has published articles in a number of professional
journals. He has also written six books, including Portfolio Theory and Capital
Markets, (McGraw-Hill, 1970), Asset Allocation Tools, (Scientific Press, 1987),
Fundamentals of Investments (with Gordon J. Alexander and Jeffery Bailey,
Prentice-Hall, 1993) and Investments (with Gordon J. Alexander and Jeffrey
Bailey, Prentice-Hall, 1990). Dr. Sharpe is a past President of the American
Finance Association. He also served as consultant to a number of corporations
and investment organizations. He is Trustee of the Barr Rosenberg mutual funds,
a director of Stanford Management Company and the Chairman of the Board of
Financial Engines, a company providing electronic portfolio advice. He received
the Nobel Prize in Economic Sciences in 1990. The address for Dr. Sharpe is the
same as that of the Funds at 100 Europa Drive, Chapel Hill, North Carolina,
27514.
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 and has been
employed by Smith Breeden since 1986. 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.
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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 and has been employed by Smith Breeden since 1988. Mr. Rowe, in
conjunction with Daniel C. Dektar, is responsible for the day-to-day management
of the Intermediate Fund, and has been involved in managing the Fund since
December of 1997. Mr. Rowe is a senior portfolio manager working primarily with
discretionary separate account clients. He implements investment strategies
designed to generate portfolio returns superior to the broad investment grade
and mortgage market indices. Mr. Rowe joined Smith Breeden in 1988. His prior
experience includes three years as Assistant Economist at the Federal Reserve
Bank of Richmond, Virginia. While at the Bank, he co-edited the sixth edition
of Instruments of the Money Market, and produced research papers for
publication in the Bank's Economic Review magazine. He holds a Master of
Business Administration with specialization in Finance from the University of
Chicago Graduate School of Business, and a Bachelor of Arts in Economics and
History from Duke University. He graduated from Duke magna cum laude, earned
Class Honors and was a National Merit Scholar.
John B. Sprow Vice President, Smith Breeden Trust
Portfolio Manager, U.S. Equity Market Plus
Fund
John B. Sprow is a Principal, Director and Executive Vice President of Smith
Breeden Associates and has been employed by Smith Breeden since 1987. 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.
Investment Adviser
Smith Breeden Associates, Inc., a registered investment adviser, acts as
investment adviser to the Funds. Approximately 54% 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, and, U.S. Equity Market
Plus Funds.
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
Provident Distributors, Inc. (the "Principal Underwriter") acts as 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
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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 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 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.
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 Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day. The Short and Intermediate 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."
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<TABLE>
<CAPTION>
Initial Minimum Additional Minimum
Type of Account Investment Investment
<S> <C> <C>
Regular $1,000 $50
Automatic Investment Plan None $50
Individual Retirement Account $ 250 $50
Gift to Minors $ 250 $50
</TABLE>
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
211 South Gulph Road
P.O. Box 61767
King of Prussia, PA 19406
All applications must be accompanied by payment in the form of a check or money
order made payable to "Smith Breeden Mutual Funds." All purchases must be made
in U.S. dollars, and checks must be drawn on U.S. banks. No cash, credit cards
or third party checks will be accepted. When a purchase is made by check and a
redemption is made shortly thereafter, the Funds will delay the mailing of a
redemption check until the purchase check has cleared your bank, which may take
up to 15 calendar days from the purchase date. If you contemplate needing
access to your investment shortly after purchase, you should purchase the
shares by wire as discussed below.
How to Open Your Account by Wire. You may make purchases by direct wire
transfers. To ensure proper credit to your account, please call the Funds at
1-800-221-3137 for instructions prior to wiring funds. Funds should be wired
through the Federal Reserve System as follows:
Boston Safe Deposit & Trust
A.B.A. Number 011001234
For credit to (identify which Fund to purchase)
Account Number 011363
FBO (name or registration and account 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,
211 South Gulph Road, P.O. Box 61767, King of Prussia, PA 19406. 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
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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 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.
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HOW TO EXCHANGE SHARES
Shares of any Fund may be exchanged for shares of another Fund at any time.
This exchange offer is available only in states where shares of such other Fund
may be legally sold. You may open a new account, or purchase additional shares
in an existing account, by making an exchange from an identically registered
Smith Breeden Fund account. A new account will have the same registration as
the existing account from which the exchange was made, and is subject to the
same initial investment minimums.
Exchanges may be made either in writing or by telephone. Written instructions
should be mailed to 211 South Gulph Road, P.O. Box 61767, 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 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
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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 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,
211 South Gulph Road, P.O. Box 61767, King of Prussia, PA 19406.
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
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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 may not be accepted for payment until 15 days after the account is
opened, if the shareholder opened the account by check. 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 Boston Safe Deposit and Trust Company. Shareholders utilizing check
writing are subject to Boston Safe Deposit Company's rules governing checking
accounts. However, this check writing facility is purely a means to redeem Fund
shares. No facilities characteristic of bank accounts, such as deposit
insurance, are provided along with the check writing option. Cancelled checks
will not be returned to the shareholder. If you need to request a copy of a
cancelled check, please contact Shareholder Services for procedures and
applicable fees.
If you would like to initiate check writing, please call Shareholder Services
at 1-800-221-3137 or check the appropriate box on the Purchase Application.
Systematic Withdrawal Plan. A shareholder may establish a Systematic Withdrawal
Plan to receive regular periodic payments from the account. An initial balance
of $10,000 is required to establish a Systematic Withdrawal Plan. There are no
service charges for establishing or maintaining a Systematic Withdrawal Plan.
The minimum amount which the shareholder may withdraw periodically is $100.
Capital gain distributions and income dividends to the shareholder's account
are received in additional shares at net asset value. Payments are then made
from the liquidation of shares at net asset value to meet the specified
withdrawals. Liquidation of shares may reduce or possibly exhaust the shares in
the shareholder's account, to the extent withdrawals exceed shares earned
through dividends and distributions, particularly in the event of a market
decline. No payment pursuant to a Systematic Withdrawal Plan will be made if
there are insufficient shares on deposit on the date of the scheduled
distribution. A subsequent deposit of shares will not result in a payment under
the plan retroactive to the distribution date. As with other redemptions, a
liquidation to make a withdrawal payment is a sale for federal income tax
purposes. The entire Systematic Withdrawal Plan payment cannot be considered as
actual yield or income since part of the Plan's payment may be a return of
capital.
A Systematic Withdrawal Plan may be terminated upon written notice by the
shareholder, or by a Fund on a 30 day written notice, and it will terminate
automatically if all shares are liquidated or withdrawn from the account or
upon the Fund's receipt of notification of the death or incapacity of the
shareholder. Shareholders may change the amount (but not below the specified
minimums) and schedule of withdrawal payments, or suspend such payments, by
giving written notice to the Transfer Agent at least five business days prior
to the next scheduled payment.
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DIVIDENDS AND DISTRIBUTIONS
The Short and Intermediate Bond Funds intend to pay monthly distributions to
their shareholders of net investment income. The U.S. Equity Market Plus Fund
intends to make quarterly distributions of net investment income. All Funds
will distribute net realized gains at least annually. 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 Bond Fund will declare a daily dividend for shareholders of
record. The Intermediate Fund's dividend payable date, and the day that
dividends are reinvested for shareholders who have made this election, is the
last business day of the month. Shares begin accruing dividends on the business
day after federal funds (funds credited to a member bank's account at the
Federal Reserve Bank) are available from the purchase payment for such shares,
and continue to accrue dividends through and including the day the redemption
order for the shares is executed. If an investor closes his account, any
accrued dividends through and including the day of redemption will be paid as
part of the redemption proceeds.
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.
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.
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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, 211 South Gulph
Road, P.O. Box 61767, King of Prussia, PA 19406 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. If your IRA account value is less than $10,000, the $12 fee will
automatically be deducted from your account. To avoid having this fee taken
from your account, you may send a check for $12, postmarked no later than
August 31st. 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 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
and options) by the U.S. Equity Market Plus Fund as a means of achieving equity
exposure in the Fund's market will require the Fund to mark
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such instruments to market, a practice which will accelerate the Fund's
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, only an insignificant amount of
Funds' 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.
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 AUDITORS
PFPC Global Fund Services (the "Transfer Agent"), 211 South Gulph Road, P.O.
Box 61767, King of Prussia, PA 19406, 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
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has any part in deciding the Funds' investment policies or which securities are
to be purchased or sold for the Funds' portfolios. Deloitte & Touche LLP has
been selected to serve as independent auditors of the Company.
FUND PERFORMANCE
Each Fund may quote the Fund's average annual total and/or aggregate total
return for various time periods in advertisements or communications to
shareholders. An average annual total return refers to the rate of return
which, if applied to an initial investment at the beginning of a stated period
and compounded over that period, would result in the redeemable value of the
investment at the end of the period assuming reinvestment of all dividends and
distributions and reflecting the effect of all recurring fees. An investor's
principal in each Fund and the Fund's return are not guaranteed and will
fluctuate according to market conditions. When considering "average" total
return figures for periods longer than one year, you should note that a Fund's
annual total return for any one year in the period might have been greater or
less than the average for the entire period. Each Fund also may use "aggregate"
total return figures for various periods, representing the cumulative change in
value of an investment in the Fund for a specific period (again reflecting
changes in the Fund's share price and assuming reinvestment of dividends and
distributions).
The Short and Intermediate 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 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. 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.
27
<PAGE>
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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.
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
March 31, March 31,
1999 1998
--------------- ---------------
<S> <C> <C>
Net Asset Value, Beginning of Period ............. $ 9.92 $ 9.83
----------- -----------
Income From Investment Operations
Net investment income ............................ 0.442 0.484
Net realized and unrealized gain (loss) on
investments ..................................... 0.020 0.114
----------- -----------
Total from investment operations ................. 0.462 0.598
----------- -----------
Less Distributions
Dividends from net investment income ............. (0.447) (0.508)
Dividends in excess of net investment income ..... -- --
----------- -----------
Total Distributions .............................. (0.447) (0.508)
----------- -----------
Net Asset Value, End of Period ................... $ 9.94 $ 9.92
=========== ===========
Total Return ..................................... 4.83% 6.24%
Ratios/Supplemental Data
Net assets, end of period ........................ $60,807,449 $78,427,855
Ratio of expenses to average net assets
Before expense limitation ....................... 1.00% 1.00%
After expense limitation ........................ 0.78% 0.78%
Ratio of net income to average net assets ........
Before expense limitation ....................... 4.56% 5.06%
After expense limitation ........................ 4.78% 5.28%
Portfolio turnover rate .......................... 298% 626%
<CAPTION>
Year Ended Year Ended Year Ended
March 31, March 31, March 31,
1997 1996 1995
---------------- ---------------- ----------------
<S> <C> <C> <C>
Net Asset Value, Beginning of Period ............. $ 9.74 $ 9.90 $ 9.90
------------ ------------ ------------
Income From Investment Operations
Net investment income ............................ 0.476 0.621 0.628
Net realized and unrealized gain (loss) on
investments ..................................... 0.146 (0.148) --
------------ ------------ ------------
Total from investment operations ................. 0.622 0.473 0.628
------------ ------------ ------------
Less Distributions
Dividends from net investment income ............. (0.476) (0.621) (0.628)
Dividends in excess of net investment income ..... (0.056) (0.012) --
------------ ------------ ------------
Total Distributions .............................. (0.532) (0.633) (0.628)
------------ ------------ ------------
Net Asset Value, End of Period ................... $ 9.83 $ 9.74 $ 9.90
============ ============ ============
Total Return ..................................... 6.57% 4.95% 6.58%
Ratios/Supplemental Data
Net assets, end of period ........................ $118,988,609 $221,825,136 $218,431,665
Ratio of expenses to average net assets
Before expense limitation ....................... 0.93% 0.93% 0.92%
After expense limitation ........................ 0.78% 0.78% 0.78%
Ratio of net income to average net assets ........
Before expense limitation ....................... 4.90% 6.13% 6.18%
After expense limitation ........................ 5.04% 6.29% 6.33%
Portfolio turnover rate .......................... 556% 225% 47%
</TABLE>
Additional performance information is presented in the Short Fund's Annual
Report, which is available without charge upon request.
28
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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
March 31, March 31,
1999 1998
--------------- ---------------
<S> <C> <C>
Net Asset Value, Beginning of Period ................. $ 10.00 $ 9.73
----------- -----------
Income From Investment Operations
Net investment income ................................ 0.525 0.590
Net realized and unrealized gain (loss) on
investments ......................................... 0.030 0.419
----------- -----------
Total from investment operations ..................... 0.555 1.009
----------- -----------
Less Distributions
Dividends from net investment income ................. ( 0.515) ( 0.561)
Dividends in excess of net investment income ......... -- --
Distributions from net realized gains on
investments ......................................... ( 0.130) ( 0.178)
Distributions in excess of net realized gains on
investments ......................................... -- --
----------- -----------
Total Distributions .................................. ( 0.645) ( 0.739)
----------- -----------
Net Asset Value, End of Period ....................... $ 9.91 $ 10.00
=========== ===========
Total Return ......................................... 5.73% 10.65%
Ratios/Supplemental Data
Net assets, end of period ............................ $55,125,797 $38,641,879
Ratio of expenses to average net assets
Before expense limitation ........................... 1.06% 1.13%
After expense limitation ............................ 0.88% 0.88%
Ratio of net income to average net assets
Before expense limitation ........................... 5.08% 5.36%
After expense limitation ............................ 5.25% 5.61%
Portfolio turnover rate .............................. 423% 583%
<CAPTION>
Year Ended Year Ended Year Ended
March 31, March 31, March 31,
1997 1996 1995
--------------- --------------- ---------------
<S> <C> <C> <C>
Net Asset Value, Beginning of Period ................. $ 10.01 $ 9.83 $ 10.01
----------- ----------- -----------
Income From Investment Operations
Net investment income ................................ 0.599 0.660 0.664
Net realized and unrealized gain (loss) on
investments ......................................... ( 0.024) 0.277 ( 0.049)
----------- ----------- -----------
Total from investment operations ..................... 0.575 0.937 0.615
----------- ----------- -----------
Less Distributions
Dividends from net investment income ................. ( 0.604) ( 0.656) ( 0.664)
Dividends in excess of net investment income ......... -- -- ( 0.108)
Distributions from net realized gains on
investments ......................................... ( 0.251) ( 0.101) --
Distributions in excess of net realized gains on
investments ......................................... -- -- ( 0.022)
----------- ----------- -----------
Total Distributions .................................. ( 0.855) ( 0.757) ( 0.794)
----------- ----------- -----------
Net Asset Value, End of Period ....................... $ 9.73 $ 10.01 $ 9.83
=========== =========== ===========
Total Return ......................................... 5.92% 9.69% 6.10%
Ratios/Supplemental Data
Net assets, end of period ............................ $37,735,525 $36,446,940 $34,797,496
Ratio of expenses to average net assets
Before expense limitation ........................... 1.16% 1.14% 2.33%
After expense limitation ............................ 0.88% 0.90% 0.90%
Ratio of net income to average net assets
Before expense limitation ........................... 5.92% 6.26% 4.77%
After expense limitation ............................ 6.19% 6.49% 6.20%
Portfolio turnover rate .............................. 409% 193% 557%
</TABLE>
Additional performance information is presented in the Intermediate Fund's
Annual Report, which is available without charge upon request.
29
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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
March 31, March 31,
1999 1998
---------------- ----------------
<S> <C> <C>
Net Asset Value, Beginning of Period ................. $ 16.86 $ 12.56
------------ ------------
Income From Investment Operations
Net investment income ................................ 0.686 0.591
Net realized and unrealized gain (loss) on
investments ......................................... (1.765) 4.940
------------ ------------
Total from investment operations ..................... 2.451 5.531
------------ ------------
Less Distributions
Dividends from net investment income ................. (0.624) (0.586)
Dividends in excess of net investment income ......... -- --
Distributions from net realized gains on
investments ......................................... (1.905) (0.645)
Distributions in excess of net realized gains on
investments ......................................... -- --
------------ ------------
Total Distributions .................................. (2.529) (1.231)
------------ ------------
Net Asset Value, End of Period ....................... $ 16.78 $ 16.86
============ ============
Total Return ......................................... 17.17% 45.71%
Ratios/Supplemental Data
Net assets, end of period ............................ $185,584,121 $136,667,439
Ratio of expenses to average net assets
Before expense limitation ........................... 1.04% 1.23%
After expense limitation ............................ 0.88% 0.88%
Ratio of net income to average net assets
Before expense limitation ........................... 4.45% 4.44%
After expense limitation ............................ 4.62% 4.79%
Portfolio turnover rate .............................. 527% 424%
<CAPTION>
Year Ended Year Ended Year Ended
March 31, March 31, March 31,
1997 1996 1995
--------------- -------------- --------------
<S> <C> <C> <C>
Net Asset Value, Beginning of Period ................. $ 12.27 $ 10.84 $ 9.88
----------- ---------- ----------
Income From Investment Operations
Net investment income ................................ 0.592 0.615 0.568
Net realized and unrealized gain (loss) on
investments ......................................... 1.813 2.768 1.081
----------- ---------- ----------
Total from investment operations ..................... 2.405 3.383 1.649
----------- ---------- ----------
Less Distributions
Dividends from net investment income ................. ( 0.590) ( 0.583) ( 0.568)
Dividends in excess of net investment income ......... -- -- ( 0.001)
Distributions from net realized gains on
investments ......................................... ( 1.525) ( 1.370) ( 0.047)
Distributions in excess of net realized gains on
investments ......................................... -- -- ( 0.073)
----------- ---------- ----------
Total Distributions .................................. ( 2.115) ( 1.953) ( 0.689)
----------- ---------- ----------
Net Asset Value, End of Period ....................... $ 12.56 $ 12.27 $ 10.84
=========== ========== ==========
Total Return ......................................... 21.41% 32.30% 17.18%
Ratios/Supplemental Data
Net assets, end of period ............................ $13,507,377 $4,766,534 $2,107,346
Ratio of expenses to average net assets
Before expense limitation ........................... 2.60% 4.58% 7.75%
After expense limitation ............................ 0.88% 0.90% 0.90%
Ratio of net income to average net assets
Before expense limitation ........................... 3.58% 1.85% 0.59%
After expense limitation ............................ 5.30% 5.53% 7.44%
Portfolio turnover rate .............................. 182% 107% 120%
</TABLE>
Additional performance information is presented in the Fund's Annual Report,
which is available without charge upon request.
30
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[GRAPHIC LOGO OF
SMITH BREEDEN HERE]
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
also get copies of this information for free on the SEC's Internet site
(www.sec.gov).
31
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SHAREHOLDER SERVICES
Account Inquiries, Prices, Balance
and Transaction Information
1-800-221-3137
DEALER SERVICES
Current Prospectuses, Sales Literature
Yields, Prices, Fund Information
1-800-221-3138
Distributed by:
Provident Distributors, Inc.
Four Falls Corporate Center
West Conshohocken, PA 19428
[GRAPHIC HERE]
SMITH BREEDEN
-------------
M U T U A L F U N D S
100 Europa Drive, Suite 200
Chapel Hill, NC 27514-2310
(919) 967-7221
