SCUDDER
- ------------------------
EQUITY/VALUE
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Scudder Micro Cap Fund
Fund #048
Annual Report
August 31, 1999
A fund which seeks long-term growth of capital by investing primarily in a
diversified portfolio of U.S. micro-cap stocks.
A no-load fund with no commissions to buy, sell, or exchange shares.
<PAGE>
Contents
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4 Letter from the Fund's President
6 Performance Update
8 Portfolio Summary
10 Portfolio Management Discussion
16 Glossary of Investment Terms
17 Investment Portfolio
28 Financial Statements
31 Financial Highlights
32 Notes to Financial Statements
36 Report of Independent Accountants
37 Tax Information
38 Officers and Trustees
39 Investment Products and Services
41 Scudder Solutions
2
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Scudder Micro Cap Fund
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ticker symbol SCMCX fund number 048
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Date of Inception: o Small-cap stocks rallied near the end of the period as
8/12/96 a healthy U.S. economy and historically attractive
valuation levels helped renew investor interest.
o Despite Scudder Micro Cap Fund's strong 13.00% return
in the last five months of the period, its 12-month
performance of 12.03% was overshadowed by the dominance
Total Net Assets as of growth stocks and selected technology issues.
of 8/31/99:
$78.3 million o Over its three-year life, the fund's total return is
comparable to that of the unmanaged Russell 2000 Index,
but with less risk.
3
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Letter from the Fund's President
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Dear Shareholders,
Despite the weak performance of micro-cap stocks over most of the
period, your fund's portfolio management team remained committed to their
disciplined approach to investing in undervalued micro-cap companies. In April,
a shift to smaller-cap stocks rewarded their commitment to this approach as the
fund outperformed large-cap stocks by a significant margin, partially offsetting
the earlier shortfall. In the following pages, portfolio managers James
Eysenbach and Calvin Young discuss the small-cap market and the fund's
performance in this environment.
For those of you who are interested in complementing your existing holdings, we
recently introduced two funds: Scudder Select 500 Fund -- which invests in a
subset of the stocks in the unmanaged S&P 500(R) Index, and Scudder Select 1000
Growth Fund -- which invests in a subset of the stocks in the unmanaged Russell
1000 Growth(R) Index. For further information on these unique funds, please
visit our Web site at www.scudder.com, or call us at 1-800-SCUDDER
(1-800-728-3337).
In closing, I would like to inform you that Daniel Pierce, retired in June as
President of Scudder Micro Cap Fund. At that time I assumed his role and
responsibilities. We are fortunate that Dan's long-standing affiliation with
Scudder is ongoing, and that we will continue to benefit from his counsel. I am
pleased to join the
<PAGE>
fund's team in this capacity, and look forward to serving your interests.
We recognize that it has been a difficult year for small-cap investors and thank
you for your continued investment in Scudder Micro Cap Fund. We believe your
patience will be rewarded over the long run.
Sincerely,
/s/Lynn S. Birdsong
Lynn S. Birdsong
President,
Scudder Micro Cap Fund
5
<PAGE>
Performance Update
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August 31, 1999
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Growth of a $10,000 Investment
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THE PRINTED DOCUMENT CONTAINS A LINE CHART HERE
CHART DATA:
Scudder Russell
Micro Cap Fund 2000 Index* S&P 500 Index*
8/96* 10000 10000 10000
2/97 11422 11105 12084
8/97 13991 13163 13871
2/98 15238 14430 16316
8/98 12038 10607 14997
2/99 12821 12388 19536
8/99 13486 13616 20968
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Fund Index Comparison
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Total Return
Growth of Average
Period ended 8/31/1999 $10,000 Cumulative Annual
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Scudder Micro Cap Fund
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1 year $ 11,203 12.03% 12.03%
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Life of Fund** $ 13,486 34.86% 10.30%
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Russell 2000 Index*
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1 year $ 12,837 28.37% 28.37%
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Life of Fund** $ 13,616 36.16% 10.64%
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S&P 500 Index*
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1 year $ 13,981 39.81% 39.81%
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Life of Fund** $ 20,968 109.68% 27.46%
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* The Russell 2000 Index is an unmanaged capitalization-weighted measure of
approximately 2000 small U.S. stocks. The Standard & Poor's 500 Index is a
capitalization-weighted index of 500 stocks. The index is designed to measure
performance of the broad domestic economy through changes in the aggregate
market value of 500 stocks representing all major industries. Index returns
assume reinvestment of dividends and, unlike Fund returns, do not reflect any
fees or expenses.
** The Fund commenced operations on August 12, 1996.
If the Adviser had not maintained the Fund's expenses, the total return for
the life of Fund period would have been lower.
6
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Returns and Per Share Information
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THE PRINTED DOCUMENT CONTAINS A BAR CHART HERE
ILLUSTRATING THE FUND TOTAL RETURN (%) AND RUSSELL 2000
INDEX TOTAL RETURN (%)
CHART DATA:
Scudder Micro Russell 2000
Cap Fund Index
1996** 0.58 2.08
1997 39.10 28.95
1998 -13.96 -19.42
1999 12.03 28.37
Yearly periods ended August 31
1996** 1997 1998 1999
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Fund Total
Return (%) .58 39.10 -13.96 12.03
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Index Total
Return (%) 2.08 28.95 -19.42 28.37
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Net Asset
Value ($) 12.07 16.77 14.37 15.21
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Income
Dividends ($) -- .02 -- --
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Capital Gains
Distributions ($) -- -- .07 .83
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* The Russell 2000 Index is an unmanaged capitalization-weighted measure of
approximately 2000 small U.S. stocks. Index returns assume reinvestment of
dividends and, unlike Fund returns, do not reflect any fees or expenses.
** The Fund commenced operations on August 12, 1996.
All performance is historical, assumes reinvestment of all dividends and
capital gains, and is not indicative of future results. Investment return and
principal value will fluctuate, so an investor's shares, when redeemed, may
be worth more or less than when purchased.
7
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Portfolio Summary
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August 31, 1999
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Diversification
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The fund seeks to be fully
invested in micro-cap
stocks.
A graph in the form of a pie chart appears here, illustrating the exact data
points in the table below.
Common Stocks 99%
Cash Equivalents 1%
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100%
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Stock Characteristics
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Remaining true to its
micro-cap discipline,
the fund's median market
capitalization is one of
the lowest among U.S.
diversified equity funds.
Micro Russell Fund as
Cap 2000 % of
Median Values Fund Universe Index Universe
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Market Capitalization 44 52 425 85%
($ millions)
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Price/Earnings 12.6 33.3 21.8 38%
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Return On Equity 11.2 5.7 11.7 196%
(3 year)
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Sales Growth (5 year) 11.0 12.7 18.1 86%
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8
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Sectors/Largest Holdings
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The fund's holdings are
the result of a disciplined
approach to valuing
companies that is based
on fundamentals such as
sales, earnings, and cash
flow.
1. Financial (15%)
First Cash, Inc.
Operator of pawn shops
2. Manufacturing (15%)
SL Industries, Inc.
Producer of electrical and electro-mechanical products
3. Consumer Discretionary (14%)
Garden Fresh Restaurant Corp.
Operator of salad buffet restaurant chain
4. Technology (12%)
Programmer's Paradise, Inc.
Direct marketer of computer and network software
5. Consumer Staples (10%)
Chock Full O'Nuts Corp.
Producer of coffees, teas, peanut products
6. Service Industries (7%)
Mercury Air Group, Inc.
Provider of fuel and ground support services to commercial
airlines, general aviation and US military
7. Construction (5%)
Turner Corp.
General builder of commercial and industrial facilities
8. Health (5%)
Polymedica Industries, Inc.
Manufacturer of specialized medical products
9. Durables (4%)
Cognitronics Corp.
Manufacturer of voice processing equipment
10. Utilities (3%)
Southwest Water Co.
Water utility
For more complete details about the Fund's investment portfolio, see page 17. A
quarterly Fund Summary and Portfolio Holdings are available upon request.
9
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Portfolio Management Discussion
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August 31, 1999
We asked portfolio managers James M. Eysenbach and Calvin S. Young to review the
market environment and fund's performance for the 12-month period ended August
31, 1999.
Q: How would you characterize the market environment for small-cap stocks over
the 12 months?
A: Small-cap stocks returned a healthy 28% (as represented by the unmanaged
Russell 2000 Index) over the period, but this paled in comparison to the 40%
return for large-cap stocks (as represented by the unmanaged S&P 500 Index). In
the small-cap sector, growth stocks (and selected technology issues) dominated
performance. The outsized return of growth stocks is reflected in the 43% return
of the Russell 2000 Growth Index. By contrast, the Russell 2000 Value Index
return of 14% paled in comparison. On balance, it was a very difficult period
for small-cap funds that focus on stocks with reasonable valuations.
Q: Underlying these results was a shift in market leadership. Please describe
what occurred.
A: The 12-month period can basically be divided into two phases. The first phase
- -- from September 1998 to the end of March 1999 -- began with a market recovery
led by large-cap stocks and growth stocks. Over this seven-month period the S&P
500 rose 35% and small stocks gained only 19%. Micro cap stocks trailed with a
9% return for the same period. While not uniform throughout, small growth stocks
(up 34% for the seven months) decisively outpaced small value stocks (up a
meager 4%). We were not surprised that growth stocks led such a dramatic rally,
although the margin of outperformance was unprecedented. During this period
growth stocks outperformed value stocks by 30 percentage points -- one of the
largest spreads in the 20-year history of the Russell indices. Very narrow
market leadership accentuated the phenomenon where a handful of primarily
Internet stocks achieved spectacular triple-digit returns.
10
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A Shift Toward Small Stocks and Value
April - August 1999
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Scudder Micro Cap Fund 13%
Small-cap stocks 8%
Large-cap stocks 3%
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The unmanaged Russell 2000 Index represents small-cap stocks and the unmanaged
S&P 500 Index represents large-cap stocks.
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The second phase ran from April through August. During this period we saw a
partial recovery for small and value stocks. This change resulted, in part, from
a realization that the U.S. economy was growing at a healthy pace and small
stocks represented attractive values relative to large-cap stocks. Over this
five-month period, small stocks outperformed large stocks by five percentage
points. (See table.)
Q: How did the fund perform for the overall period?
A: The fund returned 12.03% for the 12-month period that ended August 31, 1999.
Given our disciplined approach, which tends to emphasize the smallest stocks
with attractive valuations, we were not surprised that the fund recorded its
strongest performance during the April to August period when the market favored
small-cap stocks. The fund's shortfall for the year relative to the benchmarks
is attributable to the dominance of small growth stocks over the first seven
months of the fiscal period and the fund's characteristic value orientation. In
this narrow growth market, the fund's returns were greatly constrained by our
strict valuation approach, where our typical holding is selling at a 40%
discount to the market multiple. The market capitalization of the fund's
holdings is among the smallest among its peers. (See Stock Characteristics on
page 7.) As a result, the fund underperformed the larger-cap Russell 2000 Index
for this 12-month period.
11
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Q: Can you elaborate on your investment discipline and its impact on
performance?
A: Our portfolio management discipline is centered on size, valuation, and
diversification. It is designed to ensure style consistency (a focus on
micro-cap stocks) and below-average risk over time. For example, we purchase
stocks from a universe of micro-cap stocks with market capitalizations of less
than $200 million, sell those that grow out of this universe while diversifying
across more than 200 companies.
While we believe our investment discipline makes a positive contribution to
performance over time, it can work against us in the short run as it did during
the past fiscal year. Because our discipline is designed to ensure style
consistency, sticking with our discipline generally hurt performance over the
12-month period. At times like these, owning stocks outside the micro-cap
universe -- such as larger-cap stocks -- would have benefited performance.
Furthermore, when market leadership is very narrowly concentrated, a diversified
portfolio is more likely to underperform. However, the fund's discipline has
contributed to its strong risk-adjusted performance over the long term. For the
three-year life of the fund, its total return is comparable to that of the
Russell 2000 Index, but with less risk.
Q: In light of the recent weakness for micro-cap stocks, have you made any
adjustments to your investment discipline?
A: The dramatic underperformance of smaller-cap stocks can be disconcerting, but
we do not believe it is reason to modify our investment discipline. In the past,
small-cap stocks have sustained numerous periods of underperformance and yet
have still outperformed over the long run. History also shows that performance
leadership can shift abruptly. As a result, we are continuing to focus the fund
on micro-cap stocks, as indicated by the $44 million median market cap of its
holdings.
12
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Growth and Value Stocks Take Turns
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Russell 2000 Value Return - Russell 2000 Growth Return
THE PRINTED DOCUMENT CONTAINS A MOUNTAIN CHART HERE
CHART DATA FROM 12/79 THROUGH 8/99:
Value Outperforming (+) vs. Growth Outperforming (-)
12 Months Ending
12/79 -15.46
-21.23
-27.30
-11.11
-12.21
-14.58
-15.55
-23.48
-24.90
-28.32
-37.48
-42.56
-26.88
-14.68
-6.86
-19.33
-15.50
-19.68
-5.50
0.54
8.85
15.43
16.66
26.59
24.09
20.83
21.15
21.99
19.51
21.88
16.56
17.01
16.58
14.24
14.66
8.49
7.54
1.38
-8.59
-7.34
-4.99
-10.96
-18.62
-9.72
-5.52
-1.33
11.58
15.05
18.50
26.23
27.72
25.08
23.51
23.42
23.81
20.99
18.93
20.13
17.96
20.01
18.10
12.50
9.71
8.16
9.56
7.50
9.41
6.10
9.96
7.73
4.94
0.77
0.04
0.80
1.87
1.47
-3.03
-2.23
-3.82
0.69
1.76
3.63
1.97
2.25
3.83
3.28
0.98
0.19
2.81
3.96
5.27
3.97
1.69
-3.04
5.61
7.24
3.37
8.94
10.51
9.70
9.50
9.65
9.52
9.51
10.78
10.68
8.06
6.41
9.10
3.82
5.31
5.67
4.74
2.44
4.94
1.23
-2.48
-4.00
-6.21
-8.43
-7.74
-3.54
-6.04
-6.62
-5.59
-8.34
-11.29
-8.63
-4.55
-2.00
-2.05
-4.08
-4.36
-9.31
-9.18
-8.14
-5.53
-1.74
1.34
-0.96
-6.26
-10.79
-14.95
-7.43
-9.48
-7.67
-1.58
4.51
7.43
10.62
11.92
14.73
17.31
18.12
19.65
17.10
21.37
24.33
25.60
23.17
18.99
12.91
10.38
10.29
7.35
7.39
8.85
13.24
10.48
6.84
-0.07
0.59
0.64
5.87
6.72
6.43
4.0
3.25
0.84
-0.69
0.88
1.50
0.56
-3.78
-3.18
-4.72
-11.19
-17.07
-10.54
-9.61
-4.63
-5.59
-5.29
-5.46
-8.0
-4.78
-13.08
1996 -17.85
-5.37
7.63
2.82
0.87
6.25
9.64
10.11
7.43
18.34
21.80
28.11
1997 26.03
23.64
15.88
17.29
19.30
16.01
16.52
18.84
18.72
7.95
1.97
-1.93
10.82
6.69
7.36
14.34
12.04
8.17
0.90
-7.68
-14.11
-7.70
-10.99
-11.56
-13.45
-14.01
-14.64
8/99 -29.22
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We closely monitor our approach to stock selection, but have seen nothing to
suggest that the fundamental factors affecting stock returns over the long run
have changed dramatically. Shorter-run deviations are commonplace, but difficult
to capture systematically. Consequently, we maintain a longer-term outlook in
searching for undervalued securities -- those that are attractively priced
relative to fundamentals such as sales, earnings, and assets. As of the end of
the period, the typical holding had a p/e (price/earnings ratio) of less than
13x -- a significant discount versus the 22x median p/e of the Russell 2000
Index.
Q: How did the fund perform at the sector level?
A: Technology was one of the strongest sectors over the 12 months. Our
investment approach -- which emphasizes stocks with attractive valuation
characteristics -- dictated an underweighting in tech. In addition, our lower
growth tech holdings did not keep up with the exceptional performance of the
sector. In an environment when the best performing stocks were those with little
if any profits and high p/e's, our investment discipline faced a strong
13
<PAGE>
headwind. In this type of environment it is difficult to beat the index without
changing the parameters of our investment discipline. And, since we place a high
value on consistency and the long-term validity of our approach, we remained
committed to it.
Q: What is your outlook for micro-cap stocks?
A: Although we began to see a recovery in small-cap stocks toward the end of the
period, we believe the market still has a long way to go before valuations
return to parity with long-running averages. As a result, we have a positive
outlook for micro-cap stocks because we believe that the current market is out
of balance, especially after the strong run-up for growth stocks and a handful
of Internet issues. Historically we have seen significant differences between
growth and value stocks in the past. (See "Growth and Value Stocks Take Turns"
chart on page 13.) The last significant surge for small-cap growth stocks was in
the 1995-97 period. (See "Reversal of Fortunes" table below.)
When the "Asian Flu" hit the markets last summer, many believed that it would
drag down the U.S. economy, impacting cyclical and smaller companies the most.
In reality, the flu was not as bad as expected. In fact, the U.S. economy
remained very healthy. However, cyclical and smaller-cap stocks did not bounce
back as much as other sectors. We still think that there is more running room
for these issues, which make up an important part of the fund's investment
universe.
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Reversal of Fortunes
After trailing growth stocks by nearly 18 percentage points for the 12-month
period that ended in May 1996, value stocks went on to outperform growth by 26
percentage points over the 12 months.
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Small-cap Returns 1996 1997
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Growth 44.6% -5.4%
Value 26.8% 20.6%
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Total returns for the 12-month periods ended May 31st of each year. The
unmanaged Russell 2000 Growth Index represents small-cap growth stocks and the
unmanaged Russell 2000 Value Index represents small-cap value stocks.
14
<PAGE>
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Scudder Micro Cap Fund:
A Team Approach to Investing
Scudder Micro Cap Fund is managed by a team of Scudder Kemper Investments, Inc.
(the "Adviser") professionals, each of whom plays an important role in the
fund's management process. Team members work together to develop investment
strategies and select securities for the fund's portfolio. They are supported by
the Adviser's large staff of economists, research analysts, traders, and other
investment specialists who work in our offices across the United States and
abroad. We believe our team approach benefits fund investors by bringing
together many disciplines and leveraging our extensive resources.
Lead portfolio manager James M. Eysenbach is responsible for the fund's
day-to-day management and investment strategies. Mr. Eysenbach joined the
Adviser in 1991 as a senior quantitative analyst and has more than 10 years of
investment management experience, specializing in quantitative research,
analysis, and portfolio management.
Portfolio manager Calvin S. Young joined the Adviser in 1990 as a quantitative
analyst and has more than nine years of investment industry experience, with a
special focus on small companies.
15
<PAGE>
Glossary of Investment Terms
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Growth Stock Stock of a company that has displayed above-average
earnings growth and is expected to continue to increase
profits rapidly going forward.
Liquidity A characteristic of an investment or an asset referring to
the ease of convertibility into cash within a reasonably
short period of time.
Market
Capitalization The value of a company's outstanding shares of common
stock, determined by multiplying the number of shares
outstanding by the share price (shares x price = market
capitalization). The universe of publicly traded companies
is frequently divided into large-, mid-, and
small-capitalization segments.
Price/Earnings A widely used gauge of a stock's valuation that indicates
Ratio (p/e) what investors are paying for a company's earnings on a
(also "earnings per share basis. A higher "earnings multiple" indicates a
multiple") higher expected growth rate and the potential for greater
price fluctuations.
Standard A statistical measure of the degree to which an
Deviation investment's return tends to vary from the mean return.
Frequently used in portfolio management to measure the
variability of past returns and to gauge the likely range
of possible future returns.
Value Stock A company whose stock price does not fully reflect its
intrinsic value, as indicated by price/earnings ratio,
price/book value ratio, dividend yield, or some other
valuation measure, relative to its industry or the market
overall. Value stocks tend to display less price
volatility and may carry higher dividend yields.
Weighting Refers to the allocation of assets -- usually by sector,
(over/under) industry, or country -- within a portfolio relative to a
benchmark index, (e.g. the Russell 2000 Index) or an
investment universe.
(Source: Scudder Kemper Investments, Inc.; Barron's Dictionary of Finance and
Investment Terms)
An expanded list of terms is located at our Web site -- www.scudder.com.
16
<PAGE>
<TABLE>
<CAPTION>
Investment Portfolio as of August 31, 1999
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<S> <C> <C>
Principal Market
Amount ($) Value ($)
- ------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------
Repurchase Agreements 1.3%
- ------------------------------------------------------------------------------------
Repurchase agreement with State Street Bank
and Trust Company dated 8/31/1999 at 5.41%, to
be repurchased at $1,022,154 on 9/1/1999,
collateralized by a $1,040,000 U.S. Treasury
Note, 3.625%, 1/15/2008 (Cost $1,022,000) ........... 1,022,000 1,022,000
Shares
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- ------------------------------------------------------------------------------------
Common Stocks 98.7%
- ------------------------------------------------------------------------------------
Consumer Discretionary 14.1%
Apparel & Shoes 1.8%
Cache, Inc.* ........................................ 49,300 257,284
Candie's Inc.* (b) .................................. 57,900 106,391
G-III Apparel Group, Ltd.* .......................... 65,500 188,313
Hampshire Group, Ltd.* .............................. 29,900 375,619
Premiumwear, Inc.* .................................. 70,500 361,313
Steven Madden, Ltd.* ................................ 10,700 126,394
-------------
1,415,314
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Department & Chain Stores 1.6%
Drug Emporium, Inc.* ................................ 113,300 849,750
Duckwall-ALCO Stores, Inc.* ......................... 37,200 353,400
-------------
1,203,150
-------------
Home Furnishings 0.2%
Baldwin Piano & Organ Co.* .......................... 17,600 143,000
-------------
Hotels & Casinos 3.0%
Buckhead America Corp.* ............................. 52,100 312,600
Isle of Capri Casinos, Inc.* ........................ 70,100 674,713
Jackpot Enterprises, Inc.* .......................... 52,000 464,750
Sonesta International Hotels Corp. "A" .............. 49,000 385,875
Supertel Hospitality, Inc.* ......................... 37,900 492,700
-------------
2,330,638
-------------
Recreational Products 2.2%
Allen Organ Co. "B" ................................. 4,400 159,500
Escalade, Inc. ...................................... 30,800 546,700
Holiday RV Superstores, Inc.* ....................... 173,300 693,200
</TABLE>
The accompanying notes are an integral part of the financial statements.
17
<PAGE>
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<TABLE>
<CAPTION>
Market
Shares Value ($)
- ------------------------------------------------------------------------------------
<S> <C> <C>
Rawlings Sporting Goods Co., Inc.* ................... 15,200 141,550
Riddel Sports, Inc.* ................................. 54,900 164,700
-------------
1,705,650
-------------
Restaurants 2.9%
Benihana, Inc. "A"* .................................. 33,800 540,800
Garden Fresh Restaurant Corp.* ....................... 58,500 1,118,813
Max & Erma's Restaurants, Inc.* ...................... 80,800 575,700
-------------
2,235,313
-------------
Specialty Retail 2.4%
Brauns Fashions Corp* ................................ 15,000 225,000
Brookstone, Inc.* .................................... 33,900 567,825
InterTAN, Inc.* ...................................... 5,600 103,600
Rag Shops, Inc.* ..................................... 84,315 179,169
Reeds Jewelers, Inc.* ................................ 20,200 78,275
S & K Famous Brands, Inc.* ........................... 28,400 241,400
Ultimate Electronics, Inc.* .......................... 5,000 90,625
Wolohan Lumber Co. ................................... 27,900 355,725
-------------
1,841,619
-------------
Consumer Staples 9.8%
Alcohol & Tobacco 0.2%
Todhunter International, Inc.* ....................... 15,600 147,225
-------------
Consumer Electronic & Photographic 1.8%
Cobra Electronics Corp.* ............................. 85,800 337,838
Salton, Inc.* ........................................ 37,200 1,036,950
-------------
1,374,788
-------------
Farming 0.8%
AG Services of America, Inc.* ........................ 18,700 306,213
Sylvan, Inc.* ........................................ 27,800 288,425
-------------
594,638
-------------
Food & Beverage 6.9%
Celestial Seasonings, Inc.* .......................... 24,600 488,925
Chock Full O'Nuts Corp.* ............................. 113,300 1,182,549
Foodarama Supermarkets, Inc.* ........................ 14,100 426,525
J & J Snack Foods Corp.* ............................. 22,300 468,300
Schultz Sav-O Stores, Inc. ........................... 33,050 528,800
Seaway Food Town, Inc. ............................... 33,150 946,847
Smithfield Companies, Inc. ........................... 21,600 162,000
Suprema Specialties, Inc.* ........................... 98,500 763,375
Village Super Market, Inc. "A"* ...................... 28,100 354,763
-------------
5,322,084
-------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
18
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------
Market
Shares Value ($)
- ------------------------------------------------------------------------------------
<S> <C> <C>
Textiles 0.1%
Dyersburg Corp. ...................................... 49,100 23,016
Worldtex, Inc.* ...................................... 36,000 85,500
-------------
108,516
-------------
Health 5.0%
Biotechnology 0.5%
Synbiotics Corp.* .................................... 124,200 364,838
-------------
Health Industry Services 1.7%
Air Methods Corp.* ................................... 101,600 241,300
HPSC, Inc.* .......................................... 55,800 641,700
Healthcare Services Group, Inc.* ..................... 52,050 442,425
-------------
1,325,425
-------------
Hospital Management 0.2%
National Home Health Care Corp.* ..................... 41,890 167,560
-------------
Medical Supply & Specialty 2.6%
Infu-Tech, Inc.* ..................................... 27,300 29,006
Polymedica Industries, Inc.* ......................... 48,800 1,287,100
Scherer Healthcare, Inc.* ............................ 31,600 122,450
Span-America Medical Systems, Inc. ................... 58,400 244,550
Superior Uniform Group, Inc. ......................... 30,500 339,313
-------------
2,022,419
-------------
Communications 0.8%
Telephone/Communications
Applied Digital Solutions Inc.* ...................... 55,000 99,688
Hector Communications Corp.* ......................... 42,900 536,250
-------------
635,938
-------------
Financial 15.2%
Banks 10.5%
Alliance Bancorp of New England, Inc. ................ 37,749 394,005
Andover Bancorp, Inc. ................................ 17,000 535,500
BB&T Corporation ..................................... 7,189 240,832
Columbia Banking System, Inc.* ....................... 18,522 267,411
Equitable Federal Savings Bank* ...................... 700 12,950
First Essex Bancorp .................................. 15,800 243,913
First Keystone Financial, Inc. ....................... 6,500 83,688
First Oak Brook Bancshares, Inc. "A" ................. 29,400 586,163
Foothill Independent Bancorp ......................... 31,636 419,177
Haven Bancorp, Inc. .................................. 12,200 201,300
</TABLE>
The accompanying notes are an integral part of the financial statements.
19
<PAGE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------
Market
Shares Value ($)
- ------------------------------------------------------------------------------------
<S> <C> <C>
Hingham Institution for Savings ...................... 11,550 181,913
Jacksonville Bancorp, Inc. ........................... 3,000 48,563
Kankakee Bancorp, Inc. ............................... 4,400 115,500
Lawrence Savings Bank ................................ 45,600 384,750
MFB Corp. ............................................ 2,400 49,500
Marion Capital Holdings, Inc. ........................ 7,500 143,438
Medford Bancorp Inc. ................................. 23,600 433,650
Merchants Bancorp, Inc. .............................. 17,600 543,400
NMBT Corp. ........................................... 17,300 281,125
New Hampshire Thrift Bancshares, Inc. ................ 3,600 50,175
Northrim Bank ........................................ 42,760 446,308
Parkvale Financial Corp. ............................. 24,296 491,994
People's Bancshares, Inc. ............................ 17,600 323,400
Pinnacle Bancshares, Inc. ............................ 25,000 243,750
Progress Financial Corp. ............................. 18,174 272,610
Southwest Bancorp, Inc. .............................. 7,800 173,550
Union Bankshares Ltd.* ............................... 26,000 487,500
Winton Financial Corp. ............................... 30,300 405,263
-------------
8,061,328
-------------
Insurance 2.9%
ACCEL International Corp.* ........................... 103,900 123,381
ACMAT Corp. "A"* ..................................... 28,200 289,050
Atlantic American Corp.* ............................. 71,600 259,550
Cotton States Life Insurance ......................... 45,525 438,178
Investors Title Co. .................................. 24,100 409,700
Security National Financial Corp. "A"* ............... 77,175 231,525
Siebels Bruce Group, Inc.* ........................... 39,300 127,725
Standard Management Corp.* ........................... 66,100 351,156
-------------
2,230,265
-------------
Business Finance 0.4%
KBK Capital Corp.* ................................... 50,200 285,513
-------------
Other Financial Companies 0.9%
First Cash, Inc.* .................................... 65,900 683,713
-------------
Real Estate 0.5%
AMREP Corp.* ......................................... 65,600 393,600
-------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
20
<PAGE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Market
Shares Value ($)
- ------------------------------------------------------------------------------------
<S> <C> <C>
Media 2.3%
Broadcasting & Entertainment 1.1%
Todd-AO Corp. "A" .................................... 35,800 507,913
Unapix Entertainment, Inc.* .......................... 129,600 364,500
-------------
872,413
-------------
Print Media 1.2%
Advanced Marketing Services, Inc. .................... 43,450 912,450
-------------
Service Industries 6.7%
Environmental Services 1.3%
GZA GeoEnvironmental Technologies, Inc.* ............. 83,800 361,388
Scope Industries, Inc. ............................... 8,400 544,950
Versar, Inc.* ........................................ 39,900 107,231
-------------
1,013,569
-------------
Investment 0.5%
Advest Group, Inc. ................................... 7,200 137,700
H.D. Vest, Inc.* ..................................... 45,200 231,650
-------------
369,350
-------------
Miscellaneous Commercial Services 3.5%
American Physicians Service Group, Inc.* ............. 68,600 295,838
BI, Inc.* ............................................ 42,200 324,413
C.H. Heist Corp.* .................................... 58,900 371,806
Exponent, Inc.* ...................................... 42,200 276,938
GP Strategies Corp.* ................................. 51,320 400,938
Halifax Corp. (b) .................................... 27,150 122,175
Joule, Inc.* ......................................... 52,700 118,575
Mercury Air Group, Inc.* ............................. 86,600 606,200
RCM Technologies, Inc.* .............................. 12,800 178,400
-------------
2,695,283
-------------
Miscellaneous Consumer Services 1.4%
ACE Cash Express, Inc.* .............................. 33,025 482,991
Earl Scheib, Inc.* ................................... 6,900 31,050
ICT Group, Inc.* ..................................... 64,200 473,475
TEAM America Corp.* .................................. 18,800 104,575
-------------
1,092,091
-------------
Durables 3.9%
Aerospace 0.7%
Ducommun, Inc.* ...................................... 24,300 291,600
Sifco Industries, Inc. ............................... 26,600 226,100
-------------
517,700
-------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
21
<PAGE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Market
Shares Value ($)
- ------------------------------------------------------------------------------------
<S> <C> <C>
Automobiles 0.5%
Collins Industries Inc. .............................. 39,100 251,706
Motorcar Parts & Accessories, Inc.* (b) .............. 26,600 109,725
-------------
361,431
-------------
Leasing Companies 1.0%
Amplicon, Inc. ....................................... 31,200 374,400
Capital Associates Inc.* ............................. 36,500 104,938
PLM International Inc.* .............................. 54,300 298,650
-------------
777,988
-------------
Telecommunications Equipment 1.3%
Cognitronics Corp.* .................................. 43,650 567,450
Comdial Corp.* ....................................... 44,400 377,400
VARI-L Company, Inc.* ................................ 7,200 68,850
-------------
1,013,700
-------------
Miscellaneous 0.4%
Featherlite Manufacturing, Inc.* ..................... 49,700 298,200
-------------
Manufacturing 14.9%
Chemicals 0.7%
Aceto Corp. .......................................... 44,400 488,400
JLM Industries, Inc.* ................................ 10,200 51,000
-------------
539,400
-------------
Containers & Paper 0.4%
Tufco Technologies, Inc.* ............................ 6,600 51,563
UFP Technologies, Inc.* .............................. 86,500 291,938
-------------
343,501
-------------
Diversified Manufacturing 1.0%
Cantel Industries Inc.* ............................. 22,400 117,600
JMAR Technologies, Inc.* ............................ 98,600 172,550
McRae Industries, Inc. "A" .......................... 42,300 235,294
Pubco Corp.* ........................................ 28,100 231,825
-------------
757,269
-------------
Electrical Products 2.1%
ACME Electric Corp.* ................................ 57,600 280,800
Axsys Technologies, Inc.* ........................... 34,600 354,650
LaBarge, Inc.* ...................................... 98,800 185,250
SL Industries, Inc. ................................. 51,400 758,150
-------------
1,578,850
-------------
Industrial Specialty 5.9%
American Locker Group, Inc.* ........................ 43,200 334,800
Ault, Inc.* ......................................... 94,800 533,250
</TABLE>
The accompanying notes are an integral part of the financial statements.
22
<PAGE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Market
Shares Value ($)
- ------------------------------------------------------------------------------------
<S> <C> <C>
Badger Meter, Inc. .................................. 18,000 689,625
Ceradyne, Inc.* ..................................... 39,300 164,569
Dynamic Materials Corp.* ............................ 71,200 213,600
Foster (LB) Co. "A"* ................................ 105,500 613,219
Graham Corp.* ....................................... 32,400 269,325
Insteel Industries, Inc. ............................ 76,300 681,931
Kinark Corp.* ....................................... 135,800 229,163
Lamson & Sessions Co.* .............................. 67,700 359,656
MFRI, Inc.* ......................................... 58,900 338,675
Met-Pro Corp. ....................................... 13,800 167,325
-------------
4,595,138
-------------
Machinery/Components/Controls 3.0%
Chicago Rivet & Machine Co. ......................... 18,300 452,925
Farrel Corp. ........................................ 102,300 179,025
IMPCO Technologies, Inc.* ........................... 9,300 99,394
Newcor, Inc.* ....................................... 20,000 72,500
O.I. Corp.* ......................................... 96,600 434,700
Oilgear Co. ......................................... 19,300 164,050
On-Point Technology Systems, Inc.* .................. 45,000 63,281
Summa Industries, Inc.* ............................. 42,600 620,363
Trans-Industries, Inc.* ............................. 35,500 235,188
-------------
2,321,426
-------------
Office Equipment/Supplies 0.9%
Dixon Ticonderoga Co.* .............................. 30,100 323,575
TAB Products Co. .................................... 51,900 343,838
-------------
667,413
-------------
Specialty Chemicals 0.3%
Detrex Corp.* ....................................... 34,200 230,850
-------------
Wholesale Distributors 0.6%
Allou Health & Beauty, Inc. "A"* .................... 67,200 428,400
-------------
Miscellaneous 0.0%
American Dental Technologies, Inc.* ................. 10,300 29,613
-------------
Technology 12.1%
Computer Software 1.6%
Elcom International, Inc.* .......................... 82,200 308,250
MTS Systems Corp. ................................... 45,708 502,788
</TABLE>
The accompanying notes are an integral part of the financial statements.
23
<PAGE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Market
Shares Value ($)
- ------------------------------------------------------------------------------------
<S> <C> <C>
Scan Optics, Inc.* .................................. 90,100 275,931
Symix Systems, Inc.* ................................ 15,000 150,938
-------------
1,237,907
-------------
Diverse Electronic Products 0.7%
Reliability Inc.* ................................... 72,200 270,750
SBS Technologies, Inc.* ............................. 10,200 240,975
-------------
511,725
-------------
Edp Peripherals 0.9%
Printronix, Inc.* ................................... 19,900 371,881
Wells-Gardner Electronics Corp.* .................... 89,355 335,081
-------------
706,962
-------------
Electronic Components/Distributors 5.8%
American Technical Ceramics Corp.* .................. 55,300 480,419
Anaren Microwave Inc.* .............................. 20,500 550,938
Bel Fuse Inc. Class "A"* ............................ 13,750 462,344
Bel Fuse Inc. Class "B" ............................. 13,750 422,813
Napco Security Systems, Inc.* ....................... 48,000 156,000
Nu Horizons Electronics, Inc.* ...................... 55,300 470,050
Programmer's Paradise, Inc.* ........................ 77,100 732,450
Savior Technology Group, Inc.* ...................... 55,600 507,350
Sigmatron International, Inc.* ...................... 52,900 267,806
Trans-Lux Corp. ..................................... 32,300 242,250
Video Display Corp.* ................................ 34,500 166,031
-------------
4,458,451
-------------
Military Electronics 1.3%
EDO Corp. ........................................... 78,400 558,600
Engineered Support Systems, Inc. .................... 35,400 477,900
-------------
1,036,500
-------------
Precision Instruments 1.5%
Barringer Technologies Inc.* ........................ 25,500 142,641
Instron Corp. ....................................... 30,800 623,700
SpecTran Corp.* ..................................... 42,200 379,800
-------------
1,146,141
-------------
Semiconductors 0.3%
Zing Technologies, Inc.* ............................ 32,300 270,513
-------------
Energy 1.4%
Engineering 0.1%
Abrams Industries, Inc. ............................. 18,780 92,726
-------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
24
<PAGE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Market
Shares Value ($)
- ------------------------------------------------------------------------------------
<S> <C> <C>
Oil & Gas Production 0.7%
Hallwood Energy Corp.* .............................. 31,670 197,938
Petroleum Development Corp.* ........................ 77,600 339,500
-------------
537,438
-------------
Oil Companies 0.1%
Arabian Shield Development* ......................... 58,600 56,769
-------------
Miscellaneous 0.5%
RGC Resources, Inc. ................................. 18,700 374,000
-------------
Metals & Minerals 1.5%
Steel & Metals 1.2%
Bayou Steel Corp.* .................................. 110,900 388,150
Friedman Industries, Inc. ........................... 60,003 243,761
Webco Industries, Inc.* ............................. 61,500 276,750
-------------
908,661
-------------
Miscellaneous 0.3%
United States Lime & Minerals, Inc. ................. 37,300 270,425
-------------
Construction 5.3%
Building Materials 0.1%
Williams Industries, Inc.* .......................... 15,000 54,375
-------------
Building Products 2.0%
Baltek Corp.* ....................................... 46,100 409,138
Continental Materials Corp.* ........................ 35,400 725,700
Noland Co. .......................................... 23,700 438,450
-------------
1,573,288
-------------
Homebuilding 1.2%
Engle Homes, Inc. ................................... 33,200 342,375
Fortress Group, Inc.* ............................... 113,100 190,856
Liberty Homes, Inc. "A" ............................. 19,500 162,094
Washington Homes, Inc.* ............................. 33,000 210,375
-------------
905,700
-------------
Miscellaneous 2.0%
MYR Group, Inc. ..................................... 39,166 741,706
Turner Corp.* ....................................... 29,550 834,788
-------------
1,576,494
-------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
25
<PAGE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Market
Shares Value ($)
- ------------------------------------------------------------------------------------
<S> <C> <C>
Transportation 2.6%
Airlines 0.2%
Hawaiian Airlines, Inc.* ............................ 80,000 190,000
-------------
Marine Transportation 0.6%
International Shipholding Corp. ..................... 42,200 493,213
-------------
Railroads 0.4%
Providence & Worcester Railroad Co. 25,000 278,125
-------------
Trucking 1.4%
Boyd Brothers Transportation, Inc.* 51,000 516,375
Consolidated Delivery & Logistics, Inc.* 32,600 118,175
Kenan Transport Co. 8,500 267,750
Simon Transportation Services, Inc.* 30,000 157,500
-------------
1,059,800
-------------
Utilities 3.1%
Electric Utilities 0.2%
Unitil Corp. 6,500 169,000
-------------
Natural Gas Distribution 1.4%
Chesapeake Utilities Corp. 20,200 367,388
Energy West, Inc. 25,700 224,875
Providence Energy Corp. 17,900 487,775
-------------
1,080,038
-------------
Water Supply 1.4%
Connecticut Water Services 9,550 281,725
Southwest Water Co. 34,023 778,276
-------------
1,060,001
-------------
Miscellaneous 0.1%
Florida Public Utilities Co. 4,700 90,475
-------------
Total Common Stocks (Cost $68,979,837) 76,147,296
- ------------------------------------------------------------------------------------
Total Investment Portfolio-- 100.0% (Cost $70,001,837) (a) 77,169,296
- ------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
26
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
* Non-income producing security.
(a) The cost for federal income tax purposes was $69,936,919. At August 31,
1999, net unrealized appreciation for all securities based on tax cost was
$7,232,377. This consisted of aggregate gross unrealized appreciation for all
securities in which there was an excess of market value over tax cost of
$18,031,522 and aggregate gross unrealized depreciation for all securities in
which there was an excess of tax cost over market value of $10,799,145.
(b) Securities valued in good faith by the Valuation Committee of the Board of
Trustees at fair value amounted to $338,291 (0.43% of net assets). Their values
have been estimated by the Board of Trustees in the absence of readily
ascertainable market values. However, because of the inherent uncertainty of
valuation, those estimated values may differ significantly from the values that
would have been used had a ready market for the securities existed, and the
difference could be material. The cost of these securities at August 31, 1999
aggregated $1,049,185. These securities may also have certain restrictions as to
resale.
The accompanying notes are an integral part of the financial statements.
27
<PAGE>
Financial Statements
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Statement of Assets and Liabilities as of August 31, 1999
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Assets
- ------------------------------------------------------------------------------------
<S> <C>
Investments, at market (identified cost $70,001,837) ........... $ 77,169,296
Cash ........................................................... 1,812
Receivable for Fund shares sold ................................ 12,858
Dividends and interest receivable .............................. 24,459
Receivable for investments sold ................................ 1,525,767
Deferred organization expenses ................................. 5,442
Other assets ................................................... 1,056
---------------
Total assets ................................................... 78,740,690
Liabilities
- ------------------------------------------------------------------------------------
Payable for Fund shares redeemed ............................... 210,941
Accrued management fee ......................................... 48,467
Other payables and accrued expenses ............................ 164,831
---------------
Total liabilities .............................................. 424,239
Net assets, at market value .................................... $ 78,316,451
Net Assets
- ------------------------------------------------------------------------------------
Net assets consist of:
Net unrealized appreciation (depreciation) on investments ...... 7,167,459
Accumulated net realized gain (loss) ........................... (1,402,345)
Paid-in capital ................................................ 72,551,337
Net assets, at market value .................................... $ 78,316,451
Net Asset Value
- ------------------------------------------------------------------------------------
Net Asset Value, offering and redemption price
(Note A) per share ($78,316,451 / 5,149,376
outstanding shares of beneficial interest, $.01
par value, unlimited number of shares authorized) .............. $ 15.21
</TABLE>
The accompanying notes are an integral part of the financial statements.
28
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Statement of Operations for the year ended August 31, 1999
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Investment Income (Loss)
- ------------------------------------------------------------------------------------
<S> <C>
Income:
Dividends ................................................. $ 777,756
Interest .................................................. 67,418
---------------
845,174
---------------
Expenses:
Management fee ............................................ 677,081
Services to shareholders .................................. 554,629
Custodian and accounting fees ............................. 86,917
Trustees' fees and expenses ............................... 38,100
Auditing .................................................. 20,352
Registration fees ......................................... 20,216
Reports to shareholders ................................... 36,833
Legal ..................................................... 12,278
Amortization of organization expense ...................... 2,555
Other ..................................................... 7,793
---------------
Expenses, net ............................................. 1,456,754
Net investment income (loss) .............................. (611,580)
Realized and unrealized gain (loss) on investment transactions
- ------------------------------------------------------------------------------------
Net realized gain (loss) from investments ................. (1,468,116)
Net unrealized appreciation (depreciation) during the
period on investments ................................. 11,822,491
Net gain (loss) on investment transactions 10,354,375
Net increase (decrease) in net assets resulting from operations $ 9,742,795
</TABLE>
The accompanying notes are an integral part of the financial statements.
29
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Statements of Changes in Net Assets
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Increase (Decrease) in Net Assets Years Ended August 31,
1999 1998
- ------------------------------------------------------------------------------------
<S> <C> <C>
Operations:
Net investment income (loss) .................... $ (611,580) $ (604,298)
Net realized gain (loss) from investment
transactions .................................. (1,468,116) 5,519,340
Net unrealized appreciation (depreciation) on
investment transactions during the period ..... 11,822,491 (23,347,176)
--------------- ---------------
Net increase (decrease) in net assets resulting
from operations ................................. 9,742,795 (18,432,134)
--------------- ---------------
Distributions to shareholders from net realized
gains on investment transactions .............. (5,478,575) (535,902)
--------------- ---------------
Fund share transactions:
Proceeds from shares sold ....................... 15,769,689 72,871,032
Reinvestment of distributions ................... 5,236,859 518,950
Cost of shares redeemed ......................... (49,482,083) (43,749,787)
Redemption fees ................................. 24,451 203,752
--------------- ---------------
Net increase (decrease) in net assets from Fund
share transactions ............................ (28,451,084) 29,843,947
--------------- ---------------
Increase (decrease) in net assets ............... (24,186,864) 10,875,911
Net assets at beginning of period ............... 102,503,315 91,627,404
Net assets at end of period ..................... $ 78,316,451 $ 102,503,315
Other Information
- ------------------------------------------------------------------------------------
Increase (decrease) in Fund shares
Shares outstanding at beginning of period ....... 7,131,931 5,463,768
--------------- ---------------
Shares sold ..................................... 1,077,995 4,090,660
Shares issued to shareholders in reinvestment of
distributions ................................. 370,882 30,277
Shares redeemed ................................. (3,431,432) (2,452,774)
--------------- ---------------
Net increase (decrease) in Fund shares .......... (1,982,555) 1,668,163
Shares outstanding at end of period ............. 5,149,376 7,131,931
</TABLE>
The accompanying notes are an integral part of the financial statements.
30
<PAGE>
Financial Highlights
- --------------------------------------------------------------------------------
The following table includes selected data for a share outstanding throughout
each period (a) and other performance information derived from the financial
statements.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------
Years Ended August 31, 1999 1998 1997 1996(b)
- ------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net asset value, beginning of period $14.37 $16.77 $12.07 $12.00
--------------------------------------
Income from investment operations:
Net investment income (loss) (.10) (.08) (.03) .01
Net realized and unrealized gain (loss) on
investments 1.77 (2.28) 4.74 .06
--------------------------------------
Total from investment operations 1.67 (2.36) 4.71 .07
Less distributions from:
Net investment income -- -- (.02) --
Net realized gains on investment transactions (.83) (.07) -- --
--------------------------------------
Total distributions (.83) (.07) (.02) --
Redemption fees --*** .03 .01 --***
Net asset value, end of period $15.21 $14.37 $16.77 $12.07
--------------------------------------
Total Return (%) (c) 12.03 (13.96) 39.10(d) .58(d)**
Ratios and Supplemental Data
- ------------------------------------------------------------------------------------
Net assets, end of period ($ millions) 78 103 92 8
- ------------------------------------------------------------------------------------
Ratio of operating expenses to average daily
net assets (%) 1.61 1.39 1.75 1.75*
- ------------------------------------------------------------------------------------
Ratio of operating expenses before expense
reductions, to average daily net assets (%) 1.61 1.39 2.19 22.06*
- ------------------------------------------------------------------------------------
Ratio of net investment income (loss) to
average daily net assets (%) (.68) (.44) (.21) 2.58*
- ------------------------------------------------------------------------------------
Portfolio turnover rate (%) 4.43 33.5 17.1 --
- ------------------------------------------------------------------------------------
</TABLE>
(a) Based on monthly average shares outstanding during the period.
(b) For the Period August 12, 1996 (commencement of operations) to August 31,
1996
(c) Total return does not reflect the effect to the shareholder of the 1%
redemption fee on shares held less than one year.
(d) Total return would have been lower had certain expenses not been reduced.
* Annualized
** Not annualized
*** Amount is less than half of $.01.
31
<PAGE>
Notes to Financial Statements
- --------------------------------------------------------------------------------
August 31, 1999
A. Significant Accounting Policies
Scudder Micro Cap Fund (the "Fund") is a diversified series of Scudder
Securities Trust (the "Trust") which is registered under the Investment Company
Act of 1940, as amended (the "1940 Act"), as an open-end management investment
company organized as a Massachusetts business trust.
Effective September 22, 1997, the Fund suspended the sale of its shares to new
investors. Current individual shareholders of the Fund were able to continue to
invest in the Fund and the Fund remained open to investment through qualified
retirement plans. The Trustees reopened the Fund to new investors effective
October 23, 1998. The Trustees may determine to close the Fund again at some
point based on market conditions and other factors.
The Fund's financial statements are prepared in accordance with generally
accepted accounting principles which require the use of management estimates.
The policies described below are followed consistently by the Fund in the
preparation of its financial statements.
Security Valuation. Investments are stated at value determined as of the close
of regular trading on the New York Stock Exchange. Securities which are traded
on U.S. or foreign stock exchanges are valued at the most recent sale price
reported on the exchange on which the security is traded most extensively. If no
sale occurred, the security is then valued at the calculated mean between the
most recent bid and asked quotations. If there are no such bid and asked
quotations, the most recent bid quotation is used. Securities quoted on the
Nasdaq Stock Market ("Nasdaq"), for which there have been sales, are valued at
the most recent sale price reported. If there are no such sales, the value is
the most recent bid quotation. Securities which are not quoted on Nasdaq but are
traded in another over-the-counter market are valued at the most recent sale
price, or if no sale occurred, at the calculated mean between the most recent
bid and asked quotations on such market. If there are no such bid and asked
quotations, the most recent bid quotation shall be used.
Portfolio debt securities purchased with an original maturity greater than sixty
days are valued by pricing agents approved by the officers of the Trust, whose
quotations reflect broker/dealer-supplied valuations and electronic data
processing techniques. If the pricing agents are unable to provide such
quotations, the most recent bid quotation supplied by a bona fide market maker
shall be used. Money market instruments purchased with an original maturity of
sixty days or less are valued at amortized cost.
32
<PAGE>
- --------------------------------------------------------------------------------
All other securities are valued at their fair value as determined in good faith
by the Valuation Committee of the Board of Trustees.
Repurchase Agreements. The Fund may enter into repurchase agreements with
certain banks and broker/dealers whereby the Fund, through its custodian or
sub-custodian bank, receives delivery of the underlying securities, the amount
of which at the time of purchase and each subsequent business day is required to
be maintained at such a level that the market value is equal to at least the
principal amount of the repurchase price plus accrued interest.
Federal Income Taxes. The Fund's policy is to comply with the requirements of
the Internal Revenue Code, as amended, which are applicable to regulated
investment companies and to distribute all of its taxable income to its
shareholders. Accordingly, the Fund paid no federal income taxes and no federal
income tax provision was required.
At August 31, 1999, the Fund had a net tax basis capital loss carryforward of
approximately $1,109,000 which may be applied against any realized net taxable
capital gains of each succeeding year until fully utilized or until August 31,
2007, the expiration date, whichever occurs first. From November 1, 1998 through
August 31, 1999, the Fund incurred approximately $359,000 of net realized
capital losses. As permitted by tax regulations, the Fund intends to elect to
defer these losses and treat them as arising in the fiscal year ended August 31,
2000.
Distribution of Income and Gains. Distributions of net investment income, if
any, are made annually. Net realized gains from investment transactions, in
excess of available capital loss carryforwards, would be taxable to the Fund if
not distributed, and, therefore, will be distributed to shareholders at least
annually.
The timing and characterization of certain income and capital gains
distributions are determined annually in accordance with federal tax regulations
which may differ from generally accepted accounting principles. As a result, net
investment income (loss) and net realized gain (loss) on investment transactions
for a reporting period may differ significantly from distributions during such
period. Accordingly, the Fund may periodically make reclassifications among
certain of its capital accounts without impacting the net asset value of the
Fund.
Investment Transactions and Investment Income. Investment transactions are
accounted for on the trade date. Interest income is recorded on the accrual
basis. Dividend income is recorded on the ex-dividend date. Realized gains
33
<PAGE>
and losses from investment transactions are recorded on an identified cost
basis.
Organization Costs. Costs incurred by the Fund in connection with its
organization have been deferred and are being amortized on a straight-line basis
over a five-year period.
Redemption Fees. In general, shares of the Fund may be redeemed at net asset
value. However, upon the redemption or exchange of shares held by shareholders
for less than one year, a fee of 1% of the current net asset value of the shares
will be assessed and retained by the Fund for the benefit of the remaining
shareholders. The redemption fee is accounted for as an addition to paid-in
capital.
B. Purchases and Sales of Securities
During the year ended August 31, 1999, purchases and sales of investment
securities (excluding short-term investments) aggregated $3,965,359 and
$40,604,293, respectively.
C. Related Parties
Under the Investment Management Agreement (the "Management Agreement") with
Scudder Kemper Investments, Inc. ("Scudder Kemper" or the "Adviser"), the Fund
pays the Adviser a fee equal to an annual rate of 0.75% of the Fund's average
daily net assets, computed and accrued daily and payable monthly. As manager of
the assets of the Fund, the Adviser directs the investments of the Fund in
accordance with its investment objective, policies, and restrictions. The
Adviser determines the securities, instruments and other contracts relating to
investments to be purchased, sold or entered into by the Fund. In addition to
portfolio management services, the Adviser provides certain administrative
services in accordance with the Management Agreement. For the year ended August
31, 1999, the fee imposed amounted to $677,081, of which $48,467 is unpaid at
August 31, 1999.
Scudder Service Corporation ("SSC"), a subsidiary of the Adviser, is the
transfer, dividend paying and shareholder service agent for the Fund. For the
year ended August 31, 1999, the amount charged to the Fund by SSC aggregated
$299,994, of which $22,163 is unpaid at August 31, 1999.
Scudder Trust Company ("STC"), a subsidiary of the Adviser, provides
recordkeeping and other services in connection with certain retirement and
employee benefit plans invested in the Fund. For the year ended August 31,
34
<PAGE>
1999, the amount charged to the Fund by STC aggregated $58,722, of which $5,593
is unpaid at August 31, 1999.
Scudder Fund Accounting Corporation ("SFAC"), a subsidiary of the Adviser, is
responsible for determining the daily net asset value per share and maintaining
the portfolio and general accounting records of the Fund. For the year ended
August 31, 1999, the amount charged to the Fund by SFAC aggregated $54,171, of
which $11,502 is unpaid at August 31, 1999.
The Fund is one of several Scudder Funds (the "Underlying Funds") in which the
Scudder Pathway Series Portfolios (the "Portfolios") invest. In accordance with
the Special Servicing Agreement entered into by the Adviser, the Portfolios, the
Underlying Funds, SSC, SFAC, STC, and Scudder Investor Services, Inc., expenses
from the operation of the Portfolios are borne by the Underlying Funds based on
each Underlying Fund's proportionate share of assets owned by the Portfolios. No
Underlying Funds will be charged expenses that exceed the estimated savings to
each respective Underlying Fund. These estimated savings result from the
elimination of separate shareholder accounts which either currently are or have
the potential to be invested in the Underlying Funds. At August 31, 1999, the
Special Servicing Agreement expense charged to the Fund amounted to $93,633, of
which $10,626 is unpaid at August 31, 1999.
The Trust pays each of its Trustees not affiliated with the Adviser an annual
retainer plus specified amounts for attended board and committee meetings. For
the year ended August 31, 1999, the Trustees' fees and expenses aggregated
$38,100.
D. Line of Credit
The Fund and several Scudder Funds (the "Participants") share in a $850 million
revolving credit facility for temporary or emergency purposes, including the
meeting of redemption requests that otherwise might require the untimely
disposition of securities. The Participants are charged an annual commitment fee
which is allocated, pro rata based on net assets, among each of the
Participants. Interest is calculated based on the market rates at the time of
the borrowing. The Fund may borrow up to a maximum of 33 percent of its net
assets under the agreement.
35
<PAGE>
Report of Independent Accountants
- --------------------------------------------------------------------------------
To the Trustees of Scudder Securities Trust and the Shareholders of Scudder
Micro Cap Fund:
In our opinion, the accompanying statement of assets and liabilities, including
the investment portfolio, and the related statements of operations and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of Scudder Micro Cap Fund (the "Fund")
at August 31, 1999, the results of its operations, the changes in its net
assets, and the financial highlights for the periods indicated therein, in
conformity with generally accepted accounting principles. These financial
statements and financial highlights (hereafter referred to as "financial
statements") are the responsibility of the Fund's management; our responsibility
is to express an opinion on these financial statements based on our audits. We
conducted our audits of these financial statements in accordance with generally
accepted auditing standards which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits, which included confirmation of securities at August 31, 1999 by
correspondence with the custodian, provide a reasonable basis for the opinion
expressed above.
Boston, Massachusetts PricewaterhouseCoopers LLP
October 15, 1999
36
<PAGE>
Tax Information
- --------------------------------------------------------------------------------
August 31, 1999
The Fund paid distributions of $0.83 per share from net long-term capital gains
during its year ended August 31, 1999, of which 100% represents 20% rate gains.
Please consult a tax adviser if you have questions about federal or state income
tax laws, or on how to prepare your tax returns. If you have specific questions
about your account, please call 1-800-SCUDDER.
37
<PAGE>
Officers and Trustees
- --------------------------------------------------------------------------------
Lynn S. Birdsong*
o President and Trustee
Paul Bancroft III
o Trustee; Venture Capitalist and
Consultant
Sheryle J. Bolton
o Trustee; Chief Executive Officer,
Scientific Learning Corporation
William T. Burgin
o Trustee; General Partner, Bessemer
Venture Partners
Keith R. Fox
o Trustee; Private Equity Investor
William H. Luers
o Trustee; Chairman and President,
U.N. Association of America
Kathryn L. Quirk*
o Trustee, Vice President and
Assistant Secretary
Joan E. Spero
o Trustee; President, Doris Duke
Charitable Foundation
Thomas J. Devine
o Honorary Trustee; Consultant
Wilson Nolen
o Honorary Trustee; Consultant
Robert G. Stone, Jr.
o Honorary Trustee; Chairman
Emeritus and Director, Kirby
Corporation
Edmund R. Swanberg
o Honorary Trustee
Peter Chin*
o Vice President
J. Brooks Dougherty*
o Vice President
James M. Eysenbach*
o Vice President
James E. Fenger*
o Vice President
Philip S. Fortuna*
o Vice President
Ann M. McCreary*
o Vice President
Thaddeus Paluszek*
o Vice President
Kurt R. Stalzer*
o Vice President
Peter Taylor*
o Vice President
John Millette*
o Vice President and Secretary
John R. Hebble*
o Treasurer
Richard W. Desmond*
o Assistant Secretary
Caroline Pearson*
o Assistant Secretary
*Scudder Kemper Investments, Inc.
38
<PAGE>
Investment Products and Services
- --------------------------------------------------------------------------------
1-800-SCUDDER www.scudder.com
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
The Scudder Family of Funds+++
- --------------------------------------------------------------------------------
<S> <C>
Money Market U.S. Growth and Income
Scudder U.S. Treasury Money Fund Scudder Balanced Fund
Scudder Cash Investment Trust Scudder Dividend & Growth Fund
Scudder Money Market Series -- Scudder Growth and Income Fund
Prime Reserve Shares* Scudder Select 500 Fund
Premium Shares* Scudder S&P 500 Index Fund
Managed Shares* Scudder Real Estate Investment Fund
Scudder Government Money Market
Series -- Managed Shares* U.S. Growth
Value
Tax Free Money Market+ Scudder Large Company Value Fund
Scudder Tax Free Money Fund Scudder Value Fund***
Scudder Tax Free Money Market Scudder Small Company Value Fund
Series -- Managed Shares* Scudder Micro Cap Fund
Scudder California Tax Free Money Fund** Growth
Scudder New York Tax Free Money Fund** Scudder Classic Growth Fund***
Scudder Large Company Growth Fund
Tax Free+ Scudder Select 1000 Growth Fund
Scudder Limited Term Tax Free Fund Scudder Development Fund
Scudder Medium Term Tax Free Fund Scudder 21st Century Growth Fund
Scudder Managed Municipal Bonds
Scudder High Yield Tax Free Fund Global Equity
Scudder California Tax Free Fund** Worldwide
Scudder Massachusetts Limited Term Scudder Global Fund
Tax Free Fund** Scudder International Value Fund
Scudder Massachusetts Tax Free Fund** Scudder International Growth and
Scudder New York Tax Free Fund** Income Fund
Scudder Ohio Tax Free Fund** Scudder International Fund++
Scudder International Growth Fund
U.S. Income Scudder Global Discovery Fund***
Scudder Short Term Bond Fund Scudder Emerging Markets Growth Fund
Scudder GNMA Fund Scudder Gold Fund
Scudder Income Fund Regional
Scudder Corporate Bond Fund Scudder Greater Europe Growth Fund
Scudder High Yield Bond Fund Scudder Pacific Opportunities Fund
Scudder Latin America Fund
Global Income The Japan Fund, Inc.
Scudder Global Bond Fund
Scudder International Bond Fund Industry Sector Funds
Scudder Emerging Markets Income Fund Choice Series
Scudder Financial Services Fund
Asset Allocation Scudder Heath Care Fund
Scudder Pathway Conservative Portfolio Scudder Technology Fund
Scudder Pathway Balanced Portfolio
Scudder Pathway Growth Portfolio Preferred Series
Scudder Tax Managed Growth Fund
Scudder Tax Managed Small Company Fund
</TABLE>
39
<PAGE>
- --------------------------------------------------------------------------------
1-800-SCUDDER www.scudder.com
- --------------------------------------------------------------------------------
Retirement Programs and Education Accounts
- --------------------------------------------------------------------------------
Retirement Programs Education Accounts
Traditional IRA Education IRA
Roth IRA UGMA/UTMA
SEP-IRA
Keogh Plan
401(k), 403(b) Plans
Variable Annuities
Scudder Horizon Plan**+++ +++
Scudder Horizon Advantage**+++ +++ +++
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------
Closed-End Funds#
- -----------------------------------------------------------------------------------------
<S> <C>
The Argentina Fund, Inc. Scudder Global High Income Fund, Inc.
The Brazil Fund, Inc. Scudder New Asia Fund, Inc.
The Korea Fund, Inc. Scudder New Europe Fund, Inc.
Montgomery Street Income Securities, Inc.
</TABLE>
For complete information on any of the above Scudder funds, including management
fees and expenses, call or write for a free prospectus. Read it carefully before
you invest or send money.
+++ Funds within categories are listed in order from expected least
risk to most risk. Certain Scudder funds or classes thereof may
not be available for purchase or exchange.
+ A portion of the income from the tax-free funds may be subject to
federal, state, and local taxes.
* A class of shares of the fund.
** Not available in all states.
*** Only the Scudder Shares of the fund are part of the Scudder Family
of Funds.
++ Only the International Shares of the fund are part of the Scudder
Family of Funds.
+++ +++ A no-load variable annuity contract provided by Charter National
Life Insurance Company and its affiliate, offered by Scudder's
insurance agencies, 1-800-225-2470.
+++ +++ +++ A no-load variable annuity contract issued by Glenbrook Life and
Annuity Company and underwritten by Allstate Financial Services,
Inc., sold by Scudder's insurance agencies, 1-800-225-2470.
# These funds, advised by Scudder Kemper Investments, Inc., are
traded on the New York Stock Exchange and, in some cases, on
various other stock exchanges.
40
<PAGE>
Scudder Solutions
- --------------------------------------------------------------------------------
1-800-SCUDDER www.scudder.com
Convenient Automatic Investment Plan
ways to invest,
quickly and A convenient investment program in which money is
reliably electronically debited from your bank account monthly to
regularly purchase fund shares and "dollar cost average" --
buy more shares when the fund's price is lower and fewer
when it's higher, which can reduce your average purchase
price over time.*
Automatic Dividend Transfer
The most timely, reliable, and convenient way to purchase
shares -- use distributions from one Scudder fund to
purchase shares in another, automatically (accounts with
identical registrations or the same social security or tax
identification number).
QuickBuy
Lets you purchase Scudder fund shares electronically,
avoiding potential mailing delays; money for each of your
transactions is electronically debited from a previously
designated bank acount.
Payroll Deduction and Direct Deposit
Have all or part of your paycheck -- even government checks
-- invested in up to four Scudder funds at one time.
* Dollar cost averaging involves continuous investment in
securities regardless of price fluctuations and does not
assure a profit or protect against loss in declining
markets. Investors should consider their ability to
continue such a plan through periods of low price
levels.
Around-the- Scudder Automated Information Line: SAIL(TM) --
clock electronic 1-800-343-2890
account
service and Personalized account information, the ability to exchange
information, or redeem shares, and information on other Scudder funds
including some and services via touchtone telephone.
transactions
Scudder's Web Site -- www.scudder.com
Personal Investment Organizer: Offering account information
and transactions, interactive worksheets, prospectuses and
applications for all Scudder funds, plus your current asset
allocation, whenever your need them. Scudder's site also
provides news about Scudder funds, retirement planning
information, and more.
41
<PAGE>
- --------------------------------------------------------------------------------
1-800-SCUDDER www.scudder.com
Retirees and Automatic Withdrawal Plan
those who depend
on investment You designate the bank account, determine the schedule (as
proceeds for frequently as once a month) and amount of the redemptions,
living expenses and Scudder does the rest.
can enjoy these
convenient, Distributions Direct
timely, and
reliable Automatically deposits your fund distributions into the
automated bank account you designate within three business days after
withdrawal each distrbution is paid.
programs
QuickSell
Provides speedy access to your money by electronically
crediting your redemption proceeds to the bank account you
previously designated.
For more Call a Scudder representative at
information about 1-800-SCUDDER
these services
Or visit our Web site at
www.scudder.com
Please address The Scudder Funds
all written PO Box 2291
correspondence Boston, Massachusetts
to 02107-2291
42
<PAGE>
Notes
- --------------------------------------------------------------------------------
<PAGE>
About the Fund's Adviser
SCUDDER
P.O. Box 2291
Boston, MA 02107-2291
1-800-SCUDDER
www.scudder.com
Scudder Kemper Investments, Inc. is one of the largest and most experienced
investment management organizations worldwide, managing more than $280 billion
in assets globally for mutual fund investors, retirement and pension plans,
institutional and corporate clients, insurance companies, and private family and
individual accounts.
Scudder Kemper Investments has a rich heritage of innovation, integrity, and
client-focused service. In 1997, Scudder, Stevens & Clark, Inc., founded 80
years ago as one of the nation's first investment counsel organizations, joined
the Zurich Financial Services Group. As a result, Zurich's subsidiary, Zurich
Kemper Investments, Inc., with 50 years of mutual fund and investment management
experience, was combined with Scudder. Headquartered in New York, Scudder Kemper
Investments offers a full range of investment counsel and asset management
capabilities, based on a combination of proprietary research and disciplined,
long-term investment strategies. With its global investment resources and
perspective, the firm seeks opportunities in markets throughout the world to
meet the needs of investors.
Scudder Kemper Investments, Inc., the global asset management firm, is a member
of the Zurich Financial Services Group. The Zurich Financial Services Group is
an internationally recognized leader in financial services, including
property/casualty and life insurance, reinsurance, and asset management.
This information must be preceded or accompanied by a current prospectus.
Portfolio changes should not be considered recommendations for action by
individual investors.
