PERFORMANCE REVIEW
In the year ended March 31, 1995, the total return for the Smith
Breeden Market Tracking Fund ( the "Fund") was 17.18%, 1.60% more than
its benchmark, the S&P 500, which returned 15.58%. Since the Fund's
inception, it has achieved a total return of 39.53%, as compared to the
S&P 500 index return of 32.58%, representing an advantage of 6.95%.
The Fund also performed much better than the average S&P 500 index
fund for this period. The average total return of S&P 500 index funds as
tracked by Lipper Analytical, Inc. was only 15.09% for the year ended
March 31, 19951, or 49 basis points lower than the index. The return was
lower than the actual index due to the funds' expenses. As will be
discussed in more detail later, the Market Tracking Fund's enhanced index
strategy enables it to seek a return on its invested cash in excess of its
expenses and indexing costs.
It is noteworthy that in 1994 the S&P 500 index outperformed 78% of
stock funds. One reason the 1994 stock market favored S&P 500 stocks,
and the index, is that the weakness of the U.S. dollar benefited exporter
firms and those companies with significant operations overseas. Corporate
earnings in foreign currencies become more valuable as the dollar weakens
since the conversion ratio of dollars to foreign currency becomes greater.
This effect has particularly benefited the large corporations that
comprise the S&P 500 index. Additionally, foreign firms face greater
difficulty in competing with U.S. corporations as the dollar becomes cheaper.
A cheaper dollar lowers the price of American goods and services in
international markets, and enhances the earnings prospects of U.S. exporters.
THE LINE GRAPH DETAILING PERFORMANCE IN ACCORDANCE WITH ITEM 5a. OF FORM
N1-A IS LOCATED HERE IN THE TEXT AND IS DESCRIBED BELOW IN ACCORDANCE
WITH REG 232.304 OF REGULATION S-T.
THE GRAPH DEPICTS THE CHANGE IN VALUE OF A $10,000 INVESTMENT IN THE
MARKET TRACKING FUND VERSUS THAT OF ITS BENCHMARK, THE S&P 500 INDEX.
FROM THE FUND'S INCEPTION OF JUNE 30, 1992 THROUGH MARCH 31, 1995, AN
INVESTMENT OF $10,000 WOULD HAVE GROWN TO $13,953 IF INVESTED IN THE
FUND AND $13,258 IF INVESTED IN THE INDEX. THE RETURN IN THE FUND IS
NET OF FEES AND SALES CHARGES; THE RETURN OF THE S&P 500 INDEX DOES NOT
REFLECT FEES OR TRANSACTION COSTS. THE ANNUALIZED ONE YEAR RETURN
FOR THE FUND IS 17.18% AND SINCE INCEPTION, THE FUND'S ANNUALIZED
RETURN IS 12.87%.
The performance of the S&P 500 and the stock market in general has also
been buoyed by investors' perception that the Federal Reserve has successfully
controlled the economy's growth without increasing the risk of recession.
The effect of an increase in interest rates usually takes at least a year to
have an impact on the economy. The Federal Reserve's first increase in the
discount rate was in February, 1994. The measure of the Gross Domestic
Product (GDP) in the first quarter of 1995 supported the impact of this rate
increase a year prior, since the annualized rate of increase in the GDP was
the lowest of any in the last five quarters. The continuing stock market
rally suggests that investors are confident that the risk of recession or of
further interest rate hikes has receded.
As mentioned earlier, the Fund's strategy of investing its cash in fixed
income securities with the aim of producing a total return greater than the
Fund's expenses met with great success in the year ended March 31, 1995. The
Fund beat the S&P 500 index return by 1.57% over the period. During 1994
and the first quarter of 1995, the Market Tracking Fund's fixed income
segment was invested mainly in premium fixed-rate mortgage-backed securities
("MBS") and in GNMA adjustable-rate mortgages ("ARMS"). Holders of premium
MBS, which have a higher coupon than currently issued mortgages, benefit
when prepayments are slow. In the rising interest rate environment of 1994,
with fewer homeowners refinancing their mortgages, hedged premium MBS
produced superior returns. This was especially the case during the last four
months of the 1994 calendar year, during which time, the Fund beat the
S&P 500 index by 2.23%. When rates started to decline in the first quarter
of 1995, the excellent performance of the Fund's holdings of GNMA ARMs
helped offset the weak performance in fixed-rate premiums as investors'
prepayment concerns regarding these securities increased. The Fund had built
up a position in GNMA ARMs in previous months while they were undervalued
relative to other sectors of the mortgage market.
The Market Tracking Fund will continue to search for relative value in
the mortgage market to provide you with an incremental return after expenses
over the S&P 500. At March 31, 1995, the Fund's cash holdings represented
about 5 % of net assets in anticipation of developing opportunities.
1 Source: Barron's, April 10, 1995.
SMITH BREEDEN MARKET TRACKING FUND
SCHEDULE OF INVESTMENTS MARCH 31, 1995
Market
Face Amount Security Value
U.S. GOVERNMENT & AGENCY OBLIGATIONS - 91.57%
FEDERAL HOME LOAN MORTGAGE CORPORATION - 12.83% *
FHLMC:
$192,252 9.50%, due 07/01/02.................................$198,020
65,987 12.50%, due 02/01/14................................ 72,423
TOTAL FEDERAL HOME LOAN MORTGAGE CORPORATION
(Cost $275,001)......................................270,443
FEDERAL NATIONAL MORTGAGE ASSOCIATION - 28.34% *
FNMA:
170,739 12.50%, due 09/01/12................................ 189,297
305,431 13.50%, due 11/01/14-02/01/15....................... 340,345
FNMA ARM:
65,569 7.08%, due 12/01/26................................. 67,507
TOTAL FEDERAL NATIONAL MORTGAGE ASSOCIATION
(Cost $605,103)..................................... 597,149
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION - 48.06% *
GNMA ARM:
684,966 5.50%, due 02/20/22-03/20/22........................ 677,808
335,322 6.0%, due 05/20/21.................................. 334,930
TOTAL GOVERNMENT NATIONAL MORTGAGE ASSOCIATION
(Cost $981,636) 1,012,738
U.S. GOVERNMENT OBLIGATIONS - 2.34%
U.S. TREASURY BILL **
50,000 5.66%, due 06/29/95................................. 49,312
TOTAL U.S. GOVERNMENT OBLIGATIONS (Cost $49,301).... 49,312
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(Cost $1,911,041)..................................1,929,642
EURODOLLAR PUT OPTIONS - 0.35%
Contracts
5 Expires 6/95, Strike Price $93.25................... 875
5 Expires 12/95, Strike Price $92.25.................. 2,875
5 Expires 12/95, Strike Price $92.50.................. 3,500
TOTAL EURODOLLAR PUT OPTIONS (Cost $14,707)......... 7,250
EQUITY SWAP CONTRACTS - 3.22%
Notional Amount
S&P 500 Index Equity Swap Contract
dated 1/11/95 with Morgan Stanley Capital Markets
$923,340 Expires 7/11/95..................................... 67,981
TOTAL EQUITY SWAP CONTRACTS.............................. 67,981
TOTAL INVESTMENTS (Cost $1,925,748) - 95.14%...... 2,004,873
CASH AND OTHER ASSETS LESS LIABILITIES - 4.86%...... 102,473
NET ASSETS - 100.00%............................. $2,107,346
* Mortgage backed obligations are subject to principal paydowns as a
result of prepayments or refinancings of the underlying mortgage
loans. As a result, the average life may be substantially less than
the original maturity. The interest rate shown is the rate in effect at
March 31, 1995. ARMs have coupon rates which adjust periodically. The
adjusted rate is determined by adding a spread to a
specified index.
** The interest rate shown is the discount rate paid at the time of
purchase by the Fund.
Portfolio Abbreviations:
ARM - Adjustable Rate Mortgage
FHLMC - Federal Home Loan Mortgage Corporation
FNMA - Federal National Mortgage Association
GNMA - Government National Mortgage Association
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN MARKET TRACKING FUND
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 1995
ASSETS:
Investments at market value
(identified cost $1,925,748)(Note 1)..................$2,004,873
Cash......................................................81,060
Receivables:
Interest...............................................14,859
Variation margin on futures contracts (Note 2)............625
Securities sold.........................................3,656
Prepaid expenses...........................................2,820
Deferred organization expenses (Note 1)...................62,530
TOTAL ASSETS......................................2,170,423
LIABILITIES:
Accrued expenses..........................................10,483
Distributions payable......................................1,200
Due to adviser (Note 3)...................................51,394
TOTAL LIABILITIES....................................63,077
NET ASSETS:
(Applicable to outstanding shares of 194,482;
unlimited number of share of beneficial
interest authorized; no stated par)................$2,107,346
Net asset value, offering price and redemption
price per share ($2,107,346 / 194,482).................$10.84
SOURCE OF NET ASSETS:
Paid in capital.......................................$2,040,914
Accumulated net realized loss on investments.............(38,496)
Net unrealized appreciation(depreciation) of
investments, equity swap and futures contracts...........104,928
NET ASSETS.......................................$2,107,346
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN MARKET TRACKING FUND
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1995
INVESTMENT INCOME:
Interest and discount earned, net of amortization.....$156,990
EXPENSES:
Accounting and pricing services fees.................. 27,350
Amortization of organization expenses (Note 1)........ 27,791
Transfer agent fees................................... 29,919
Legal fees............................................ 12,472
Registration fees..................................... 19,652
Custodian fees........................................ 7,251
Advisory fees (Note 3)................................ 11,056
Trustees fees and expenses............................ 4,274
Insurance expense..................................... 1,900
Other................................................. 4,169
TOTAL EXPENSES BEFORE REIMBURSEMENT............... 145,834
Expenses reimbursed by Adviser (Note 3)...........(128,959)
NET EXPENSES...................................... 16,875
NET INVESTMENT INCOME ............................ 140,115
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized loss on investments...................... (64,050)
Change in unrealized appreciation(depreciation)
of investments, equity swap and futures contracts.... 229,458
Net realized and unrealized gain on investments,
equity swap and futures contracts.................... 165,408
Net increase in net assets resulting from operations..$305,523
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN MARKET TRACKING FUND
STATEMENTS OF CHANGES IN NET ASSETS
Year Ended Year Ended
March 31, 1995 March 31, 1994
OPERATIONS:
Net investment income............................ $140,115 $135,900
Net realized gain (loss) on investments. (64,050) 57,426
Change in unrealized appreciation
(depreciation) of investments,
equity swap and futures contracts..... 229,458 (155,969)
Net increase in net assets resulting
from operations....................... 305,523 37,357
DISTRIBUTIONS TO SHAREHOLDERS:
Dividends from net investment income.... (104,085) (77,182)
Dividends in excess of net investment
income................................ (251) -
Distributions from net realized gains on
investments........................... (9,133) (115,776)
Distributions in excess of net realized
gains on investments.................. (13,962) (9,611)
Total distributions..................... (127,431) (202,569)
CAPITAL SHARE TRANSACTIONS:
Shares sold............................. 200,709 2,077,867
Shares issued on reinvestment of
distributions......................... 120,434 9,822
Shares redeemed......................... (152,408) (1,065,804)
Increase in net assets resulting from
capital share transactions (a)........ 168,735 1,021,885
TOTAL INCREASE IN NET ASSETS........ 346,827 856,673
NET ASSETS:
Beginning of period..................... 1,760,519 903,846
End of period...........................$2,107,346 $1,760,519
(a) Transactions in capital shares were as follows:
Shares sold........................ 19,300 191,195
Shares issued on reinvestment of
distributions..................... 11,593 931
Shares redeemed.................... (14,689) (97,117)
Net increase....................... 16,204 95,009
Beginning balance ................. 178,278 83,269
Ending balance..................... 194,482 178,278
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN MARKET TRACKING FUND
FINANCIAL HIGHLIGHTS
The following average per share data, ratios and supplemental
information has been derived from information provided in the
financial statements.
Year Year Period
Ended Ended Ended
March 31, 1995 March 31, 1994 March 31, 1993*
Net Asset Value
Beginning of Period..... $9.88 $10.85 $10.00
Income From Investment Operations
Net investment income..... 0.568 0.476 0.355
Net realized and
unrealized gain (loss)
equity swaps and
futures contracts...... 1.081 (0.216) 1.281
Total from investment
operations......... 1.649 0.260 1.636
Less Distributions
Dividends from net
investment income..... (0.568) (0.472) (0.311)
Dividends in excess of
net investment income. (0.001) - -
Distributions from
net realized gains
on investments........ (0.047) (0.701) (0.420)
Distributions in excess
of net realized gains
on investments........ (0.073) (0.057) (0.055)
Total distributions. (0.689) (1.230) (0.786)
Net Asset Value,
End of Period........... $10.84 $9.88 10.85
Total Return.............. 17.18% 2.19% 22.59%
Ratios/Supplemental Data
Net assets, end of
period.................. $2,107,346 $1,760,519 $903,846
Ratio of expenses
to average
net assets (1)........ 0.90% 0.90% 0.57%
Ratio of net investment
income to average
net assets (2)........ 7.44% 8.02% 5.28%
Portfolio turnover rate. 120% 119% 271%
______________________
(1) The annualized ratio of expenses to average net assets prior
to reimbursement by the Adviser was 7.75%, 7.08%, and 28.48%
for the years ended March 31, 1995, March 31, 1994, and the
period ended March 31, 1993, respectively.
(2) The annualized ratio of net investment income to average net
assets prior to reimbursement of expenses by the Adviser was
0.59%, 1.84%, and (22.63%) for the years ended March 31, 1995,
March 31, 1994, and the period ended March 31, 1993,
respectively.
* The Smith Breeden Market Tracking Fund commenced operations
June 30, 1992.
** Annualized
The accompanying notes are an integral part of these financial statements.
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
Smith Breeden Market Tracking Fund (the "Fund") is a series of the
Smith Breeden Trust (the "Trust"), an open-end, diversified management
investment company registered under the Investment Company Act of 1940,
as amended. The following is a summary of significant accounting
policies consistently followed by the Fund.
A. Security Valuation: Portfolio securities are valued at current market
value provided by a pricing service or by a bank or broker/dealer experienced
in such matters, when over-the-counter market quotations are readily
available. Securities and other assets for which market prices are not readily
available are valued at fair market value as determined in accordance with
procedures approved by the Board of Trustees. All money market instruments
and debt securities originally purchased with remaining maturities of 60 days
or less shall be valued at their amortized cost.
B. Distributions and Taxes: The Fund intends to continue to qualify for
and elect the special tax treatment afforded regulated investment companies
under Subchapter M of the Internal Revenue Code, thereby relieving the Fund
of federal income taxes. To so qualify, the Fund intends to distribute
substantially all of its net investment income and net realized capital
gains, if any, less any available capital loss carry forward. As of
March 31, 1995, the Fund had no net capital loss carry forward.
C. Repurchase Agreements: The Fund may enter into repurchase agreements
with member banks of the Federal Reserve System having total assets in excess
of $500 million and securities dealers, provided that such banks or dealers
meet the credit guidelines of the Fund's Board of Trustees. In a repurchase
agreement, the Fund acquires securities from a third party with the commitment
that they will be repurchased by the seller at a fixed price on an agreed
upon date. The Fund's custodian maintains control or custody of these
securities which collateralize the repurchase agreements until maturity of
the repurchase agreements. The value of the collateral is monitored daily,
and if necessary, additional collateral is received to ensure that the market
value of the underlying assets remains sufficient to protect the Fund in the
event of the seller's default. However, in the event of default or bankruptcy
of the seller, the Fund's right to the collateral may be subject to legal
proceedings.
D. Reverse Repurchase Agreements: A reverse repurchase agreement involves
the sale by the Fund of portfolio assets concurrently with an agreement by the
Fund to repurchase the same assets at a later date at a fixed price. The Fund
will maintain a segregated account with its custodian, which will be marked to
market daily, consisting of cash, U.S. Government securities or other liquid
high-grade debt obligations equal in value to its obligations under reverse
repurchase agreements. In the event the buyer of securities under a reverse
repurchase agreement files for bankruptcy or becomes insolvent, the Fund's use
of the proceeds of the agreement may be restricted pending a determination by
the other party, or its trustee or receiver whether to enforce the Fund's
obligation to repurchase the securities.
E. Determination Of Gains Or Losses On Sales Of Securities: Gains or losses
on the sale of securities are calculated for accounting and tax purposes on
the identified cost basis.
F. Deferred Organization Expenses: Deferred organization expenses are being
amortized on a straight-line basis over five years.
G. Securities Transactions and Investment Income: Interest income is accrued
daily on both long-term bonds and short-term investments. Interest income also
includes net amortization from the purchase of fixed-income securities.
Transactions are recorded on the first business day following the trade
date. Realized gains and losses from security transactions are
determined and accounted for on the basis of identified cost.
2. FINANCIAL INSTRUMENTS
A. Derivative Financial Instruments Held or Issued for Purposes other than
Trading: The Fund uses interest rate futures contracts for risk management
purposes in order to reduce fluctuation of the Fund's net asset value
relative to its targeted option-adjusted duration. Upon entering into a
futures contract, the Fund is required to deposit either cash or securities
in an amount (initial margin) equal to a certain percentage of the contract
value. Subsequent payments (variation margin) are made or received by the
Fund each day. The variation margin payments are equal to the daily changes in
the contract value and are recorded as unrealized gains or losses. The Fund
recognizes a realized gain or loss when the contract is closed or expires
equal to the difference between the value of the contract at the time it was
opened and the value at the time it was closed.
Futures contracts involve costs and may result in losses. The effective use
of futures strategies depends on the Fund's ability to terminate futures
positions at times when the Fund's investment adviser deems it desirable to
do so. The use of futures also involves the risk of imperfect correlation
among movements in the values of the securities underlying the futures
purchased and sold by the Fund, of the futures contract itself, and of the
securities which are the subject of a hedge.
The Fund had the following open futures contracts as of March 31, 1995:
Principal Expiration Unrealized
Type Amount Position Month Gain/Loss
Eurodollar $1,000,000 Long September, 1995 $ 3,596
Eurodollar $2,000,000 Short September, 1996 (4,257)
Eurodollar $3,000,000 Short September, 1997 (2,814)
Eurodollar $3,000,000 Short September, 1998 (3,090)
Eurodollar $1,000,000 Short September, 1999 96
$ (6,469)
The aggregate market value of investments pledged to cover margin
requirements for the open positions at March 31, 1995 was $49,312.
B. Derivative Financial Instruments Held or Issued for Trading Purposes:
The Fund invests in a combination of Equity Swap Contracts and Futures
Contracts on the S&P 500 Index whose return is expected to track movements
in the S&P 500 Index.
The counterparty to an Equity Swap Contract will typically be a bank,
investment banking firm or broker/dealer. The counterparty will
generally agree to pay the Fund the amount, if any, by which the notional
amount of the Equity Swap Contract would have increased in value had it been
invested in the stocks comprising the S&P 500 Index in proportion to the
composition of the Index, plus the dividends that would have been received
on those stocks. The Fund will agree to pay to the counterparty a floating
rate of interest (typically the London Interbank Offered Rate plus a spread)
on the notional amount of the Equity Swap Contract plus the amount, if any,
by which that notional amount would have decreased in value had it been
invested in such stocks. Payments under the Equity Swap Contracts may be made
at the conclusion of the contract or periodically during its term. If there
is a default by the counterparty to an Equity Swap Contract, the Fund will
be limited to contractual remedies pursuant to agreements related to the
transaction. There is no assurance that Equity Swap Contract counterparties
will be able to meet their obligations pursuant to Equity Swap Contracts
or that, in the event of default, the Fund will succeed in pursuing
contractual remedies. The Fund thus assumes the risk that it may be delayed
in, or prevented from, obtaining payments owed to it pursuant to Equity Swap
Contracts. The Fund will closely monitor the credit quality of Equity Swap
Contract counterparties in order to minimize this risk.
The Fund had four open futures contracts on the S&P 500 Index as of March 31,
1995:
Principal Expiration Unrealized
Type Amount Position Month Gain
S&P 500 $1,010,740 Long June, 1995 $32,272
3. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES
Smith Breeden Associates, Inc. (the "Adviser"), a registered investment
adviser, provides the Fund with investment management services. As
compensation for these services, the Fund pays the Adviser a fee computed
daily and payable monthly, at an annual rate equal to 0.70% of the Fund's
average daily net asset value. The Adviser has voluntarily agreed to limit
the expenses of the Fund to 0.90% of the Fund's average daily net assets.
This voluntary agreement may be terminated or modified at any time by the
Adviser in its sole discretion, except that the Adviser has agreed to
limit expenses of the Fund to 0.90% through March 31, 1995. For the year
ended March 31, 1995, the Adviser received fees of $11,056 and reimbursed
the Fund $128,959.
Effective August 1, 1994, the Fund adopted a Distribution and Services
Plan (the "Plan") pursuant to Rule 12b-1 under the Investment Company Act
of 1940. The purpose of the Plan 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 Fund, reducing redemptions, or otherwise maintaining or
improving services provided to shareholders by such dealers or other
persons. The Plan provides for payments by the Adviser, out of its advisory
fee paid to it by the Fund, to dealers and other persons at the annual rate
of up to 0.25% of the Fund's average net assets subject to the authority
the Trustees of the Fund to reduce the amount of payments permitted under
the Plan or to suspend the Plan for such periods as they may determine.
Subject to these limitations, the amount of such payments and the purposes
for which they are made shall be determined by the Adviser.
Certain officers and trustees of the Fund are also officers and directors
of the Adviser.
4. INVESTMENT TRANSACTIONS
During the year ended March 31, 1995, purchases and proceeds from sales
of securities, other than short-term investments, aggregated $2,494,150
and $1,983,398, respectively. The cost of securities for federal income
tax purposes is $1,925,748. Net unrealized appreciation of investments,
equity swaps and futures contracts consists of:
Gross unrealized appreciation.......$140,750
Gross unrealized depreciation.......(35,822)
Net unrealized appreciation.........$104,928
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders,
Smith Breeden Market Tracking Fund of the Smith Breeden Trust:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of the Smith Breeden Market
Tracking Fund of the Smith Breeden Trust as of March 31, 1995, and
the related statements of operations and changes in net assets for
each of the years in the two-year period then ended and financial
highlights for each of the years in the two-year period then ended
and the period June 30, 1992 (commencement of operations)
to March 31, 1993. These financial statements and financial highlights
are the responsibility of the Fund's management. Our responsibility is
to express an opinion on these financial statements and financial
highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements
and financial highlights are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. Our procedures included
confirmation of securities owned at March 31, 1995 by correspondence
with the custodian. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights
present fairly, in all material respects, the financial position of
the Smith Breeden Market Tracking Fund of the Smith Breeden Trust as
of March 31, 1995, the results of its operations, the changes in net
assets, and financial highlights for the respective stated periods in
conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
May 12, 1995
