SMITH BREEDEN TRUST
SMITH BREEDEN MARKET TRACKING FUND
PROSPECTUS
August 1, 1995
100 Europa Drive, Suite 200
Chapel Hill, North Carolina 27514
(919) 967-7221
Smith Breeden Market Tracking Fund (the "Fund") is a series of
Smith Breeden Trust (the "Trust"), an open-end, diversified
management investment company managed by Smith Breeden
Associates, Inc. (the "Adviser"). The Fund's objective is to
provide a total return approximating the Standard & Poor's 500
Composite Stock Price Index (the "S&P 500 Index"). To achieve
its objective, the Fund will invest in Equity Swap Contracts
(defined below) and S&P 500 and other stock index futures
contracts as well as fixed income securities which are issued or
guaranteed by the U.S. Government, its agencies or
instrumentalities. The Fund also may invest a substantial
portion of its assets in fixed income securities that directly or
indirectly represent a participation in, or are collateralized by
and payable from, mortgage loans on real property. The Fund may
employ various hedging techniques in connection with its fixed
income investments. On occasion, the Fund may purchase
additional securities with borrowed funds which may result in a
leveraged capital structure. See "Investment Objective and
Policies -- Fixed Income Segment."
This Prospectus explains concisely what you should know before
investing in the Fund. Please read it carefully and keep it for
future reference. You can find more detailed information about
the Fund in the August 1, 1995 Statement of Additional
Information, as amended from time to time. For a free copy of
the Statement write to Fund/Plan Broker Services, Inc., #2 West
Elm Street, Post Office Box 874, Conshohocken, Pennsylvania
19428-0874, or call (800) 221-3138. The Statement has been filed
with the Securities and Exchange Commission and is incorporated
into this Prospectus by reference.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED
BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE
SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE
COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
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TABLE OF CONTENTS
Page
EXPENSE TABLE. . . . . . . . . . . . . . . . . . . 3
FINANCIAL HIGHLIGHTS . . . . . . . . . . . . . . . 4
INVESTMENT OBJECTIVE, POLICIES
AND RISK CONSIDERATIONS . . . . . . . . . . . . . 5
OTHER INVESTMENT PRACTICES AND
RISK CONSIDERATIONS . . . . . . . . . . . . . . . 10
MANAGEMENT OF THE FUND . . . . . . . . . . . . . . 12
PURCHASE AND REDEMPTION OF
SHARES. . . . . . . . . . . . . . . . . . . . . . 17
DISTRIBUTIONS AND TAXES. . . . . . . . . . . . . . 21
VALUATION OF FUND SHARES . . . . . . . . . . . . . 22
PERFORMANCE. . . . . . . . . . . . . . . . . . . . 22
DESCRIPTION OF THE TRUST . . . . . . . . . . . . . 23
APPENDIX A . . . . . . . . . . . . . . . . . . . . 25
This Prospectus is not an offering of the securities described
herein in any state in which the offering is unauthorized. No
sales representative, dealer or other person is authorized to
give any information or make any representations other than those
contained in this Prospectus.
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<PAGE>
EXPENSE TABLE
The purpose of this table is to assist an investor in
understanding the various costs and expenses, as a percentage of
net assets of the Fund, that a shareholder will bear in
connection with an investment in the Fund.
Shareholder Transaction Expenses
Maximum Sales Charge Imposed on Purchases
(as a percentage of offering price) NONE
Redemption Fees
(as a percentage of amount redeemed) NONE*
Annual Fund Operating Expenses
(as a percentage of average net assets)
Management Fees (a) 0.70%
Other Expenses
(after expense limitation) (a) 0.20%
Total Fund Operating Expenses -----
(after expense limitation) (a) 0.90%
___________________
* An additional service fee of $9 per transaction may be
imposed on redemptions executed by wire transfer.
(a) The Other Expenses and Total Fund operating expenses
shown in the table reflect an undertaking by the Adviser to bear
expenses of the Fund and/or waive its fees to the extent
necessary to limit Total Fund Operating Expenses to 0.90% through
March 31, 1996 and are estimates which are based upon Total Fund
Operating expenses for the fiscal year ended March 31, 1995.
Absent the expense limitation, estimated Management Fees, Other
Expenses and Total Fund Operating Expenses would be 0.70%, 7.05%
and 7.75%, respectively. For the year ending March 31, 1995,
actual Management Fees, Other Expenses and actual Total Fund
Operating Expenses were 0.70%, 0.20%, and 0.90% respectively,
reflecting the expense limitation.
(b) Pursuant to a distribution and services plan, the
Adviser may pay annual distribution and servicing fees of up to
0.25% of the Fund's net assets out of its management fee. See
"Purchase and Redemption of Shares -- Distribution and Services
Plan."
____________________
The following example illustrates the expenses that apply to a
$1,000 investment in the Fund over various time periods, assuming
(1) a 5% annual return and (2) redemption or no redemption at end
of each time period.
Year 1 Year 3 Year 5 Year 10
$ 9 $ 29 $ 50 $ 112
These examples are based on the annual operating expenses shown
in the table above and should not be considered a representation
of past or future expenses or performance.<PAGE>
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FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD)
The following selected per share data and ratios cover the period
from June 30, 1992, the date the Fund commenced operations,
through March 31, 1995 and are a part of the Fund's financial
statements which have been audited by Deloitte & Touche LLP,
independent auditors. The Fund's most recent annual audited
financial statements and the report of Deloitte & Touche LLP
thereon appear in the Fund's Statement of Additional Information.
This data should be read in conjunction with the financial
statements and notes thereto included in the Fund's Statement of
Additional Information.
FINANCIAL HIGHLIGHTS
Year Ended Year Ended Period 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) on
Investments, Equity
Swap 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
Before expense
reimbursement 7.75% 7.08% 28.48%*
After expense
reimbursement 0.90% 0.90% 0.57%*
Ratio of Net Income
to Average Net
Assets
Before expense
reimbursement 0.59% 1.84% (22.63%)*
After expense
reimbursement 7.44% 8.02% 5.28%*
Portfolio Turnover
Rate 120% 119% 271%
Additional performance information is presented in the Annual
Report for the Fund which will be made available without charge
upon request.
* Annualized<PAGE>
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INVESTMENT OBJECTIVE, POLICIES AND RISK CONSIDERATIONS
The Fund seeks to provide a total return approximating the
S&P 500 Index. Total return is a measure of investment
performance which includes all of the interest, dividends and
other income, net of expenses, paid on the Fund's investments, as
well as all realized and unrealized capital gains and losses.
For a description of how the total return of the Fund is
calculated, see "Performance". The S&P 500 Index is composed of
500 common stocks, most of which are listed on the New York Stock
Exchange. Standard & Poor's Corporation, which is not a sponsor
of or in any other way affiliated with the Fund, chooses the 500
stocks included in the S&P 500 Index on the basis of market value
and industry diversification. The S&P 500 Index assigns relative
values to the stocks included in the index, weighted according to
each stock's total market value relative to the total market
value of the other stocks included in the index.
The Fund seeks to achieve its objective by dividing its
portfolio into two separate segments. The Fund's first portfolio
segment, the "Equity Simulation Segment," will invest in a
combination of Equity Swap Contracts (described more fully
below), futures contracts on the S&P 500 stock index and on other
stock indices, including, but not limited to the New York Stock
Exchange ("S&P 500 and Other Stock Index Futures") and common
stocks whose return (before deducting allocated costs) is
expected to track movements in the S&P 500 Index. The Fund
expects its use of stock index futures other than S&P 500 Stock
Index Futures to be minimal. The Fund's second portfolio
segment, the "Fixed Income Segment," will seek a total return
greater than the aggregate costs of the Fund (including the costs
of the Equity Simulation Segment such as those relating to the
Equity Swap Contracts and S&P 500 and other Stock Index Futures)
by investing in fixed-income securities (and futures, options,
floors, caps and swaps related thereto). Hence, the Fixed Income
Segment will seek to generate income (consisting primarily of
interest income) and gains which exceed the expenses of operating
the entire Fund. As discussed more fully below, if the Equity
Simulation Segment produces capital appreciation or depreciation
for the Fund corresponding to movements of the S&P 500 Index in a
magnitude correlated to the Fund's total net assets, whether the
Fund outperforms or underperforms the S&P 500 Index will depend
on whether the total return on the Fixed Income Segment is
greater or is less than the Fund's expenses (including
transaction costs and the costs of the equity derivative
instruments held in the Equity Simulation Segment).
The investment objective of the Fund is not fundamental, and
may be changed without a vote of the majority of the shareholders
of the Fund. Shareholders will receive written notification at
least thirty days prior to any change in the Fund's investment
objective. If such a change in the investment objective of the
fund occurs, such changes may result in the Fund having
investment objectives different from the objectives which the
shareholders considered appropriate at the time of their
investment in the Fund.
Equity Simulation Segment
The Equity Simulation Segment will use equity swap contracts
whose return (before deducting the interest costs described
below) is expected to track closely the return of the S&P 500
Index ("Equity Swap Contracts"). The Equity Simulation Segment
may also invest in S&P 500 and Other Stock Index Futures and
common stocks whose returns are expected to have a high
correlation with the S&P 500 Index.
Equity Swap Contracts. 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 Inter Bank Offered Rate) 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. Therefore, the return to the Fund on
any Equity Swap Contract should be the gain or loss on the
notional amount plus dividends on the stocks comprising the S&P
500 Index (as if the Fund had invested the notional amount in
stocks comprising the S&P 500 Index) less the interest paid by
the Fund on the notional amount. The Fund will only enter into
Equity Swap Contracts on a net basis, i.e., the two parties'
obligations are netted out, with the Fund paying or
receiving, as the case may be, only the net
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amount of any payments. 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 the 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 of Equity Swap Contract counterparties
in order to minimize this risk.
The Fund may from time to time enter into the opposite side
of Equity Swap Contracts (i.e., where the Fund is obligated to
pay the increase (net of interest) or receive the decrease (plus
interest) on the S&P 500 Index) to reduce the amount of the
Fund's equity market exposure consistent with the Fund's
objective. These positions are sometimes referred to as "Reverse
Equity Swap Contracts".
S&P 500 Index Futures. The Equity Simulation Segment of the Fund
may also invest in S&P 500 and Other Stock Index Futures to the
extent necessary to cause the notional amount of its Equity Swap
Contracts (less the notional amount of Reverse Equity Swap
Contracts) plus the face amount of its S&P 500 and Other Stock
Index Futures plus the value of its common stocks to approximate
the Fund's total net assets.
S&P 500 and Other Stock Index Futures represent contracts to
buy an integral number of units of the S&P 500 Index or some
other stock index, including but not limited to the New York
Stock Exchange, at a specified future date at a price agreed upon
when the contract is made. Upon entering into a contract, the
Fund will be required to deposit with its custodian in a
segregated account in the name of the futures broker a specified
amount of cash or securities, generally not exceeding 5% of the
face amount of the contract. This amount is known as "initial
margin" and is in the nature of a performance bond or good faith
deposit on the contract which is returned to the Fund upon
termination of the futures contract, assuming all contractual
obligations have been satisfied. Subsequent payments, called
"variation margin" to and from the broker, will be made on a
daily basis as the price of the S&P 500 or Other Stock Index
fluctuates, making the position in the futures contract more or
less valuable, a process known as "marking to the market."
Positions in S&P 500 or Other Stock Index Futures may be
closed out only by entering into a futures contract sale on the
futures exchange on which the futures are traded. The liquidity
of the market in S&P 500 or Other Stock Index Futures could be
adversely affected by "daily price fluctuation limits"
established by the exchange which limit the amount of fluctuation
in the price of an S&P 500 or Other Stock Index Futures contract
during a single trading day. In such events, it may not be
possible for the Fund to close out its futures contract position,
and, in the event of adverse price movements, the Fund would
continue to be required to make daily cash payments of variation
margin.
Common Stocks. When S&P 500 or Other Stock Index Futures and/or
Equity Swap Contracts are overpriced relative to the common
stocks underlying the S&P 500 Index, the Fund may also invest
directly in the common stocks represented by the S&P 500 Index..
The Fund will generally not own all 500 issues, but will attempt
to purchase a basket of common stocks which, on average, are
expected to match movements in the S&P 500 Index. Subject to
limits on investment in other investment companies, the Fund may
also invest in these stocks indirectly by purchasing interests in
asset pools investing in such stocks. To the extent that the
Fund purchases interests in other investment companies,
shareholders of the Fund may be subject to a layering of expenses
because they may indirectly bear a proportionate share of the
expenses of such investment companies (including advisory fees)
in addition to bearing the direct expenses of the Fund.
Limitations on the Use of Equity Swap Contracts and S&P 500 Index
Futures. The Fund will invest in a combination of Equity Swap
Contracts, Reverse Equity Swap Contracts, S&P 500 or Other Stock
Index Futures and common stocks to achieve the same opportunity
and risk profile for the Equity Simulation Segment (disregarding
for this purpose the interest and other transaction costs
described above) as that of a
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hypothetical portfolio, equal in size to the Fund, invested in the
common stocks comprising the S&P 500 Index in proportion to their
respective weight in the S&P 500 Index. The Fund will not use
Equity Swap Contracts or S&P 500 Index Futures to leverage the Fund.
The Fund will not enter into any Equity Swap Contract or
Reverse Equity Swap Contract unless, at the time of entering into
such transaction, the unsecured senior debt of the counterparty
is rated at least A by Moody's Investors Service, Inc.
("Moody's") or Standard & Poor's Corporation ("S&P"). In
addition, the staff of the SEC considers Equity Swap Contracts
and Reverse Equity Swap Contracts to be illiquid securities.
Consequently, while the staff maintains this position, the Fund
will not invest in Equity Swap Contracts or Reverse Equity Swap
Contracts if, as a result of the investment, the total value of
such investments together with that of all other illiquid
securities which the Fund owns would exceed 15% of the Fund's
total assets.
The Adviser and the Fund do not believe that the Fund's
obligations under Equity Swap Contracts or Reverse Equity Swap
Contracts are senior securities, so long as a segregated account
is maintained, and, accordingly, the Fund will not treat them as
being subject to its borrowing restrictions. The net amount of
the excess, if any, of the Fund's obligations over its
entitlements with respect to each Equity Swap Contract and each
Reverse Equity Swap Contract will be accrued on a daily basis and
an amount of cash, U.S. Government Securities or other liquid
high quality debt securities having an aggregate market value at
least equal to the accrued excess will be maintained in a
segregated account by the Fund's custodian.
The Fund will not purchase S&P 500 or Other Stock Index
Futures, except for bona fide hedging purposes, if as a result
the Fund's aggregate initial margin deposits and premiums would
be greater than 5% of the Fund's total assets. In addition to
margin deposits, when the Fund purchases an S&P 500 or Other
Stock Index Futures Contract, it is required to maintain at all
times while the S&P 500 or Other Stock Index Future is held by
the Fund, cash, U.S. government securities or other liquid high
quality debt obligations in a segregated account with its
Custodian, in an amount which, together with the initial margin
deposit on the futures contract, is equal to the current delivery
or cash settlement value of the futures contract.
General. As indicated above, the Equity Simulation Segment of
the Fund's portfolio will seek to obtain the same opportunity and
risk profile (disregarding, for this purpose, the interest and
other transaction costs described above) as a hypothetical
portfolio, equal in size to the net asset value of the Fund,
invested in the stocks comprising the S&P 500 Index in proportion
to their respective weightings in the S&P 500 Index. This means,
for example, that if the Fund has total assets of $100 million,
the Equity Simulation Segment might: (1) enter into an Equity
Swap Contract with a notional amount of $50 million, (2) purchase
an S&P 500 Index Futures contract with a face amount of $45
million, and (3) purchase $5 million worth of common stocks
comprising the S&P 500 Index in proportion to their respective
weightings in the S&P 500 Index. The Fixed Income Segment would
invest $95 million in various fixed income assets with
appropriate hedging strategies. See "Fixed Income Segment." If,
during the course of the year, the stocks comprising the S&P 500
Index appreciate 10% on average and pay a 4% dividend, and if the
interest on the Equity Swap Contract's notional amount is 6%, at
the end of the year the counterparty to the equity swap contract
will be required to pay the Fund $4 million ($7 million
appreciation and dividends minus $3 million interest). The S&P
500 Index Futures contract should be closed out at a gain of $3.6
million (since the pricing of S&P 500 Futures carries an implicit
cost of carry) and the common stocks should now be worth $5.7
million. If, in addition, the Fund's total expenses (other than
brokerage expenses and the interest on the notional amount of the
Equity Swap contract as described above) is .90% of total net
assets (i.e., $0.9 million dollars), the Fund would achieve a
total return equal to the S&P 500 Index only if the Fixed Income
Segment has a total return equal to 6.9% per annum. If the Fixed
Income Segment achieves this result, then the Fund's total net
assets will be $114 million - an increase of 14% and a total
return equal to the S&P 500 Index. If the Fixed Income Segment's
total return is greater or less than 6.9% per annum, the Fund's
total return will be greater or less than the S&P 500 Index.
The Equity Simulation Segment's actual opportunities for
gain and risk of loss will tend to be greater than a
hypothetical portfolio invested in the stocks comprising the
S&P 500 Index if the aggregate of
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the notional amount of the Equity Swap Contracts (less the
notional amount of any Reverse Equity Swap Contracts) plus the
face amount of the S&P 500 or Other Stock Index Futures plus the
common stocks owned by the Fund exceeds the Fund's total
net assets and will tend to be smaller if such aggregate is less
than the Fund's total net assets. Under normal conditions, the
Fund expects the Fund's total net assets generally to be up to 5%
more or less than this aggregate because purchases and
redemptions of Fund shares will change the Fund's total net
assets frequently and because S&P 500 Index Futures can only be
purchased in integral multiples of the S&P 500 Index. Also, the
ability of the Equity Simulation Segment of the Fund's portfolio
to replicate the opportunity and risk profile (disregarding, for
this purpose, the interest and other transactional costs
described above) of a hypothetical stock portfolio may be
diminished by imperfect correlations between price movements of
the S&P 500 Index itself with price movements of S&P 500 Index
and Other Stock Index Futures and/or common stocks purchased by
the Fund. In addition, the purchase and sale of common stocks
and S&P 500 and Other Stock Index Futures involve transaction
costs and Equity Swap Contracts require the Fund to pay interest
on the notional amount of the contract. Therefore, if the
aggregate face amount of the S&P 500 and Other Stock Index
Futures, the notional amount of the Equity Swap Contracts (less
the notional amount of any Reverse Equity Swap Contracts) and the
value of the Equity Simulation Segment's common stocks is
precisely equal to the Fund's total net assets, and if there is
exact price movement correlation between the Fund's common stocks
and/or S&P 500 Index and Other Stock Index Futures and the S&P
500 Index, the Fund will outperform the S&P 500 Index only if the
total net return on the Fixed Income Segment of the Fund's
portfolio exceeds the sum of (1) the Equity Simulation Segment's
transaction costs on S&P 500 and Other Stock Index Futures and
common stock, (2) the interest payments under Equity Swap
Contracts and (3) all the other Fund expenses (e.g., management,
custodial, transfer agency, accounting and legal fees) which are
described more fully under "Management of the Fund."
Fixed Income Segment
The Fixed Income Segment will invest primarily in U.S.
Government Securities and other fixed income securities. While
these securities generally have maturities of up to 30 years, the
Fixed Income Segment will engage in various hedging strategies so
that it is expected that the Fixed Income Segment will have a
volatility similar to that of a one year Treasury Bill.
"U.S. Government Securities" are securities issued or
guaranteed as to principal and interest by the U.S. Government,
its agencies, authorities or instrumentalities and include
securities supported by the full faith and credit of the United
States, as well as those supported by the discretionary authority
of the U.S. Government to purchase the issuer's obligations,
those supported by the right of the issuer to borrow from the
United States Treasury and those supported only by the credit of
the issuing agency, authority or instrumentality itself. U.S.
Government Securities include conventional bills, notes and
bonds, as well as collateralized mortgage obligations ("CMOs")
and other mortgage-backed securities, adjustable rate securities,
IO/PO strips (defined below) and zero coupon securities,
described more fully below. The Fixed Income Segment may invest
substantially in FNMA, FHLMC and GNMA mortgage-backed
certificates and other U.S. Government Securities representing
ownership interests in mortgage pools.
In addition to investing in U.S. Government Securities, the
Fixed Income Segment may invest a portion of its assets in bank
certificates of deposit, corporate debt obligations and mortgage-
backed and other asset-backed securities of non-governmental
issuers. These investments generally involve credit risk, as
well as the risk (present with all fixed-income securities) of
fluctuations in value as market rates of interest change. To
reduce credit risk, however, the Segment's investments in fixed-
income securities will all, at the time of purchase, be either of
investment grade (as rated by S&P or by Moody's), or unrated but
determined by the Manager to be of a quality comparable to
obligations that are so rated. The lowest quality investment
grade fixed income securities are rated BBB by Moody's or Baa by
S&P and have certain speculative characteristics and are more
susceptible to adverse changes in circumstances and economic
conditions than higher rated fixed income securities. The
Adviser will monitor the Fund's investments in fixed income
securities and will cause the Fund to dispose of any such
security the rating of which is reduced to below investment
grade.
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Mortgage-Backed and Other Asset-Backed Securities. Interest and
principal payments (including prepayments) on the mortgages
underlying mortgage-backed securities are passed through to the
holders of the mortgage-backed security. Prepayments occur when
the mortgagor on an individual mortgage prepays the remaining
principal before the mortgage's scheduled maturity date. As a
result of the pass-through of prepayments of principal on the
underlying securities, mortgage-backed securities are often
subject to more rapid prepayment of principal than their stated
maturity would indicate. Because the prepayment characteristics
of the underlying mortgages vary, it is not possible to predict
accurately the realized yield or average life of a particular
issue of pass-through certificates. Prepayments are important
because of their effect on the yield and price of the securities.
During periods of declining interest rates, such prepayments can
be expected to accelerate and the Fund would be required to
reinvest the proceeds at the lower interest rates then available.
In addition, prepayments of mortgages which underlie securities
purchased at a premium could result in capital losses because the
premium may not have been fully amortized at the time the
obligation is prepaid. As a result of these principal payment
features, the values of mortgage-backed securities generally fall
when interest rates rise, but their potential for capital
appreciation in periods of falling interest rates is limited
because of the prepayment feature. In order to hedge against
possible prepayment the Fund may purchase certain options and
options on futures transactions as described more fully in
Appendix A. The mortgage-backed securities purchased by the Fund
may include adjustable rate instruments. See "Adjustable Rate
Securities" below.
The Fixed Income Segment may also invest in other mortgage-
backed and asset-backed securities, rated at least A by Moody's
or S&P such as securities backed by pools of automobile loans,
educational loans and credit card receivables. Asset-backed
securities of non-governmental issuers may involve prepayment
risks similar to those of U.S. Government guaranteed mortgage-
backed securities and also involve risk of loss of principal if
the obligers of the underlying obligations default in payment of
the obligations.
Collateralized Mortgage Obligations ("CMOs") A CMO is a security
backed by a portfolio of mortgages or mortgage-backed securities
held under an indenture. The issuer's obligation to make
interest and principal payments is secured by the underlying
portfolio of mortgages or mortgage-backed securities. CMOs are
issued with a number of classes or series which have different
maturities representing interests in some or all of the interest
or principal on the underlying collateral or a combination
thereof. CMOs of different classes are generally retired in
sequence as the underlying mortgage loans in the mortgage pool
are repaid. In the event of sufficient early prepayments on such
mortgages, the class or series of CMO first to mature generally
will be retired prior to its stated maturity. Thus, the early
retirement of a particular class or series of CMO held by the
Fixed Income Segment would have the same effect as the prepayment
of mortgages underlying a mortgage-backed pass-through security.
CMOs also include securities ("Residuals") representing the
interest in any excess cash flow and/or the value of any
collateral remaining after the issuer has applied cash flow from
the underlying mortgages or mortgage-backed securities to the
payment of principal of and interest on all other CMOs and the
administrative expenses of the issuer. Residuals have value only
to the extent income from such underlying mortgages or mortgage-
backed securities exceeds the amounts necessary to satisfy the
issuer's debt obligations represented by all other outstanding
CMOs.
Zero Coupon Securities, Strips and Residuals. The Fund may also
invest in "zero coupon" securities (which are issued at a
significant discount from face value and pay interest only at
maturity rather than at intervals during the life of the
security) or in certificates representing undivided interests in
payments of interest only or principal only ("IO/PO Strips") on
some other fixed income security (including asset-backed
securities). Zero coupon securities, IO/PO Strips and Residuals
tend to be more volatile than other types of securities. IO
Strips and Residuals also involve the additional risk of loss of
a substantial portion or the entire value of the investment if
the underlying securities are prepaid. In addition, if a CMO
bears interest at an adjustable rate, the cash flows on the
related Residual will also be extremely sensitive to the level of
the index upon which the rate adjustments are based.
The Fund is required to accrue and distribute income from
zero coupon securities on a current basis, even though the
Fund does not receive that income currently in cash.
Thus, the Fund may have to sell
-9-
other investments to obtain cash needed to make income
distributions, which may reduce the Fund's assets and may
thereby increase its expense ratio and decrease its rate of
return. Certain Residuals may involve similar consequences for
the Fund.
Adjustable Rate Securities. Adjustable rate securities are
securities that have interest rates that are reset at periodic
intervals, usually by reference to some interest rate index or
market interest rate. They may be U.S. Government Securities or
securities of other issuers rated at least A by Moody's or S&P.
Some adjustable rate securities are backed by pools of mortgage
loans. Although the rate adjustment feature may act as a buffer
to reduce sharp changes in the value of adjustable rate
securities, these securities are still subject to changes in
value based on changes in market interest rates or changes in the
issuer's creditworthiness. Because the interest rate is reset
only periodically, changes in the interest rates on adjustable
rate securities may lag changes in prevailing market interest
rates. Also, some adjustable rate securities (or the underlying
mortgages) are subject to caps or floors that limit the maximum
change in interest rate during a specified period or over the
life of the security. Because of the resetting of interest
rates, adjustable rate securities are less likely than non-
adjustable rate securities of comparable quality and maturity to
increase significantly in value when market interest rates fall.
Other Portfolio Strategies. In order to hedge its fixed income
securities, the Fixed Income Segment may engage in portfolio
strategies involving financial futures contracts and options on
securities eligible for purchase by the Fund. In order to hedge
against prepayment of mortgage-backed and other asset-backed
securities, the Fixed Income Segment may also purchase options on
financial futures contracts and on securities eligible for
purchase by the Segment. The Fixed Income Segment may also seek
to hedge against interest rate fluctuations by making short sales
of securities and by purchasing interest rate caps or floors or
by entering into interest rate swaps. See Appendix A for a more
detailed description of these portfolio strategies and the
associated risks.
OTHER INVESTMENT PRACTICES AND RISK CONSIDERATIONS
The Fund's Fixed Income Segment may also engage in the
following investment practices, each of which may involve certain
special risks. The Statement of Additional Information contains
more detailed information about these practices, including
limitations designed to reduce these risks.
Securities Loans, Repurchase Agreements and Forward Commitments
The Fund may lend portfolio securities to broker-dealers and
may enter into repurchase agreements. These transactions must be
fully collateralized at all times but involve some risk to the
Fund if the other party should default on its obligations and the
Fund is delayed or prevented from recovering the collateral. The
Fund may also purchase securities for future delivery, which may
increase its overall investment exposure and involves a risk of
loss if the value of the securities declines prior to the
settlement date.
Reverse Repurchase Agreements, Dollar Roll Agreements and
Borrowing
In order to increase the income of the Fixed Income Segment,
the Fund may enter into reverse repurchase agreements and dollar
roll agreements with commercial banks and registered broker-
dealers. Appendix A contains a more detailed explanation of
these practices. Reverse repurchase agreements and dollar rolls
are considered borrowings by the Fund and require segregation of
assets with the Fund's custodian in an amount equal to the Fund's
obligations pending completion of such transactions. The Fund
may also use reverse repurchase agreements and dollar rolls and
borrow money from banks in an amount up to 33 1/3% of the Fund's
total assets to realize investment opportunities, for
extraordinary or emergency purposes, or for the clearance of
transactions. Borrowing from banks usually involves certain
transaction and ongoing costs and may require the Fund to
maintain minimum bank account balances. Use of these borrowing
techniques to purchase securities is a speculative practice known
as "leverage." Depending on whether the performance of the
investments purchased with borrowed funds is sufficient to meet
the costs of borrowing, the Fund's net asset value per share will
increase or decrease, as the case may be, more rapidly than if
the Fund did not employ leverage.
-10-
Short Sales
The Fund may make short sales of securities. A short sale
is a transaction in which the Fund sells a security it does not
own in anticipation that the market price of that security will
decline. The Fund expects to make short sales both as a form of
hedging to shorten the overall duration of the portfolio and in
order to maintain portfolio flexibility.
When the Fund makes a short sale, it must borrow the
security sold short and deliver it to the broker-dealer through
which it made the short sale as collateral for its obligation to
deliver the security upon completion of the transaction. The
Fund may have to pay a fee to borrow particular securities and is
often obligated to pay over any payments received on such
borrowed securities.
Until the Fund replaces a borrowed security, it will
maintain daily a segregated account (not with the broker)
containing cash, U.S. Government securities, or other liquid
high-grade debt obligations, such that (i) the amount deposited
in the account plus any cash, U.S. Government securities or other
liquid high-grade debt obligations deposited with the broker as
collateral will equal the current value of the security sold
short and (ii) the amount deposited in the segregated account
plus the amount deposited with the broker as collateral will not
be less than the market value of the security at the time it was
sold short. Depending on arrangements made with the broker from
which it borrowed the security, the Fund may not receive any
payments (including interest) on collateral deposited with such
broker-dealer.
If the price of the security sold short increases between
the time of the short sale and the time the Fund replaces the
borrowed security, the Fund will incur a loss; conversely, if the
price declines, the Fund will realize a gain. Although the
Fund's gain is limited to the amount at which it sold the
security short, its potential loss is limited only by the maximum
attainable price of the security less the price at which the
security was sold. Unless market interest becomes negative, for
a fixed income security this maximum sales price is equal to the
undiscounted sum of the largest possible payments of principal
and interest.
The Fund will not make a short sale if, after giving effect
to such sale, the market value of all securities sold exceeds 25%
of the value of the Fund's total net assets. The Fund may also
effect sales "against the box" without respect to such
limitations. In this type of short sale, at the time of the
sale, the Fund owns or has the immediate and unconditional right
to acquire at no additional cost the identical security.
Illiquid Securities
The Fund may invest up to 15% of its net assets in
securities for which there are legal or contractual restrictions
on resale or for which there is no readily available market or
other illiquid securities, including non-terminable repurchase
agreements having maturities of more than seven days. See
"Investment Restrictions" in the Statement of Additional
Information. The Adviser will monitor the Fund's investments in
illiquid securities under the supervision of the Trustees. The
determination of whether certain IO/PO Strips issued by the U.S.
Government and backed by fixed rate mortgages or any other
securities in which the Fund desires to invest are liquid shall
be made by the Trustees or the Adviser under guidelines
established by the Trustees in accordance with applicable
pronouncements of the SEC. At present, all other IO/PO Strips,
other residual interests of CMO's and OTC options are treated as
illiquid securities. The SEC staff also currently takes the
position that the interest rate swaps, caps and floors discussed
in Appendix A, as well as Equity Swap Contracts and Reverse
Equity Swap Contracts, are illiquid. The Fund intends to conduct
its investment operations accordingly.
Portfolio Turnover
The Adviser buys and sells securities for the Fund whenever
it believes it is appropriate to do so. Portfolio turnover
generally involves some expense to the Fund, including brokerage
commissions or dealer mark-ups and other transaction costs on the
sale of securities and reinvestment in other securities. Such
transactions may result in realization of taxable capital gains.
The portfolio turnover rate for the last fiscal period is shown
in the Table under the heading "Financial Highlights".
-11-
While the Fund will pay commissions in connection with its
options and future transactions an possibly in relation to any
purchase of common stocks, most of the other securities in which
the Fund invests are generally traded on a "net" basis with
dealers acting as principals for their own account without a
stated commission. Nevertheless, high portfolio turnover may
involve correspondingly greater brokerage commissions and other
transaction costs which will be borne directly by the Fund.
Another potential consequence of high portfolio turnover is
that, if 30% or more of the Fund's gross income for a taxable
year were derived from gains from the sale or other disposition
of securities and certain other investments held for less than
three months, the Fund would not qualify as a regulated
investment company and, therefore, would be subject to corporate
income tax during that taxable year. The Adviser endeavors to
manage the investment composition of the Fund and to adjust the
portfolio turnover, if necessary, to ensure the Fund's treatment
as regulated investment company.
Fundamental Policies
Except for any policy explicitly identified as
"fundamental," the investment objective and policies of the Fund
described in this Prospectus may be changed without shareholder
approval. If there is a change in the Fund's investment
objective, shareholders should consider whether the Fund remains
an appropriate investment in light of their then current
financial position and needs.
The Fund is managed by Smith Breeden Associates, Inc., (the
"Adviser"), 7300 College Boulevard, Suite 430, Overland Park,
Kansas 66210, which provides investment advisory and portfolio
management services for the Trust pursuant to an Investment
Advisory Agreement. The Adviser also provides executive and
other personnel for management of the Fund. Pursuant to the
Trust's Agreement and Declaration of Trust, the Trustees
supervise the affairs of the Fund as conducted by the Adviser.
The Adviser also serves as the investment adviser and portfolio
manager to the other registered investment companies in the Smith
Breeden Family of Funds.
-12-
MANAGEMENT OF THE FUND
Trustees and Officers
The Trust's Trustees are responsible for deciding matters of
general policy and reviewing the actions of the Adviser,
distributor and transfer agent. The officers of the Trust are
elected by the Trustees and conduct and supervise the Fund's
daily
business operations. The Trust's trustees and officers are
identified below. The Trust's trustees also serve as trustees of
other mutual funds in the Smith Breeden Family of Funds.
BOARD OF TRUSTEES
AFFILIATED WITH
TRUSTEE ADVISER SINCE
Douglas T. Breeden* 1982
Dr. Breeden, the Chairman of the Board of Smith Breeden
Associates, co-founded the firm in 1982. Dr. Breeden has served on
business school faculties at Duke University, Stanford University and
the University of Chicago, and as a visiting professor at Yale
University and at the Massachusetts Institute of Technology. He
is the Editor of the Journal of Fixed Income. Dr. Breeden has
served as Associate Editor for five journals in financial economics,
and was elected to the Board of Directors of the American Finance
Association. He has published several well-cited articles in
finance and economics journals. He holds a Ph.D. in Finance from
the Stanford University Graduate School of Business, and a B.S.
in Management Science from the Massachusetts Institute of
Technology. Dr. Breeden taught in the Portfolio Management Program
at the Nomura School of Advanced Management in Tokyo from 1987
to 1992. He serves as Chairman of the Board for Roosevelt Bank of St.
Louis. He also serves as Chairman of Harrington Financial Group, the
holding company for Harrington Bank, F.S.B., of Richmond, Indiana.
Michael J. Giarla* 1985
Principal, Executive Vice President, Director and Chief Operating
Officer, Smith Breeden Associates, Inc., President, Smith Breeden
Family of Funds, Associate Editor, Journal of Fixed Income 1991-
1993. He has published several book chapters and articles regarding
mortgage-backed securities investments, risk management and
hedging. MBA with concentration in Finance, Arjay Miller Scholar,
Stanford University. BS in statistics, summa cum laude, Phi Beta
Kappa, Harvard Club of Boston Scholar, Harvard University.
Trustee, the Roxbury Latin School, Boston, MA.
Stephen M. Schaefer
Stephen M. Schaefer is Esmee Fairbairn Professor of Finance at
London Business School. Previously on the Faculty of the
Graduate School of Business of Stanford University, he has also
taught at the Universities of California (Berkeley), Chicago, British
Columbia and Venice. His research interests focus on capital
markets and financial regulation. He has served on the editorial
board of a number of professional journals including, currently,
the Journal of Fixed Income, the Review of Derivative Research
and Ricerche Economiche. He consults for a number of leading
financial institutions and is an Independent Board Member of
the Securities and Futures Authority of Great Britain.
Myron S. Scholes
Myron S. Scholes is the Frank E. Buck Professor of Finance at the
Graduate School of Business Stanford University (since 1983); a
Senior Research Fellow at the Hoover Institution (since 1987);
and is currently on leave as a Professor of Law, Stanford Law School.
He is a principal in the money management firm, Long-Term Capital
Management Co. (since 1993). He is a Research Associate of the
National Bureau of Economic Research and is a member of the
Econometric Society. Professor Scholes was also a managing director and co-
-13-
head of the fixed income derivatives group at Salomon Brothers
between 1991-1993. Prior to coming to Stanford University,
Professor Scholes was the Edward Eagle Brown Professor of Finance at
the Graduate School of Business, University of Chicago (1974-1983).
He served as the Director of the University of Chicago's Center for
Research in Security Prices from 1974-1980. Prior to coming to the
University of Chicago, Professor Scholes was first an Assistant
Professor then an Associate Professor at the Sloan School of
Management, at M.I.T. from 1968 to 1973. He received his PhD in
1969 from the Graduate School of Business, University of Chicago.
He has honorary Doctor of Law degrees from the University of Paris
and McMaster University. He is a past president of the American
Finance Association (1990).
Dr. Scholes has published numerous articles in academic journals
and in professional volumes. He is most noted as the
co-originator of the Black-Scholes Options Pricing Model as described
in a paper, "The Pricing of Options and Corporate Liabilities," published
in the Journal of Political Economy (May 1973) (with Fischer Black).
His other papers include such topics as risk-return relations, the
effects of dividend policy on stock prices, the effects of taxes
and tax policy on corporate decision making. His book with Mark
Wolfson (Stanford University) "Taxes and Business Strategy: A
Planning Approach" was published by Prentice Hall in 1991.
William F. Sharpe
William F. Sharpe is the STANCO 25 Professor of Finance at
Stanford University's Graduate School of Business. He is best known as
one of the developers of the Capital Asset Pricing Model, including
the beta and alpha concepts used in risk analysis and performance
measurement. He developed the widely-used binomial method for
the valuation of options and other contingent claims. He also
developed the computer algorithm used in many asset allocation
procedures. Dr. Sharpe has published articles in a number of
professional journals. He has also written six books, including
Portfolio Theory and Capital Markets, (McGraw-Hill, 1970), Asset
Allocation Tools, (Scientific Press, 1987), Fundamentals of
Investments (with Gordon J. Alexander and Jeffery Bailey,
Prentice-Hall, 1993) and Investments (with Gordon J. Alexander and
Jeffery Bailey, Prentice-Hall, 1995). Dr. Sharpe is a past President
of the American Finance Association. He has also served as
consultant to a number of corporations and investment organizations.
He is also a member of the Board of Trustees of Rosenberg Series
Trust, an investment company, and a director at CATS Software and
Stanford Management Company. He received the Nobel Prize in
Economic Sciences in 1990.
*Interested party
-14-
OFFICERS
Affiliated With
Officer Title Adviser Since
Douglas T. Breeden Chairman 1982
Michael J. Giarla President and Chief 1985
Executive Officer
John B. Sprow Vice President, 1987
Portfolio Manager
Portfolio Adviser for the Smith Breeden Market Tracking Fund,
Principal, Smith Breeden Associates, Inc. Mr. Sprow is the
trading co-ordinator for all client investments. He has been primarily
responsible for the day-to-day management of the Market Tracking
Fund since its inception in 1992. He currently advises three
mortgage securities portfolios. Previously was a research
assistant at Duke University and Cornell University. Earned an
MBA with a concentration in Finance, Duke University and a BS in
Materials Science and Engineering from Cornell University where
he was awarded the Carpenter Technology Scholarship for three
consecutive years.
Marianthe S. Mewkill Vice President, 1992
Secretary, Treasurer,
and Chief Accounting Officer
Principal, Smith Breeden Associates, Inc. She was previously
employed as a Controller for the Hunt Alternatives Fund and as an
Associate at Goldman Sachs & Co. and Senior Auditor at Arthur
Anderson & Co. She earned an M.B.A. with concentrations in
Finance and Accounting from New York University, and graduated
from Wellesley College, magna cum laude with a B.A. in History and
French, and a minor in Economics.
Investment Management
Smith Breeden Associates, Inc., Overland Park, Kansas 66210, a
registered investment adviser (the "Adviser"), acts as the
investment adviser to the Fund. The Adviser also serves as the
investment adviser to the other funds in the Smith Breeden Family
of Funds. Douglas T. Breeden, Chairman and President of the
Adviser, owns approximately 71% of the Adviser's voting stock, as
of March 31, 1995.
Under its Investment Advisory Agreement with the Fund, the
Adviser, subject to the general supervision of the Fund's Board of
Trustees, manages the Fund's portfolio and provides for the administration
of all of the Fund's other affairs. It is the responsibility of the
Adviser to place purchase and sale orders for the Fund's
portfolio transactions. John Sprow, a Principal of the Adviser, is the
portfolio manager for the Smith Breeden Market Tracking Fund, and
has been primarily responsible for the day-to-day investment
management of the Fund since its inception in 1992.
The Adviser has extensive experience providing investment advice
to financial institution, insurance, pension and charitable
foundation clients, particularly in the area of mortgage backed securities.
At March of 1995, the Adviser provided investment advice on a
discretionary and non-discretionary basis relating to over $10
billion in mortgage securities. The Adviser has provided such
services since 1982 with assets under management exceeding $1
billion since 1984.
A number of governmental agencies have engaged the Adviser to
provide risk analysis and portfolio management for mortgage
securities. The Federal Deposit Insurance Corporation, Federal
Savings and Loan Insurance Corporation, Resolution Trust
Corporation, Office of Thrift Supervision and various Federal
Home Loan Regional Banks have engaged the Adviser for various
securities-related projects. One of the most significant
governmental agency projects involved the disposition of CMO
residuals purchased by the former
-15-
Silverado Banking of Denver at an original cost exceeding $700 million.
The Adviser is currently advising the Federal Home Loan Bank of Boston
regarding a mortgage security portfolio exceeding $3 billion in assets.
None of the government project activity is included in the advisory assets
discussed above.
The Adviser was one of the first market participants to develop
effective option adjusted evaluation models. For over twelve
years, the Adviser has developed and traded on proprietary
mortgage prepayment projections. Such projections are available only to
advisory clients and, in contrast to prepayment projections
developed by securities firms, are not used for any broker
trading or arbitrage operations.
The principals and staff of the Adviser collectively have
accumulated over 100 years of experience analyzing and investing
in mortgage securities and controlling the related risks while in
the employ of the Adviser. Key employees of the Adviser who may
contribute investment ideas, research and analysis for the
benefit of the Fund and who are not officers or Trustees of the Fund
are:
Associated With
Adviser Since
Michael L. Bamburg 1986
Principal, Smith Breeden Associates, Inc. Mr. Bamburg assists
in analyzing, trading, designing, and hedging mortgage asset
portfolios for clients of Smith Breeden Associates. He
supervises client data for consistency and integrity. He also
supervises monthly analyses, including total rate of return,
mark-to-market net worth, spread income and hedge performance.
Mr. Bamburg is also involved in marketing Smith Breeden Associates'
mutual funds to institutional investors. Previously was a corporate
management associate with Volume Shoe Corporation, a division of
the May Company, and worked on a mortgage market study for
Citicorp. Earned an MBA and a BS with concentrations in Finance,
University of Kansas. Received the Ford Finance Scholarship for
graduate business studies at Kansas University.
Carl D. Bell 1991
Principal, Smith Breeden Associates, Inc. Mr. Bell develops
computer programs to value and hedge interest rate sensitive
securities and provides research support to the client service
and trading functions. Mr. Bell manages Smith Breeden's library of
analytical software and is active in the analysis and modeling of
mortgage prepayment behavior. Previously, Mr. Bell has been a
Staff Consultant at Andersen Consulting and a Research Assistant
with Putnam, Hayes & Bartlett. He received a Master of Business
Administration with a Concentration in Finance from the Fuqua
School of Business, Duke University, where he received the Hanes
Scholarship and was designated a Fuqua Scholar. Mr. Bell holds a
Bachelor of Science in Mathematics with a Minor in Industrial
Management from Carnegie Mellon University.
Craig J. Cerny 1985
Executive Vice President, Principal and Director of Smith
Breeden Associates, Inc. President of Harrington Financial Group,
the holding company for Harrington Bank, Richmond, Indiana.
He also serves as Chairman and CEO of Harrington Bank, FSB.
Mr. Cerny has made numerous presentations to financial institutions
and federal regulators regarding investments and risk management.
While with Smith Breeden, he has participated in trade and portfolio
analysis in support of the management of twenty-five mortgage
security portfolios. Previously was the Director of Financial
Planning/Analysis and Region Controller for field operations for
Pizza Hut, Inc., a division of Pepsico. Earned an MBA in Finance
with Distinction and BS in Finance, Honors Convocation from
Arizona State University.
-16-
Daniel C. Dektar 1986
Director of Trading, Executive Vice-President, Principal and
Director of Smith Breeden Associates, Inc. Mr. Dektar has been
primarily responsible for the day-to-day management of the Short
and Intermediate Series from their commencement of operations in
1992. Previously employed in investment banking capacities at
Morgan Stanley & Co. Earned an MBA with a concentration in
Finance, Arjay Miller Scholar, Stanford University, and a B.S. in
Business Administration, summa cum laude, Phi Beta Kappa, Phi Eta
Sigma, White Award as top student in finance and Regents Scholar
at the University of California at Berkeley.
Stephen A. Eason, C.F.A. 1988
Executive Vice President, Principal and Director of Smith Breeden
Associates, Inc. While with Smith Breeden, Mr. Eason has
participated in trade and portfolio decisions regarding the
management of twelve mortgage security portfolios. Previously,
Vice President-Institutional Sales, specializing in thrift mortgage
sales, at Salomon Brothers and Assistant Treasurer at Chase
Manhattan Bank., N.A. Earned an MBA with a concentration in
Finance, The Wharton School, a BS with highest honors in Business
Administration, University of Arkansas, and won the Wall Street
Journal Award as outstanding finance student.
Sharon E. Fankhauser 1986
Principal and Chief Financial Officer of Smith Breeden
Associates, Inc. Ms. Fankhauser handles financial reporting,
budgeting, tax research and planning for Smith Breeden Associates's
four offices. She ensures compliance with agency regulations and
administers the company's internal trading and other policies.
Previously was a Certified Public Accountant for Mayer Hoffman
McCann of Kansas City, Missouri. Earned an MBA with a
concentration in Accounting at California State University, and a BA
with honors in Sociology from Drake University. She was awarded
the Elijah Watts Sells Award for the top 100 candidates passing the
Certified Public Accountant Exam.
Lawrence E. Golaszewski 1987
Principal, Smith Breeden Associates, Inc. Mr. Golasweski
provides investment and risk management consulting services for
several institutional clients and mutual funds. He is actively involved
in the analysis, trading and hedging of complex mortgage securities.
His other special projects have included the analysis of a
proposed hedging program for two Southwest Plan thrifts, the analysis
and liquidation of a portfolio of complex mortgage securities, and
the comprehensive balance sheet analysis of a multi-billion dollar
savings bank for FDIC and OTS regional offices. Earned an MBA
with a concentration in Finance, University of Chicago and a BS in
Finance and Accounting, summa cum laude, New York State Regents
Scholar, State University of New York at Buffalo.
Gerald J. Madigan 1984
Executive Vice President, Principal and Director of Smith
Breeden Associates, Inc. President, Smith Breeden Mutual Funds 1992
to 1994. Chairman, Peoples Federal Savings Association, Richmond,
Indiana 1989 to 1992. Mr. Madigan has provided portfolio advice
to ten of Smith Breeden's financial institution clients. He oversaw
the disposition of the complex mortgage securities portfolio of
Silverado Banking. Previously employed by Touche Ross & Co. as
Senior Management Consultant, Hallmark Cards Incorporated, Arthur
Andersen & Co., Indiana University as an instructor, and Federal
Deposit Insurance Corporation. MBA, concentration in Finance,
with distinction from the Honors Program, Indiana University. BS in
Accounting with High Distinction, Indiana University. Phi Eta
Sigma, Beta Alpha Psi and Beta Gamma Sigma, Indiana University.
-17-
William F. Quinn 1986
Principal, Director of Client Services, Smith Breeden Associates,
Inc. Mr. Quinn provides investment and risk management advice to
a number of institutional clients. He specializes in the
analytical, trading, tax and accounting aspects of complex
mortgage securities and hedging instruments. He is actively involved in
the formulation and implementation of investment and risk management
policies and procedures as well as clients' strategic plans and
business plans. Earned an MS with concentrations in Finance, MIS
and System Dynamics, Sloan School of Management, M.I.T, and a BS
in Management Science from M.I.T.
Timothy D. Rowe 1988
Principal, Smith Breeden Associates. Mr. Rowe has expertise in
mortgage portfolio management, portfolio restructuring, financial
institution loan and deposit pricing, and the profitability of
branch operations. He currently advises three mortgage
securities portfolios and has advised three other mortgage security
portfolios. Previously was an Assistant Economist at the Federal
Reserve Bank of Richmond, Virginia. Earned an MBA with a
concentration in Finance, University of Chicago, a BA in
Economics and History, magna cum laude, Class Honors and National
Merit Scholar, Duke University.
For investment advisor, management and administration
services provided to the Fund, the Adviser receives a fee, computed daily
and payable quarterly, at the annual rate of 0.70% of the Fund's
average daily net assets. In addition to the advisory fee, the
Fund pays all expenses associated with its operations, including,
without limitation, fees and expenses paid to the Fund's
Independent Trustees, taxes, brokerage commissions, expenses of
issue or redemption of shares, fees and expenses of registering
and qualifying the Fund and its shares for distribution under federal
and state laws and regulations, charges of custodians, auditing,
tax preparation, tax consulting, and legal expenses, expenses of
determining net asset value of the Fund's shares, reports to
shareholders, expenses of meetings of shareholders, expenses of
printing and mailing prospectuses, proxy statements and proxies
to existing shareholders, and its insurance premiums. However,
until March 31, 1996, the Adviser has voluntarily agreed to reduce its
compensation and, to the extent necessary, absorb other expenses
of the Fund in order that expenses of the Fund (exclusive of
ordinary brokerage commissions, taxes and extraordinary expenses)
do not exceed 0.90% of the Fund's average net assets.
The Adviser places all orders for purchases and sales of the
Fund's securities. Subject to seeking the most favorable price
and execution available, the Adviser may consider sales of shares of
the Fund (and, if permitted by law, of other funds managed by the
Adviser) as a factor in the selection of broker-dealers.
Transfer Agent, Principal Underwriter and Custodian
Fund/Plan Services, Inc. ("Fund/Plan Services" or the
"Transfer Agent") serves as the Fund's transfer and dividend
disbursing agent and performs certain shareholder servicing
functions. In addition, Fund/Plan Services maintains certain
records of the Fund pursuant to an Accounting Services Agreement.
Fund Plan Broker Services, Inc., an affiliate of the Transfer
Agent, is the Fund's principal underwriter (the "Principal
Underwriter") for which it receives a fee of $5,000 per annum
paid by the Adviser under the Fund's Distribution and Services Plan
discussed below.
The Bank of New York acts as the custodian of the Fund's
assets. The Bank of New York's office is at 48 Wall Street, New
York, New York 10286.
-18-
PURCHASE AND REDEMPTION OF SHARES
Purchase of Fund Shares
Shares of the Fund may be purchased at their net asset value
(with no sales charge) on a continuous basis from the Fund. As
each payment is received, full and fractional shares of the Fund
will be purchased at the net asset value next computed and proper
entry will be made on the books of the Fund. The minimum initial
investment is $1,000 with a $50 minimum on subsequent
investments. Investments may be made by mail or wire.
Shares of the Fund may be purchased by mail by check or by
federal funds wire. Direct purchase orders received by the
Transfer Agent by 4:00 p.m., Eastern time, and accompanied by
check or wire are confirmed at that day's public offering price.
Direct purchase orders accompanied by check or wire transfer
received by the Transfer Agent after 4:00 p.m., Eastern time, are
confirmed at the public offering price next determined on the
following business day.
Shareholders should send federal funds wires to United
Missouri Bank, KC, N.A., ABA #10-10-00695, for credit to
Fund/Plan Services, Inc. A/C 98-7037-071-9, for further credit to:
Smith Breeden Market Tracking Fund (include shareholder name,
and shareholder account number). To obtain a new account number,
an investor should call the Transfer Agent at (800) 221-3137 by
12:00 noon, Eastern time.
Shares may be purchased through investment dealers who, as
part of the services they provide, must transmit orders promptly.
They may charge for these services. Wire orders for shares of
the Fund received by dealers prior to 4:00 p.m., Eastern time, and
received by the Transfer Agent before 7:00 p.m., Eastern time, on
the same day are confirmed at that day's net asset value. Orders
received by dealers after 4:00 p.m., Eastern time, are confirmed
at the net asset value on the following business day. It is the
dealer's obligation to place the order with the Transfer Agent
before 7:00 p.m., Eastern time.
The Fund and the Principal Underwriter reserve the right to
reject any order for the purchase of shares or to waive the
minimum
investment requirements. Subject to its stated investment
objective and policies, the Fund also reserves the right to issue
its shares in exchange for mortgage securities or other
securities
meeting its investment policies. The number of Fund shares to be
issued will equal the then current market value of the securities
acquired, divided by the Fund's next determined net asset value
per
share.
Shareholders will receive confirmation statements each time
there is a transaction which affects an account.
Share certificates will only be issued upon receipt of a
written request.
Telephone Transactions
The privilege to initiate telephone transactions by telephone
will be made available automatically to shareholders unless they
indicate they do not want the privilege by checking the
appropriate box on the Shareholder Account Application. The Fund
will employ reasonable procedures to ensure that instructions
communicated by telephone are genuine. These procedures include,
but are not limited to, recording telephone instructions and requesting
verification of account number, registration, and tax
identification number. In the event of a fraudulent telephone
transaction, the Fund will not be liable unless the Fund did not
employ reasonable procedures to ensure that the instructions were
genuine.
Automatic Investment Plan
The Plan provides a convenient method by which an investor
may have amounts deducted directly from his or her checking account
for investment in the Fund. The minimum initial and subsequent
investment pursuant to this plan is $50 per month.
-19-
Purchasing Shares of the Fund in Connection with Retirement Plans
Shares of the Fund may be used in a Fund-sponsored individual
retirement account ("IRA") providing for tax-deferred investments
for individuals. Shareholders wishing to establish an IRA
account should consult their tax advisor regarding 1) their individual
qualifying status, and 2) any current changes to the tax
regulations governing these accounts. A shareholder may hold
shares of the Fund in an IRA sponsored by the Fund for a $12.00
annual custodial fee. The Fund also may be used as an investment
for a variety of other retirement programs.
Purchases Through Securities Dealers
Shareholders can make a purchase through securities dealers
who, as part of the services they provide, must transmit orders
promptly. They may charge for these services.
Securities dealers and other firms provide varying
arrangements for their clients to purchase and redeem Fund
shares. Some may establish higher minimum investment
requirements than set forth above. Firms may arrange with their
clients for other investment or administrative services. Such firms
may independently establish and charge additional amounts to their
clients for such services, which charges would reduce the
clients' return. Firms also may hold Fund shares in nominee or
street name as agent for and on behalf of their customers. In such
instances, the Fund's transfer agent will have no information with
respect to or control over accounts of specific shareholders. Such
shareholders may obtain access to their accounts and information
about their accounts only from their brokerage firm. Certain of
these firms may receive compensation from the Fund's shareholder
service agent for recordkeeping and other expenses relating to
these nominee accounts. In addition, certain privileges with
respect to the purchase and redemption of shares or the
reinvestment of dividends may not be available through such
firms. Some firms may participate in a program allowing them access
to their clients' accounts for servicing including, without
limitation, transfers of registration and dividend payee changes,
and may perform functions such as generation of confirmation
statements and disbursement of cash dividends. This Prospectus
should be read in connection with such firms' material regarding
their fees and services.
Share Certificates
Shares for an initial investment as well as subsequent
investments, including the reinvestment of dividends and capital
gains distributions, are generally credited to an account in the
name of an investor on the books of the Series, without the
issuance of a share certificate. Maintaining shares in this
manner (also known as "plan balance") minimizes the risk of loss
or theft of a share certificate. A certificate will be issued if
requested in writing by the shareholder or by his broker.
Systematic Withdrawal Plan
A shareholder may establish a Systematic Withdrawal Plan
and receive regular periodic payments from the account. An initial
balance of $10,000 is required to establish an account under this
plan. There are no service charges for establishing or
maintaining a Systematic Withdrawal Plan. The minimum amount
which the shareholder may withdraw periodically is $100. Capital
gain distributions and income dividends to the shareholder's account
are received in additional shares at net asset value. Payments are
then made from the liquidation of shares at net asset value to
meet the specified withdrawals. Liquidation of shares may reduce or
possibly exhaust the shares in the shareholder's account, to the
extent withdrawals exceed shares earned through dividends and
distributions, particularly in the event of a market decline. No
payment pursuant to a Systematic Withdrawal Plan will be made if
there are insufficient shares on deposit on the date of the
scheduled distribution. A subsequent deposit of shares will not
result in a payment under the Systematic Withdrawal Plan
retroactive to the distribution date. As with other redemptions,
a liquidation to make a withdrawal payment is a sale for federal
income tax purposes. The entire Systematic Withdrawal Plan
payment cannot be considered as actual yield or income since part
of such a Systematic Withdrawal Plan payment may be a return of
capital.
A Systematic Withdrawal Plan may be terminated on written
notice by the shareholder or the Fund, and it will terminate
automatically if all shares are liquidated or withdrawn from the
account, or upon the Fund's receipt of notification of the death
or incapacity of the shareholder. Shareholders may change the
amount (but not below the specified minimums) and schedule of
withdrawal payments or suspend such payments by giving written
notice to the Transfer Agent at least seven business days
prior to the end of the month preceding a
-20-
scheduled payment. Share certificates may not be issued while a
Systematic Withdrawal Plan is in effect.
Exchange Privilege
Shares of the Fund may be exchanged for shares of any other
fund in the Smith Breeden Family of Funds which is eligible for
sale in the shareholder's state of residence. Because the
exchange is considered a redemption and purchase of shares, the
shareholder may recognize gain or loss for federal income tax
purposes. Backup withholding and information reporting may
also apply. Additional information regarding the possible tax
consequences of such an exchange is included under the caption
"Additional Information on Distributions and Taxation" in the
Statement of Additional Information.
There are differences among the funds in the Smith Breeden
Family of Funds. Before making an exchange, a shareholder should
obtain and review a current prospectus of the fund into which the
shareholder wishes to transfer. When exchanging shares,
shareholders should be aware that the funds may have different
dividend payment dates. The dividend payment schedules should be
checked before exchanging shares. The amount of any accumulated,
but unpaid dividend is included in the net asset value per share.
Exchanges will be effected upon receipt of written instructions
signed by all account owners and accompanied by any outstanding
share certificates properly endorsed. Exchanges out of any single
fund will be limited to four per calendar year. This limit does
not include reinvestment of dividends in a different fund.
Shareholders can elect to adopt the privilege to initiate
telephone exchanges from a fund into an identically registered
account in another fund. The Telephone Exchange Privilege is
available only for uncertificated shares. During periods of
drastic economic or market changes, it is possible that the
Telephone Exchange Privilege may be difficult to implement. In
this event, shareholders should follow the other exchange
procedures discussed in this section, including the procedures
for processing exchanges through broker/dealers. The Telephone
Exchange Privilege may be modified or discontinued by the Fund at
any time upon 60 days' notice to shareholders.
Exchanges Through Securities Dealers. As is the case with
all purchases and redemptions of the Fund's shares, the Fund will
accept exchange orders by telephone or other means of electronic
transmission from securities dealers who execute a dealer
agreement with the Principal Underwriter. Such a dealer-ordered
exchange will be effective only for uncertificated shares on deposit
in the shareholder's account or for which certificates have previously
been deposited. A securities dealer may charge a fee for
handling an exchange. The use of the exchange program may be
discontinued or modified by the Fund at any time upon 60 days' notice
to shareholders.
Distribution and Services Plan
The Trust has adopted a Distribution and Services Plan for
the Fund pursuant to Rule 12b-1 under the 1940 Act. 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 to dealers and other persons at the annual rate of up
to 0.25% of the Fund's average net assets, subject to the authority of
the Trustees 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. (Pursuant to the terms of the Plan the Adviser
currently pays the Principal Underwriter $5,000 per annum as
compensation for its distribution and servicing activities.)
Any distribution and servicing related payments made by the
Adviser to investment dealers or other persons are subject to the
continuation of the Plan, the terms of any related service
agreements, and any applicable limits imposed by the National
Association of Securities Dealers, Inc.
-21-
Redemption
1. By Telephone with Payment to a Pre-authorized Bank Account:
A shareholder may redeem shares by telephone to the Transfer
Agent. Redemption instructions telephoned to the Transfer Agent
must include the shareholder's name and account number.
Redemption proceeds will be mailed to the registered address;
payment may also be made by wire directly to any commercial bank
previously designated by the shareholder in a shareholder account
application. The Transfer Agent may accept telephone redemption
instructions from any person who has properly identified himself as
the owner of an account or the owner's broker where the owner has
not declined in writing to utilize this service. The Fund will employ
reasonable procedures to ensure that instructions communicated by
telephone are genuine. These procedures include, but are not
limited to, recording telephone instructions and written
confirmation of requests. The Fund may be liable for any losses
due to fraudulent or unauthorized instructions.
During periods of unusual economic or market changes, the
telephone redemption privilege may be difficult to implement.
Under such circumstances, shareholders should employ the
alternative redemption methods discussed in this section.
Redemptions by telephone are not available with respect to
shares for which certificates are outstanding.
2. By Mail:
A shareholder may redeem shares by sending a letter
requesting redemption to Fund/Plan Services, Inc., Post Office Box
874, Conshohocken, Pennsylvania 19428.
Redemption proceeds will be mailed to the shareholder's
registered address, or mailed or wired to a pre-authorized bank
account as requested. Proceeds of redemption may also be sent to
some other party or account as requested, however in such cases
the signature(s) on the redemption request must be guaranteed.
To be considered in proper form, the signature(s) of all
registered owners or previously designated signers must be
guaranteed if the redemption request involves any of the
following:
(1) the proceeds of the redemption are over $25,000;
(2) the proceeds (in any amount) are to be paid to someone
other than the registered owner(s) of the account;
(3) the proceeds (in any amount) are to be sent to any
address other than the address of record, pre-authorized
bank account or brokerage firm account; or
(4) share certificates, if the redemption proceeds are in
excess of $25,000.
Signatures must be guaranteed by an "eligible guarantor
institution" as defined in Rule 17Ad-15 under the Securities
Exchange Act of 1934. Eligible guarantor institutions include
banks, brokers, dealers, credit unions, national securities
exchanges, registered securities associations, clearing agencies
and savings associations. A broker-dealer guaranteeing
signatures must be a member of a clearing corporation or
maintain net capital of at least $100,000. Credit unions must
be authorized to issue signature guarantees. Signature guarantees
will be accepted from any eligible guarantor institution which
participates in a signature guarantee program. A notarized
signature will not be sufficient for the request to be in proper form.
Where shares to be redeemed are represented by share
certificates, the request for redemption must be accompanied by
the share certificate and a share assignment form signed by the
registered shareholders exactly as the account is registered,
with the signature(s) guarantee as referenced above. Shareholders
are advised, for their own protection, to send the share certificate
and assignment form in separate envelopes if they are being
mailed in for redemption.
-22-
Liquidation requests of corporate, partnership, trust,
custodianship accounts and accounts under court jurisdiction and
retirement plan accounts may require additional documentation to
be in proper form.
Please call Fund/Plan Services, Inc. at 1-800-221-3137 with
any questions about a proposed liquidation. Payment for redeemed
shares will be sent within seven days after receipt of a request
in proper form, except that the Fund may delay the mailing of the
redemption check, or a portion thereof, until the Fund's
depository banks has made fully available for withdrawal the check
used to purchase Fund shares, which may take up to 15 days or more.
Although the use of a certified or cashier's check will generally
reduce this delay, shares purchased with these checks will also
be held pending clearance. Shares purchased by federal funds wire
are available for immediate redemption (i.e., payments will be
transmitted by wire on the business day following receipt of a
request received prior to 4 p.m. Eastern time). In addition, the
right of a redemption may be suspended or the date of payment
postponed if the New York Stock Exchange is closed (other than
customary closing) or upon the determination of the SEC that
trading on the New York Stock Exchange is restricted or an
emergency exists, or if the SEC permits it by order for the
protection of shareholders. Of course, the amount you receive
may be more or less than your investment, depending on fluctuations
in the market value of securities owned by the Fund. Shareholders
will be charged a fee of $10 for redemptions by wire.
Selling Shares Through Securities Dealers
Shares of the Fund may also be sold by contacting your
securities dealer or investment firm (by telephone or in
writing). Securities dealers and investment firms that have entered
into a selling group agreement with the Fund's Principal Underwriter
can effect redemptions on the shareholder's behalf by telephone or
other expedited means at the net asset value next calculated
after receiving the shareholder's request in proper form. The
securities dealer or investment firm is responsible for prompt
transmission of redemption requests to the Series' Transfer Agent,
and may charge a fee for handling such requests.
Shareholder Inquiries
Any questions or communications regarding a shareholder's
account should be directed to Fund/Plan Services, Inc. at 1-800-
221-3137, Monday through Friday, from 9 a.m. to 7 p.m Eastern
time.
DISTRIBUTIONS AND TAXES
Distributions
The Fund pays out as dividends substantially all of its net
investment income (which comes from dividends and interest it
receives from its investments) and net realized capital gains.
All dividends and/or distributions will be paid in shares of
the Fund, at net asset value, unless the shareholder elects to
receive cash. The Fund declares and pays dividends out of
investment income quarterly, and distributes net realized capital
gains at least once annually. Dividends and capital gains
distributions may be declared more or less frequently at the
discretion of the Trustees.
Federal Income Taxes
The Fund intends to qualify as a "regulated investment
company" for federal income tax purposes and to meet all other
requirements that are necessary for it to be relieved of federal
income taxes on income and gains it distributes to shareholders.
The Fund will distribute annually substantially all of its
ordinary income and net capital gains on a current basis.
All Fund distributions will be taxable to you as ordinary
income, except that any distributions of net long-term capital
gains will be taxed as such, regardless of how long you have held
Fund shares. Distributions will be taxable as described above
whether received in cash or in shares through the reinvestment of
distributions.
Early in each year the Fund will notify you of the amount and
tax status of distributions paid to you by the Fund for the
preceding year.
-23-
The foregoing is a summary of certain federal income tax
consequences of investing in the Fund. You should consult your
tax adviser to determine the precise effect of an investment in the
Fund on your particular tax situation.
VALUATION OF FUND SHARES
The net asset value per share of the Fund is determined as of
the close of trading (currently 4:00 p.m. Eastern time) each day
that the Adviser and Transfer Agent are open for business and on
which there is a sufficient degree of trading in the Fund's
portfolio securities that the net asset value of the Fund's
shares might be affected. As of the date of this Prospectus, current
holiday schedules indicate net asset value will not be calculated
on the day after New Year's Day, Presidents' Day, Martin Luther
King Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Columbus Day, Veteran's Day, Thanksgiving Day, the day
following Thanksgiving, Christmas Eve and Christmas Day.
The net asset value per share of the Fund is determined in
the following manner: the aggregate of all liabilities, including
accrued expenses and taxes and any necessary reserves, are
deducted from the aggregate gross value of all assets, and the
difference is divided by the number of shares of the Fund
outstanding at the time. For the purposes of determining the
aggregate net assets of the Fund, cash and receivables will be valued
at their realizable amounts. Portfolio securities for which market
quotations are readily available are stated at market value. Interest
will be recorded as accrued. Under procedures approved by the
Board of Trustees, the securities in the Fund's portfolio are valued
at current market value provided by a pricing service, 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 following procedures
approved by the Board of Trustees.
PERFORMANCE
Total return data may from time to time be included in
advertisements about the Fund. "Total return" since inception
through the most recent calendar quarter represents the average
annual compounded rate of return on an investment in the Fund of
$1,000 at the net asset value at the beginning of the period.
Total return may also be presented for other periods. Quotations
of total return for any period when an expense limitation is in
effect will be greater than if the limitation had not been in
effect. The Fund's performance may be compared to the S&P 500
Index and other indices. See the Statement of Additional
Information.
All data is based on the Fund's past investment results and
does not predict future performance. Investment performance,
which will vary, is based on many factors, including market
conditions, the composition of the Fund's portfolio, and the Fund's
operating expenses. Investment performance also often reflects the
risks associated with the Fund's investment objective and policies.
These factors should be considered when comparing the Fund's
investment results to those of other mutual funds and other
investment vehicles.
DESCRIPTION OF THE TRUST
Smith Breeden Trust is a Massachusetts business trust
organized under an Agreement and Declaration of Trust, dated
December 18, 1991. A copy of the Trust's Agreement and
Declaration of Trust, which is governed by Massachusetts law, is
on file with the Secretary of State of The Commonwealth of
Massachusetts.
The Trust has authorized a single series with an unlimited
number of authorized shares representing beneficial interest in
the Fund. The Trust may create additional series of shares, each
of which will represent beneficial interest in a mutual fund other
than the Smith Breeden Market Tracking Fund. Each such series
of shares may also be further subdivided into classes. Each share
has one vote, with fractional shares voting proportionally. Shares
are freely transferable, are entitled to dividends as declared by the
Trustees, and, if the Fund were liquidated, would receive the net
assets of the Fund. Although the Trust is not required to hold
annual meetings of its shareholders, shareholders have the right
to call a meeting to elect or remove trustees, or to take other
actions as provided in the Declaration of Trust. Upon written
request by the holders of at least
-24-
1% of the outstanding shares stating that such shareholders wish
to communicate with the other shareholders for the purpose of
obtaining the signatures necessary to demand a meeting to
consider removal of a trustee, the Trust has undertaken to
provide a list of shareholders or to disseminate appropriate
materials (at the expense of the requesting shareholders).
-25-
<PAGE>
FUND INFORMATION
SMITH BREEDEN TRUST,
SMITH BREEDEN MARKET TRACKING FUND
100 Europa Drive, Suite 200
Chapel Hill, NC 27514
INVESTMENT ADVISER
Smith Breeden Associates, Inc.
7300 College Blvd., Suite 430
Overland Park, KS 66210
INVESTOR SERVICING,
DIVIDEND DISBURSING,
AND TRANSFER AGENT
Fund/Plan Services, Inc.
P.O. Box 8701
Conshohocken, PA 19428
CUSTODIAN
Bank of New York
48 Wall Street
New York, NY 10286
INDEPENDENT AUDITORS
Deloitte & Touche LLP
117 Campus Drive
Princeton, NJ 08540
LEGAL COUNSEL
Ropes & Gray
One International Place
Boston, MA 02110
PRINCIPAL UNDERWRITER
Fund Plan Broker Services, Inc.
#2 West Elm Street
P.O. Box 874
Conshohocken, PA 19428-0874<PAGE>
-26-
APPENDIX A
OTHER PORTFOLIO STRATEGIES (FIXED INCOME SEGMENT)
Options on Securities; Financial Futures and Options
In order to hedge against the possible prepayment of
securities underlying mortgage-backed and other asset-backed
securities, the Fund may purchase call options on those
securities in which the Fixed Income Segment may invest, including
options that are traded on securities exchanges and in the
over-the-counter market ("OTC Options"). The Fund will engage in
OTC Options transactions only with primary United States government
securities dealers recognized by the Federal Reserve Bank of New
York. The premiums paid on call options purchased and any related
transaction costs will increase the cost of securities acquired upon
exercise of the option, and, unless the price of the underlying security
rises sufficiently, the options may expire worthless to the Fund.
The Fund may also purchase options on financial futures contracts
for similar hedging purposes. In addition, the Fund may hedge
against changes in the values of Fixed Income Segment portfolio
securities by selling financial futures contracts.
In general, investment in futures contracts requires the Fund
to deposit with the applicable exchange or other specified
financial intermediary as security for its obligations an amount
of cash or other specified debt securities which initially is 1% to
5% of the face amount of the contract and which thereafter
fluctuates on a periodic basis as the value of the contract fluctuates.
Investment in options involves payment of a premium for the
option without any further obligation on the part of the Fund.
There is no overall limitation on the percentage of the
Fund's assets which may be subject to a hedge position.
Options and futures transactions involve certain special
risks, and may result in losses. The losses from investing in
futures are potentially unlimited. The effective use of options
and futures depends on the Fund's ability to terminate options
and futures positions at times when the Adviser deems it desirable to
do so. Although the Fund will take an option or futures contract
position only if the Adviser believes there is a liquid secondary
market for the option or futures contract, there is no assurance
that the Fund will be able to effect closing transactions at any
particular time or at an acceptable price.
The Fund's ability to hedge effectively all or a portion of
the Fixed Income Segment's securities through options and futures
transactions depends on the degree to which movements in the
prices of the security underlying the hedging instrument correlate with
movements in the prices of the hedging instrument or of the
portion of the Fixed Income Segment's securities being hedged. The
Fund therefore bears the risk that prices of hedged securities will
not move to the same degree as the hedging instrument or that price
movements in the hedging instrument will not accurately reflect
price movements in the security underlying the hedging
instrument. It is also possible that there may be a negative correlation
between the securities underlying the hedging instrument and the
hedged securities, which would result in a loss on both the
hedged securities and the hedging instrument.
At times, the Fund may sell interest rate futures in a
different dollar amount than the dollar amount of securities
being hedged depending on the expected relationship between the
volatility of the prices of such securities and the volatility of
the futures contracts, based on duration calculations by the
Adviser. If the actual price movements of the securities and
futures are inconsistent with their durations as so calculated,
the hedge may not be fully effective.
The Fund will not maintain open short positions in interest
rate futures contracts if, in the aggregate, the value of the
open positions (marked to market) exceeds the current market value
of its securities portfolio plus or minus the unrealized gain or
loss on those open positions, adjusted for the expected volatility
relationship between the portfolio and the futures contracts
based on duration calculations. If this limitation should be exceeded
at any time, the Fund will take prompt action to close out the
appropriate number of open contracts to bring its open futures
position into compliance with this limitation.
-27-
Interest Rate Caps, Floors and Swaps
The Fund may use interest rate caps and floors to hedge
against changes in the values of fixed income securities held by
the Fixed Income Segment. The purchase of an interest rate cap
entitles the purchaser, to the extent that a specific index
exceeds a specified interest rate, to receive payments of interest on a
notional principal amount from the party selling the interest
rate cap. The purchase of an interest rate floor entitles the
purchaser, to the extent that a specified index falls below a
specified interest rate, to receive payments of interest on a
notional principal amount from the party selling the interest
rate floor. Interest rate caps and floors involve the risk that the
other party will be unable to meet its payment obligations to the
Fund. The Fund will maintain in a segregated account with its
custodian cash or high-grade liquid assets in an amount at least
equal to its obligations, if any, under interest rate cap and
floor arrangements.
Interest rate swaps involve the exchange of the two parties'
respective commitments to pay or receive interest (e.g., an
exchange of floating rate payments for fixed rate payments). The
Fund may enter into interest rate swaps, on either an asset-based
or liability-based basis, depending on whether it is hedging its
assets or its liabilities, and will usually enter into interest
rate swaps on a net basis, i.e., the two payment streams are
netted out, with the Fund receiving or paying, as the case may be,
only the net amount of the two payments. Inasmuch as these
hedging transactions are entered into for good faith hedging
purposes, the Adviser and the Fund believe such obligations do not
constitute senior securities and, accordingly, will not treat them as
being subject to its borrowing restrictions. The net amount of the
excess, if any, of the Fund's obligations over its entitlement
with respect to each interest rate swap will be accrued on a daily
basis and an amount of cash or liquid high-grade debt securities
having an aggregate net asset value at least equal to the accrued
excess will be maintained in a segregated account by a custodian
that satisfies the requirements of the Investment Company Act. To
the extent that the Fund enters into interest rate swaps on other
than a net basis, the amount maintained in a segregated account
will be the full amount of the Fund's obligations, if any, with respect
to such interest rate swaps, accrued on a daily basis. The Fund
will not enter into any interest rate swap, cap or floor transaction,
unless the unsecured senior debt or the claims-paying ability of
the other party thereto is rated at least A by Moody's or S&P at
the time of entering into such transaction. If there is a default
by the other party to such a transaction, the Fund will have
contractual remedies pursuant to the agreement related to the
transaction. There is no assurance that interest rate swap, cap
or floor counterparties will be able to meet their obligations
pursuant to interest rate 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 interest
rate swaps, caps or floors. The Fund and Adviser will closely
monitor, subject to the oversight of the Portfolio's Board of
Trustees, the creditworthiness of the interest rate swap contract
counterparties in order to minimize risk.
The swap market has grown substantially in recent years with
a large number of banks and investment banking firms acting both
as principals and as agents utilizing standardized swap
documentation. As a result, the swap market has become relatively
liquid, although the Fund still treats swaps as illiquid investments
subject to the limitation on such investments described in the
Prospectus at "Other Investment Practices - Illiquid Securities."
Caps and floors are more recent innovations for which standardized
documentation has not yet been developed and, as a result, are
less liquid than swaps. Caps and floors are accordingly also
considered to be illiquid investments subject to the same limitation.
Reverse Repurchase Agreements and Dollar Roll Agreements
The Fixed Income Segment may enter into reverse repurchase
agreements and dollar roll agreements with commercial banks and
registered broker-dealers to seek to enhance returns.
Reverse repurchase agreements involve sales by 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.
During the reverse repurchase agreement period, the Fund continues
to receive principal and interest payments on these securities and
also has the opportunity to earn a return on the collateral
furnished by the counterparty to secure its obligation to
redeliver the securities.
-28-
Dollar rolls are transactions in which the Fund sells
securities for delivery in the current month and simultaneously
contracts to repurchase substantially similar (same type and
coupon) securities on a specified future date. During the roll
period, the Fund forgoes principal and interest paid on the
securities. The Fund is compensated by the difference between the
current sales price and the forward price for the future purchase
(often referred to as the "drop") as well as by the interest
earned on the cash proceeds of the initial sale.
The Fund will establish a segregated account with its
custodian in which it will maintain cash, U.S. Government
securities or other liquid high grade debt obligations equal in
value to its obligations in respect of reverse repurchase
agreements and dollar rolls. Reverse repurchase agreements and
dollar rolls involve the risk that the market value of the
securities retained by the Fund may decline below the price of
the securities the Fund has sold but is obligated to repurchase under
the agreement. In the event the buyer of securities under a
reverse repurchase agreement or dollar roll files for bankruptcy or
becomes insolvent, the Fund's use of the proceeds of the agreement
may be restricted pending a determination by the other party or its
trustee or receiver, whether to enforce the Fund's obligation to
repurchase the securities. Reverse repurchase agreements and
dollar rolls are considered borrowings by the Fund.
OTHER PORTFOLIO STRATEGIES
(EQUITY SIMULATION SEGMENT)
Any investment in warrants, valued at the lower of cost of
market, may not exceed 5.0% of the value of the Fund's net assets.
Included within that amount, but not to exceed 2.0% of the value of
the Fund's net assets, may be warrants which are not listed on the
New York or American Stock Exchange. Warrants acquired by the Fund
in units or attached to securities may be deemed to be without value.
-29-
<PAGE>
SMITH BREEDEN TRUST
SMITH BREEDEN MARKET TRACKING FUND
STATEMENT OF ADDITIONAL INFORMATION
August 1, 1995
This statement of Additional Information contains information
which may be useful to investors and is not included in the
Prospectus of Smith Breeden Market Tracking Fund. This Statement
is not a Prospectus and is only authorized for distribution when
accompanied or preceded by the Prospectus of the Fund dated
August 1, 1995, as may be amended from time to time. The
Statement should be read together with the Prospectus.
TABLE OF CONTENTS
Page
DEFINITIONS . . . . . . . . . . . . . . . . . . . . . . . . . 2
INVESTMENT RESTRICTIONS OF THE FUND. . . . . . . . . . . . . . 2
MISCELLANEOUS INVESTMENT PRACTICES AND
RISK CONSIDERATIONS . . . . . . . . . . . . . . . . . . . . 5
TAXES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
FUND CHARGES AND EXPENSES. . . . . . . . . . . . . . . . . . . 8
MANAGEMENT OF THE FUND . . . . . . . . . . . . . . . . . . . . 9
THE INVESTMENT ADVISORY AGREEMENT AND OTHER SERVICES . . . . . 10
PRINCIPAL HOLDERS OF SECURITIES AND CONTROLLING PERSONS. . . . 13
DETERMINATION OF NET ASSET VALUE . . . . . . . . . . . . . . . 14
ADDITIONAL INFORMATION REGARDING PURCHASES
AND REDEMPTIONS OF FUND SHARES . . . . . . . . . . . . . 15
SHAREHOLDER INFORMATION. . . . . . . . . . . . . . . . . . . . 16
SUSPENSION OF REDEMPTIONS. . . . . . . . . . . . . . . . . . . 16
SHAREHOLDER LIABILITY. . . . . . . . . . . . . . . . . . . . . 16
STANDARD PERFORMANCE MEASURES. . . . . . . . . . . . . . . . . 17
INDEPENDENT AUDITORS . . . . . . . . . . . . . . . . . . . . 19
EXPERTS. . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
REPORT OF INDEPENDENT AUDITORS AND FINANCIAL STATEMENTS. . . . 19
-1-
<PAGE>
SMITH BREEDEN TRUST,
SMITH BREEDEN MARKET TRACKING FUND
Statement of Additional Information
DEFINITIONS
The "Trust" -- Smith Breeden Trust
The "Fund" -- Smith Breeden Market Tracking Fund, a series
of the Trust offering its shares to the
public.
The "Adviser" -- Smith Breeden Associates, Inc., the Fund's
investment adviser.
The "Custodian"-- The Bank of New York, the Fund's
custodian.
"Fund/Plan
Services" -- Fund/Plan Services, Inc., the Fund's investor
servicing agent.
INVESTMENT RESTRICTIONS OF THE FUND
Subject to the Fund's ability to invest all or substantially all
of its assets in another investment company with substantially
the same investment objective, as fundamental investment
restrictions, which may not be changed without a vote of a
majority of the outstanding voting securities, the Fund may not
and will not:
1. Issue senior securities, borrow money or pledge its assets,
except that the Fund may borrow from banks or through reverse
repurchase agreements or dollar rolls up to 33 1/3% of the value
of its respective total assets (calculated when the loan is made)
for temporary, extraordinary or emergency purposes and to take
advantage of investment opportunities and may pledge up to 33
1/3% of the value of its total assets to secure such borrowings.
For purposes of this restriction, the purchase or sale of
securities on a "when-issued" or delayed delivery basis, the
purchase and sale of futures contracts, the entry into forward
contracts, reverse repurchase agreements and dollar roll
transactions, short sales, interest rate caps, floors and swaps,
mortgage swaps, and collateral arrangements with respect thereto
and such other practices as may be determined by counsel to the
Fund (consistent with pronouncements of the Securities and
Exchange Commission) are not deemed to be a pledge of assets and
-2-
none of such transactions or arrangements nor obligations of the
Fund to Trustees pursuant to deferred compensation arrangements
are deemed to be the issuance of a senior security.
2. Act as underwriter except to the extent that, in connection
with the disposition of portfolio securities, it may be deemed to
be an underwriter under certain federal securities laws.
3. Purchase any security (other than obligations of the U.S.
Government, its agencies and instrumentalities) if as a result
25% or more of the Fund's total assets (determined at the time of
investment) would be invested in one or more issuers having their
principal business activities in the same industry.
4. Purchase any security, other than mortgage-backed securities,
obligations of the U.S. Government, its agencies or
instrumentalities or collateralized mortgage obligations, if as a
result the Fund would have invested more than 5% of its
respective total assets in securities of issuers (including
predecessors) having a record of less than three years of
continuous operation.
5. Acquire, sell, lease or hold real estate or real estate
limited partnerships, except that it may invest in securities of
companies which deal in real estate and in securities
collateralized by real estate or interests therein and it may
acquire, sell, lease or hold real estate in connection with
protecting its rights as a creditor.
6. Purchase or sell commodities or commodity contracts, except
that the Fund may purchase and sell financial futures contracts
and options thereon. (Does not include caps, floors, collars or
swaps.)
7. Invest in interests in oil, gas, mineral leases or other
mineral exploration or development program.
8. Invest in companies for the purpose of exercising control or
management.
9. Purchase securities of other investment companies, except to
the extent permitted by the Investment Company Act.
10. Make loans of money or property to any person, except
through loans of portfolio securities to qualified institutions,
the purchase of debt obligations in which the Fund may invest
consistently with its investment objectives and policies and
investment limitations or the investment in repurchase agreements
with qualified institutions. The Fund will not lend portfolio
securities if, as a result, the aggregate of such loans exceeds
33 1/3% of the value of the Fund's total assets (including such
loans).
-3-
11. Purchase securities on margin (but the Fund may obtain such
short-term credits as may be necessary for the clearance of
transactions); provided that the deposit or payment by the Fund
of initial or variation margin in connection with options or
futures contracts is not considered the purchase of a security on
margin.
12. Make short sales of securities or maintain a short position
if, when added together, more than 25% of the value of the Fund's
net assets would be (i) deposited as collateral for the
obligation to replace securities borrowed to effect short sales,
and (ii) allocated to segregated accounts in connection with
short sales. Short sales "against-the-box" are not subject to
this limitation.
It is contrary to the Fund's present policy, which may be changed
without shareholder approval, to:
(a) sell over-the-counter options which it does not own;
(b) sell options on futures contracts which options it does not
own; or
As noted in the Prospectus, the Fund may invest up to 15% of its
total net assets in illiquid securities.
In order to comply with certain "blue sky" restrictions, the Fund
will not, as a matter of operating policy, invest in securities
of any issuer if, to the knowledge of the Fund, any officer or
Trustee of the Fund or the Fund's Adviser owns more than one half of 1%
of the outstanding securities of such issuer, and such officers
and Trustees who own more than one half of 1% own in the aggregate more
than 5% of the outstanding securities of such issuer.
All percentage limitations on investments will apply at the
time of the making of an investment and shall not be considered
violated unless an excess or deficiency occurs or exists
immediately after and as a result of such investment.
The Investment Company Act of 1940 provides that a "vote of
a majority of the outstanding voting securities" of the Fund
means the affirmative of the lesser of (1) more than 50% of the
outstanding shares of the Fund, or (2) 67% or more of the shares
present at a meeting if more than 50% of the outstanding shares
are represented at the meeting in person or by proxy.
-4-
MISCELLANEOUS INVESTMENT PRACTICES AND RISK
CONSIDERATIONS
The Fund's Prospectus states that the Fund may engage in
each of the following investment practices. However, the fact
that the Fund may engage in a particular practice does not
necessarily mean that it will actually do so.
Repurchase Agreements
The Fixed Income Segment may invest in repurchase
agreements. A repurchase agreement is a contract under which the
Fund acquires a security for a relatively short period (usually
not more than one week) subject to the obligation of the seller
to repurchase and the Fund to resell such security at a fixed
time and price (representing the Fund's cost plus interest). It
is the Fund's present intention to enter into repurchase
agreements only with commercial banks and registered broker-
dealers and only with respect to obligations of the U.S.
government or its agencies or instrumentalities. Repurchase
agreements may also be viewed as loans made by the Fund which are
collateralized by the securities subject to repurchase. The
Adviser will monitor such transactions to determine that the
value of the underlying securities is at least equal at all times
to the total amount of the repurchase obligation, including the
interest factor. If the seller defaults, the Fund could realize
a loss on the sale of the underlying security to the extent that
the proceeds of sale including accrued interest are less than the
resale price provided in the agreement including interest. In
addition, if the seller should be involved in bankruptcy or
insolvency proceedings, the Fund may incur delay and costs in
selling the underlying security or may suffer a loss of principal
and interest if the Fund is treated as an unsecured creditor and
required to return the underlying collateral to the seller's
estate.
Forward Commitments
The Fixed Income Segment may enter into contracts to
purchase securities for a fixed price at a future date beyond
customary settlement time ("forward commitments" and "when
issued" and "delayed delivery" securities) if the Fund holds
until the settlement date, in a segregated account, cash or high-
grade debt obligations in an amount sufficient to meet the
purchase price, or if the Fund enters into offsetting contracts
for the forward sale of other securities it owns. Forward
commitments may be considered securities in themselves, and
involve a risk of loss if the value of the security to be
purchased declines prior to the settlement date. Where such
purchases are made through dealers, the Fund relies on the dealer
to consummate the sale. The dealer's failure to do so may result
in the loss to the Fund of an advantageous return or price.
Although the Fund will generally enter into forward commitments
with the intention of acquiring securities for its portfolio or
for delivery pursuant to options contracts it has entered into,
the Fund may dispose of a commitment prior to settlement if the
Adviser deems it appropriate to do so. The Fund may realize
short-term profits or losses upon the sale of forward
commitments.
-5-
Securities Loans
The Fund may make secured loans of Fixed Income Segment
securities amounting to not more than 33 1/3% of the Fund's total
assets thereby realizing additional income. The risks in lending
portfolio securities, as with other extensions of credit, consist
of possible delay in recovery of the securities or possible loss
of rights in the collateral should the borrower fail financially.
As a matter of policy, securities loans are made to broker-
dealers pursuant to agreement requiring that loans be
continuously secured by collateral in cash or short-term debt
obligations at least equal at all times to the value of the
securities on loan. The borrower pays to the Fund an amount
equal to any dividends or interest received on securities lent.
The Fund retains all or a portion of the interest received on
investment of the cash collateral or receives a fee from the
borrower. Although voting rights, or rights to consent, with
respect to the loaned securities pass to the borrower, the Fund
retains the right to call the loans at any time on reasonable
notice, and it will do so in order that the securities may be
voted by the Fund if the holders of such securities are asked to
vote upon or consent to matters materially affecting the
investment. The Fund may also call such loans in order to sell
the securities involved.
Borrowing
The Fixed Income Segment may borrow from banks and enter
into reverse repurchase agreements or dollar rolls (as described
in Appendix A of the Prospectus) up to 33 1/3% of the value of
the Fund's total assets (computed at the time the loan is made)
to take advantage of investment opportunities and for
extraordinary or emergency purposes, or for the clearance of
transactions. The Fund may pledge up to 33 1/3% of its total
assets to secure these borrowings. If the Fund's asset coverage
for borrowings falls below 300%, the Fund will take prompt action
to reduce its borrowings even though it may be disadvantageous at
that time from an investment point of view. The Fund will incur
borrowing costs when it leverages, including payment of interest
and any fee necessary to maintain a line of credit, and may be
required to maintain a minimum average balance. If the income and
appreciation on assets acquired with borrowed funds exceed their
borrowing cost, the Fund's investment performance will increase,
whereas if the income and appreciation on assets acquired with
borrowed funds are less than their borrowing costs, investment
performance will decrease. In addition, if the Fund borrows to
invest in securities, any investment gains made on the securities
in excess of the costs of the borrowing, and any gain or loss on
hedging, will cause the net asset value of the shares to rise
faster than would otherwise be the case. On the other hand, if
the investment performance of the additional securities purchased
fails to cover their cost (including any interest paid on the
money borrowed) to the Fund, the net asset value of the Fund's
shares will decrease faster than would otherwise be the case.
This speculative characteristic is known as "leverage."
-6-
TAXES
Taxation of the Fund
The Fund intends to qualify each year as a regulated
investment company under Subchapter M of the Internal Revenue
Code of 1986, as amended (the "Code"). In order so to qualify
and to qualify for the special tax treatment accorded regulated
investment companies and their shareholders, the Fund must, among
other things:
(a) Derive at least 90% of its gross income from dividends,
interest, payments with respect to certain securities loans, and
gains from the sale of stock, securities and foreign currencies,
or other income (including but not limited to gains from options,
futures, or forward contracts) derived with respect to its
business of investing in such stock, securities, or currencies;
(b) derive less than 30% of its gross income from gains from the
sale or other disposition of certain assets (including
securities) held for less than three months;
(c) distribute with respect to each taxable year at least 90% of
its taxable and tax-exempt income for such year; and
(d) diversify its holdings so that, at the end of each fiscal
quarter (i) at least 50% of the market value of the Fund's assets
is represented by cash and cash items, U.S. Government
securities, securities of other regulated investment companies,
and other securities limited in respect of any one issuer to a
value not greater than 5% of the value of the Fund's total assets
and 10% of the outstanding voting securities of such issuer, and
(ii) not more than 25% of the value of its assets is invested in
the securities (other than those of the U.S. Government or other
regulated investment companies) of any one issuer or of two or
more issuers which the Fund controls and which are engaged in the
same, similar, or related trades or businesses.
Qualification as a regulated investment company exempts the
Fund from federal income tax on income paid to its shareholders
in the form of dividends (including capital gain dividends). A
dividend paid to shareholders by the Fund in January of a year
generally is deemed to have been paid by the Fund on December 31
of the preceding year, if the dividend was declared and payable
to shareholders of record on a date in October, November or
December of that preceding year.
If the Fund failed to qualify as a regulated investment
company accorded special tax treatment in any taxable year, the
Fund would be subject to tax on its taxable income at corporate
rates, and could be required to recognize unrealized gains, pay
substantial taxes and interest and make substantial distributions
before requalifying as a regulated investment company that is
accorded special tax treatment.
-7-
If the Fund fails to distribute in a calendar year
substantially all of its ordinary income for such year and
substantially all of its net capital gain for the year ending
October 31 (or later if the Fund is permitted so to elect and so
elects), plus any retained amount from the prior year, the Fund
will be subject to a 4% excise tax on the undistributed amounts.
The Fund intends generally to make distributions sufficient to
avoid imposition of the 4% excise tax. In calculating its
income, the Fund must include dividends in income not when
received but on the date when the stock in question is acquired
or becomes ex-dividend, whichever is later. Also, a portion of
the yield on certain high yield securities (including certain
payment-in-kind bonds) issued after July 10, 1989 may be treated
as dividends.
Return of capital distributions
If the Fund makes a distribution to you in excess of its
current and accumulated "earnings and profits" in any taxable
year, the excess distribution will be treated as a return of
capital to the extent of your tax basis in your shares, and
thereafter as capital gain. A return of capital is not taxable,
but it reduces your tax basis in your shares.
FUND CHARGES AND EXPENSES
Management Fees
The Fund pays a monthly fee to the Adviser based on the
average net assets of the Fund, as determined at the close of
each business day during the month, at an annual rate of 0.70%.
Advisory fees paid for the fiscal year ended March 31, 1995 were
$11,056. Advisory fees paid from inception, June 30, 1992
through March 31, 1995 were $18,372. The amounts paid in prior
fiscal years reflect the previous advisory contract rate of 0.35%
of average net assets. During the three-year period ended March
31, 1995, the Adviser reimbursed the Fund in aggregate $345,325
under expense limitation provisions.
Other Expenses
The Fund pays its own expenses, including, but not limited
to auditing, legal, tax preparation and consulting, insurance,
custodial, accounting, shareholder servicing and shareholder
report expenses. Fees paid to Fund/Plan Services which serves as
the Fund's shareholder servicing and accounting agent are
determined by contract as approved by the Board of Trustees.
-8-
MANAGEMENT OF THE FUND
The Board of Trustees has the responsibility for the overall
management of the Fund, including general supervision and review
of its investment activities. The Trustees, in turn, elect the
officers of the Fund who are responsible for administering the
day-to-day operations of the Fund. Trustees and officers of the
Fund are identified in the Prospectus.
All of the Trustees are Trustees of all the other funds
managed by the Adviser and each independent trustee receives fees
for his or her services. For details of trustees' fees paid by
the Fund, see "Fund Charges and Expenses" in this Statement.
The Agreement and Declaration of Trust of the Fund provides
that the Fund will indemnify its Trustees and officers against
liabilities and expenses incurred in connection with litigation
in which they may be involved because of their offices with the
Fund, except if it is determined in the manner specified in the
Agreement and Declaration of Trust that they have not acted in
good faith in the reasonable belief that their actions were in
the best interests of the Fund or that such indemnification would
relieve any officer or Trustee of any liability to the Fund or
its shareholders by reason of willful misfeasance, bad faith,
gross negligence or reckless disregard of his or her duties.
Trustees and officers of the Fund who are also officers or
shareholders of the Adviser will benefit from the advisory fees
paid by the Fund.
Potential Conflicts of Interest
Principals of the Adviser as individuals own 99% of the
common stock of Harrington Financial Group, the holding company
for Harrington Bank, FSB of Richmond, Indiana (the
"Association"). As of March 31, 1995, the Association had total
assets of $263 million.
Douglas T. Breeden, in combination with immediate family
members, controls over 75% of the common stock of Community First
Financial Group, Inc. , the holding company for English State
Bank of English, Indiana (the "Bank"). As of March 31, 1995, the
Bank had total assets of $76 million. The Adviser furnishes
certain Investment Advisory services to the Bank and Association.
The Fund will transact no business directly or indirectly with
either the Bank or the Association. The Bank and Association
invest in assets of the same types as those to be held by the
Fund.
The Adviser may also manage advisory accounts with
investment objectives similar to or the same as those of the
Fund, or different from the Fund but trading in the same type of
securities and instruments as the Fund. Portfolio decisions and
results of the Fund's investments may differ from those of such
accounts managed by the Adviser. When two or more accounts
managed by the Adviser seek to purchase or sell the same assets,
the assets actually purchased or sold may be allocated among the
accounts on a basis determined by the Adviser in its good faith
discretion to be equitable. In some cases, this system may
adversely affect the size or the price of the position obtainable
for the Fund.
-9-
THE INVESTMENT ADVISORY AGREEMENT AND OTHER SERVICES
The investment manager of the Fund is Smith Breeden
Associates, Inc. (the "Adviser"). The table in the Prospectus
indicates which officers and trustees are affiliated persons of
the Adviser.
Under the Investment Advisory Agreement between the Fund and
the Adviser, subject to such policies as the Trustees may
determine, the Adviser, at its expense, furnishes continuously an
investment program for the Fund and makes investment decisions on
behalf of the Fund. Subject to the control of the Trustees, the
Adviser also manages, supervises and conducts the other affairs
and business of the Fund, furnishes office space and equipment,
provides bookkeeping and clerical services (including
determination of the Fund's net asset value, but excluding
shareholder accounting services) and places all orders for the
purchase and sale of the Fund's portfolio securities.
For details of the Adviser's compensation under the
Investment Advisory Agreement, see "Fund Charges and Expenses" in
this Statement. The Adviser's compensation under the Investment
Advisory Agreement may be reduced in any year if the Fund's
expenses exceed the limits on investment company expenses imposed
by any statute or regulatory authority of any jurisdiction in
which shares of the Fund are qualified for offer or sale. The
term "expenses" is defined in the statutes or regulations of such
jurisdictions, and, generally speaking, excludes brokerage
commissions, taxes, interest and extraordinary expenses. The
only such limitation as of the date of this Statement (imposed by
the State of California) was 2.5% of the first $30 million of
average net assets, 2% of the next $70 million and 1.5% of any
excess over $100 million.
Under the Investment Advisory Agreement, the Adviser may
reduce its compensation to the extent that the Fund's expenses
exceed such lower expense limitation as the Adviser may, by
notice to the Fund, voluntarily declare to be effective. The
expenses subject to this limitation are exclusive of brokerage
commissions, interest, taxes, and extraordinary expenses. The
terms of the expense limitation currently in effect are described
in the Prospectus and on the following page. The Fund pays all
expenses not assumed by the Adviser including, without
limitation, auditing, legal, tax preparation and consulting,
custodial, investor servicing and shareholder reporting expenses.
The Investment Advisory Agreement provides that the Adviser
shall not be subject to any liability to the Fund or to any
shareholder of the Fund for any act or omission in the course of
or connected with rendering services to the Fund in the absence
of willful misfeasance, bad faith, gross negligence or reckless
disregard of its duties on the part of the Adviser.
The Investment Advisory Agreement may be terminated without
penalty by vote of the Trustees or the shareholders of the Fund,
or by the Adviser, on 60 days written notice. It may be amended
only by a vote of the shareholders of the Fund. The Investment
-10-
Advisory Agreement also terminates without payment of any penalty
in the event of its assignment as defined in the Investment
Company Act. The Investment Advisory Agreement provides that it
will continue in effect after its initial term of two years only
so long as such continuance is approved at least annually by vote
of either the Trustees or the shareholders, and, in either case,
by a majority of the Trustees who are not "interested persons" of
the Adviser or the Fund. In each of the foregoing cases, the
vote of the shareholders is the affirmative vote of a "majority
of the outstanding voting securities".
Under the terms of the Investment Advisory Agreement, the
Adviser performs certain administrative services as follows: (1)
coordinates with the Fund's custodian and Transfer Agent and
monitors the services they provide to the Fund; (2) coordinates
with and monitors other third parties furnishing services to the
Fund; (3) provides the Fund with necessary office space,
telephones and other communications facilities and personnel
competent to perform administrative and clerical functions for
the Fund; (4) supervises the preparation by third parties of all
Federal, state and local tax returns and reports of the Fund
required by applicable law; (5) prepares and, after approval by
the Fund, files and arranges for the distribution of proxy
materials and periodic reports to shareholders of the Fund as
required by applicable law; (6) prepares and, after approval by
the Fund, arranges for the filing of such registration statements
and other documents with the Securities and Exchange Commission
and other Federal and state regulatory authorities as may be
required by applicable law; (7) reviews and submits to the
officers of the Fund for their approval invoices or other
requests for payment of Fund expenses; and (8) takes such other
actions with respect to the Fund as may be necessary in the
opinion of the Administrator to perform its duties under the
agreement.
The Adviser has voluntarily agreed to bear normal operating
expenses (excluding litigation, indemnification and other
extraordinary expenses) of the Fund, and, if necessary, to waive
its advisory fee, for the period ending March 31, 1996 such that
total operating expenses would not exceed 0.90% of the average
net assets of the Fund. Such expense limitations, if any, are
calculated daily based on average net assets and may be continued
or modified by the Adviser at any time in its sole discretion.
Portfolio Transactions
Investment decisions
Investment decisions for the Fund and for the other
investment advisory clients of the Adviser are made with a view
to achieving their respective investment objectives. Investment
decisions are the product of many factors in addition to basic
suitability for the particular client involved. Thus, a
particular security may be bought or sold for certain clients
even though it could have been bought or sold for other clients
at the same time. Likewise, a particular security may be bought
for one or more clients when one or more other clients are
selling the security. In some instances, one client may sell a
particular security to another client. It also sometimes happens
that two or more clients simultaneously purchase or sell the same
security, in which event each day's transactions in
-11-
such security are, insofar as possible, averaged as to price and
allocated between such clients in a manner which in the Adviser's
opinion is equitable to each and in accordance with the amount being
purchased or sold by each. There may be circumstances when
purchases or sales of portfolio securities for one or more
clients will have an adverse effect on other clients.
Brokerage and research services
Transactions on U.S. stock exchanges, commodities markets
and futures markets and other agency transactions involve the
payment by the Fund of negotiated brokerage commissions. Such
commissions vary among different brokers. In addition, a
particular broker may charge different commissions according to
such factors as the difficulty and size of the transaction.
There is generally no stated commission in the case of securities
traded in the over-the-counter markets, but the price paid by the
Fund usually includes an undisclosed dealer commission or mark-
up. In underwritten offerings, the price paid by the Fund
includes a disclosed, fixed commission or discount retained by
the underwriter or dealer. The Fund paid approximately $1000 in
brokerage commissions on futures and options transactions for the
fiscal year ended March 31, 1995.
The Adviser places all orders for the purchase and sale of
portfolio investments for the Fund and may buy and sell
investments for the Fund through a substantial number of brokers
and dealers. In so doing, the Adviser uses its best efforts to
obtain for the Fund the most favorable price and execution
available. In seeking the most favorable price and execution,
the Adviser, having in mind the Fund's best interests, considers
all factors it deems relevant, including, by way of illustration,
price, the size of the transaction, the nature of the market for
the security or other investment, the amount of the commission,
the timing of the transaction taking into account market prices
and trends, the reputation, experience and financial stability of
the broker-dealer involved and the quality of service rendered by
the broker-dealer in other transactions.
When it is determined that several brokers or dealers are
equally able to provide the best net price and execution, the
Adviser may execute transactions through brokers or dealers who
provide quotations and other services to its advisory clients,
including the quotations necessary to determine these clients'
net assets, in such amount of total brokerage as may reasonably
be required in light of such services, and through brokers and
dealers who supply statistical and other data to the Adviser and
its clients in such amount of total brokerage as may reasonably
be required.
Consistent with the Rules of Fair Practice of the National
Association of Securities Dealers, Inc. and subject to seeking
the most favorable price and execution available and such other
policies as the Trustees may determine, the Adviser may consider
sales of shares of the Fund (and, if permitted by law, of the
other funds managed by the Adviser) as a factor in the selection
of broker-dealers to execute portfolio transactions for the Fund.
-12-
The Adviser conducts extensive proprietary fixed income
research with emphasis on mortgage-backed securities. The
Adviser is not dependent on any broker for such research and
analysis and, thus is able to transact business with brokers
regardless of the brokers' research capabilities or provision of
such research to brokerage customers. The Adviser uses multiple
electronic quotation services for trading and pricing purposes.
The Adviser pays for these services directly out of its advisory
fees. The Adviser is not involved in any soft dollar
arrangements. The Adviser does utilize broker pricing guidance
for certain assets not consistently available through electronic
quotation services.
Investor Servicing Agent and Underwriter
Fund/Plan Services is the Fund's investor servicing agent
(transfer, plan and dividend disbursing agent), for which it
receives fees which are paid monthly by the Fund as an expense of
all its shareholders. See "Fund Charges and Expenses" in this
Statement for information on fees and reimbursements received by
Fund/Plan Services. Fund/Plan Services is also investor
servicing agent for the other funds managed by the Adviser and
receives fees from each of those funds for its services.
Custodian
The Bank of New York ("Custodian") acts as custodian of the
Fund's assets. In carrying out its duties under its custodian
contract, the Custodian may employ one or more subcustodians
whose responsibilities will include safeguarding and controlling
the Fund's cash and securities, handling the receipt and delivery
of securities and collecting interest and dividends on the Fund's
investments. The Fund pays the Custodian an annual fee based on
the assets of the Fund and the Fund's securities transactions.
The Fund also pays the Custodian an annual fee based on the
Fund's securities holdings for the year and reimburses the
Custodian for certain out-of-pocket expenses incurred by it or
any subcustodian employed by it in performing custodial services.
The Custodian pays the fees and other charges of any subcustodian
employed by it.
PRINCIPAL HOLDERS OF SECURITIES AND CONTROLLING PERSONS
Listed below are the names and addresses of those
shareholders who, as of June 30, 1995, owned 5% or more of the
shares of the Fund.
Shareholder Percentage Owned
Sammie C. Bledsoe 22.58%
Sammie C. Bledsoe Trust
1737 East 30th Place
Tulsa, OK 74114
Shepard Barbash and Vicki Ragan 17.14%
1732 Meadowdale Avenue
Atlanta, GA 30306-3114
-13-
Michael J. Giarla 6.72%
Trust Smith Breeden Assoc., Inc. PSP
FBO Timothy D. Rowe
7300 College Boulevard, Suite 430
Overland Park, KS 66210-1879
A Fund Trustee owns less than 1% of the shares of the Fund as
of June 30, 1995.
DETERMINATION OF NET ASSET VALUE
The Fund determines net asset value as of the close of regular
trading on the New York Stock Exchange at 4 p.m..
If any securities held by the Fund are restricted as to
resale, the Adviser determines their fair value following
procedures approved by the Trustees. The Trustees periodically
review such valuation procedures. The fair value of such
securities is generally determined as the amount which the Fund
could reasonably expect to realize from an orderly disposition of
such securities over a reasonable period of time. The valuation
procedures applied in any specific instance are likely to vary from
case to case. However, consideration is generally given to the
financial position of the issuer and other fundamental analytical
data relating to the investment and to the nature of the
restrictions on disposition of the securities (including any
registration expenses that might be borne by the Fund in connection
with such disposition). In addition, specific factors are also
generally considered, such as the cost of the investment, the
market value of any unrestricted securities of the same class (both
at the time of purchase and at the time of valuation), the size of
the holding, the prices of any recent transactions or offers with
respect to such securities and any available analysts' reports
regarding the issuer.
Generally, trading in certain securities is substantially
completed each day at various times prior to the close of regular
trading on the Exchange. The values of these securities used in
determining the net asset value of the Fund's shares are computed
as of such times. Also, because of the amount of time required to
collect and process trading information as to large numbers of
securities issues, the values of certain securities (such as
convertible bonds and U.S. Government securities) are determined
based on market quotations collected earlier in the day at the
latest practicable time prior to the close of the Exchange.
Occasionally, events affecting the value of such securities may
occur between such times and the close of the Exchange which will
not be reflected in the computation of the Fund's net asset value.
If events materially affecting the value of such securities occur
during such period, then these securities will be valued at their
fair market value following procedures approved by the Trustees.
-14-
ADDITIONAL INFORMATION REGARDING PURCHASES
AND REDEMPTIONS OF FUND SHARES
All checks, drafts, wires and other payment mediums used for
purchasing or redeeming shares of the Fund must be denominated in
U.S. Dollars. The Fund reserves the right, in its sole discretion,
to either (a) reject any order for the purchase or sale of shares
denominated in any other currency, or (b) to honor the transaction
or make adjustments to shareholder's account for the transaction as
of a date and with a foreign currency exchange factor determined by
the drawee bank.
Dividend checks which are returned to the Fund marked "unable
to forward" by the postal service will be deemed to be a request to
change the dividend option and the proceeds will be reinvested in
additional shares at the current net asset value until new
instructions are received.
Redemptions in Kind
The Fund has committed itself to pay in cash all requests for
redemption by any shareholder of record, limited in amount,
however, during any 90-day period to the lesser of $250,000 or 1%
of the value of the Fund's net assets at the beginning of such
period. Such commitment is irrevocable without the prior approval
of the Securities and Exchange Commission. In the case of requests
for redemption in excess of such amounts, the Trustees reserve the
right to make payments in whole or in part in securities or other
assets of the Fund in case of any emergency, or if the payment of
such redemption in cash would be detrimental to the existing
shareholders of the Fund. In such circumstances, the securities
distributed would be valued at the price used to compute the Fund's
net assets. Should the Fund do so, a shareholder may incur
brokerage fees or other transaction costs in converting the
securities to cash.
Principal Underwriter
Fund/Plan Broker Services, Inc. (the "Principal Underwriter"),
#2 West Elm Street, P.O. Box 874, Conshohocken, Pennsylvania
19428-0874, is the principal underwriter for the Fund. The
Principal Underwriter is registered as a broker-dealer under the
Securities Exchange Act of 1934 and is a member of the National
Association of Securities Dealers, Inc. The offering of the Fund's
shares is continuous.
The Fund's underwriting agreement with the Principal
Underwriter provides that the Fund will pay all fees and expenses
in connection with: registering and qualifying its shares under the
various state "blue sky" laws; preparing, setting in type,
printing, and mailing its prospectuses and reports to shareholders;
and issuing its shares, including expenses of confirming purchase
orders.
The Principal Underwriter acts as the agent of the Fund in
connection with the sale of its shares in all states in which the
shares are qualified and in which the Principal Underwriter is
qualified as a broker-dealer. Under the underwriting agreement,the
-15-
Principal Underwriter may accept orders for Fund shares at the
offering price. For these services, the Adviser pays the Principal
Underwriter $5000. The Principal Underwriter may enter into
agreements with other broker-dealers for the sale of Fund shares by
them.
Reinvestment Date
The dividend reinvestment date is the date on which the
additional shares are purchased for the investor who has its
dividends reinvested. This date will vary and is not necessarily
the same date as the record date or the payable date for cash
dividends.
Special Services
The Fund may pay certain financial institutions which maintain
omnibus accounts with the Fund on behalf of numerous beneficial
owners for recordkeeping operations performed with respect to such
beneficial owners. Such financial institutions may also charge a
fee for their services directly to their clients.
SHAREHOLDER INFORMATION
Each time shareholders buy, redeem or exchange shares or
receive a distribution, they will receive a statement confirming
the transaction and listing their current share balance. The Fund
also sends annual and semiannual reports that keep shareholders
informed about its portfolio and performance, and year-end tax
information to simplify their recordkeeping. Shareholders may call
Fund/Plan Services toll-free at 1-800-221-3137 between 9:00 a.m.
and 7:00 p.m. (Eastern Time) for more information, including
account balances.
SUSPENSION OF REDEMPTIONS
The Fund may not suspend shareholders' right of redemption, or
postpone payment for more than seven days, unless the New York
Stock Exchange (the "Exchange") is closed for other than customary
weekends or holidays, or if permitted by the rules of the
Securities and Exchange Commission during periods when trading on
the Exchange is restricted or during any emergency which makes it
impracticable for the Fund to dispose of its securities or to
determine fairly the value of its net assets, or during any other
period permitted by order of the Commission for protection of
investors.
SHAREHOLDER LIABILITY
Under Massachusetts law, shareholders could, under certain
circumstances, be held personally liable for the obligations of the
Fund. However, the Agreement and Declaration of Trust disclaims
shareholder liability for acts or obligations of the Fund and
requires that notice of such disclaimer be given in each agreement,
obligation, or instrument entered into or executed by the Fund or
the Trustees. The Agreement and Declaration of Trust provides for
indemnification out of Fund property for all loss and expense of
any shareholder held personally liable for the obligations of
the Fund. Thus, the risk of a shareholder incurring
-16-
financial loss on account of shareholder liability is limited to
circumstances in which the Fund would be unable to meet its
obligations. The likelihood of such circumstances is remote.
STANDARD PERFORMANCE MEASURES
Total return data for the Fund may from time to time be
presented in this Statement and in advertisements. Total return
for the life of the Fund is determined by calculating the actual
dollar amount of investment return on a $1,000 investment in the
Fund made at the net asset value at the beginning of the period,
and then calculating the annual compounded rate of return which
would produce that amount. Total return for a period of one year
is equal to the actual return of the Fund during that period.
Total return calculations assume reinvestment of all Fund
distributions at net asset value on their respective reinvestment
dates. As of March 31, 1995, the average annual total return for
the Fund since inception is 12.87%. The average annual total
return for the one year period ended March 31, 1995 is 17.18%.
At times, the Adviser may reduce its compensation or assume
expenses of the Fund in order to reduce the Fund's expenses. The
per share amount of any such fee reduction or assumption of
expenses for the life of the Fund, will be reflected in the
Prospectus as updated. Any such fee reduction or assumption of
expenses would increase the Fund's total return during the period
of the fee reduction or assumption of expenses.
Independent statistical agencies measure the Fund's investment
performance and publish comparative information showing how the
Fund, and similar investment companies, performed in specified time
periods. Two agencies whose reports are commonly used for such
comparisons are Lipper Analytical Services and Wiesenberger
Investment Companies Service. From time to time, the Fund may
distribute these comparisons to its shareholders or to potential
investors.
The Fund's performance may also from time to time be compared
to Standard & Poor's 500 Composite Stock Price Index (the "S&P 500
Index"). The S&P 500 Index is an unmanaged list of common stocks
frequently used as a general measure of stock market performance.
Standard & Poor's performance figures reflect changes of market
prices and reinvestment of all regular cash dividends and are not
adjusted for commissions or other costs. Because the Fund is a
managed portfolio investing in a variety of securities and
derivative instruments, the securities it owns will not match those
in the Index.
Other publications, indices, and averages which may be used
are as follows:
a) CDA Mutual Fund Report, published by CDA Investment
Technologies, Inc. - analyzes price, current yield, risk, total
return and average rate of return (average annual compounded growth
rate) over specified time periods for the mutual fund industry.
-17-
b) Mutual Fund Source book, published by Morningstar, Inc. -
analyzes price, yield, risk and total return for equity and fixed
income funds.
c) Financial publications: Barron's, Business Week, Changing
Times, Financial World, Forbes, Fortune, and Money magazines - rate
fund performance over specified time periods.
d) Consumer Price Index (or Cost of Living Index), published
by the U.S. Bureau of Labor Statistics - a statistical measure of
change, over time, in the price of goods and services in major
expenditure groups.
e) Stocks, Bonds, Bills, and Inflation, published by Ibbotson
Associates - historical measure of yield, price and total return
for common and small company stock, long-term government bonds,
treasury bills, and inflation.
f) Savings and Loan Historical Interest Rates - as published
in the U.S. Savings & Loan League Fact Book.
g) Salomon Brothers Broad Bond Index or its component indices
- - The Broad Index measures yield, price and total return for
Treasury, Agency, Corporate, and Mortgage bonds.
h) Salomon Brothers Composite High Yield Index or its
component indices - The High Yield Index measures yield, price and
total return for Long-Term High-Yield Index, Intermediate-Term
High-Yield Index and Long-Term Utility High-Yield Index.
i) Lehman Brothers Aggregate Bond Index or its component
indices - The Aggregate Bond Index measures yield, price and total
return for Treasury, Agency, Corporate, Mortgage, and Yankee bonds.
j) Lehman Brothers Government/Corporate Bond Index.
k) Other taxable investments including certificates of
deposit (CD's), money market deposit accounts (MMDA's), checking
accounts, savings accounts, money market mutual funds, repurchase
agreements, and government securities.
l) Historical data supplied by the research departments of
Lehman Brothers, First Boston Corporation, Morgan Stanley, Salomon
Brothers, Merrill Lynch, Goldman Sachs, Prudential Securities and
Donaldson Lufkin and Jenrette.
m) Donoghues's Money Fund Report - industry averages for
seven-day annualized and compounded yields of taxable, tax-free and
government money funds.
n) Total returns and yields for Treasury Securities and fixed
income indices as published by Ryan Laboratories or other
suppliers.
-18-
Volatility
Occasionally statistics may be used to specify Fund volatility
or risk. Measures of volatility or risk are generally used to
compare fund net asset value or performance relative to a market
index. One measure of volatility is beta. The ratio of the
expected excess return on the portfolio to the expected excess
return on the market index is called beta. Equity funds commonly
use the S&P 500 as their market index. A beta of more than 1.00
indicates volatility greater than the market, and a beta of less
than 1.00 indicates volatility less than the market. Another
measure of volatility or risk is standard deviation. Standard
deviation is used to measure variability of net asset value or
total return around an average, over a specified period of time.
the premise is that greater volatility connotes greater risk
undertaken in achieving performance.
A statistic often used by sophisticated institutional
investors when comparing the relative performance of portfolios is
the Sharpe Ratio. This statistic is the portfolio's excess return
(relative to T-Bills) divided by the standard deviation of its
returns.
All data are based on past performance and do not predict
future results.
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey
08540, are the Fund's independent auditors, providing audit
services, tax return review and preparation services and assistance
and consultation in connection with the review of various
Securities and Exchange Commission filings.
EXPERTS
The financial statements of the Fund and related notes thereto
included in this Statement of Additional Information have been so
included in reliance upon the report of Deloitte & Touche LLP,
independent auditors, given on the authority of said firm as
experts in auditing and accounting.
REPORT OF INDEPENDENT AUDITORS AND FINANCIAL STATEMENTS
See attached report.
-19-
<PAGE>
ANNUAL REPORT
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
