PERFORMANCE REVIEW
The Smith Breeden Market Tracking Fund provided at total return
of 32.30% for the year ended March 31, 1996, while the S&P 500
index return was 32.10%. The annualized total return of the
Market Tracking Fund from its inception on June 30, 1992 through
March 31, 1996 was 17.74%, while the annualized return of the
S&P 500 index was 16.10% over the same period.
The S&P 500 index, with dividends reinvested, has posted
positive returns every month from December 1994 through March
1996, with the one exception of a -0.36% return in October of
1995. This excellent performance was supported by strong
corporate earnings combined with low inflation and generally
falling long term interest rates. Long term interest rates, as
measured by the yield on the benchmark thirty year U.S. Treasury
Bond, fell from 7.43% in March 1995 to 5.96% in December 1995.
Falling long term interest rates benefit stocks in two ways.
Firstly, as bond yields fall, the price of bond investments
increases, and stocks become more attractive as an alternative
to bonds. Secondly, lower interest rates directly help raise
corporate earnings by lowering interest expense, which in turn
supports higher stock prices.
IN ACCORDANCE WITH REG. 232.304 OF REGULATION S-T, THE FOLLOWING
IS A DESCRIPTION OF THE GRAPH PRESENTED HERE IN THE TEXT IN
COMPLIANCE WITH ITEM 5a. OF FORM N-1A:
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 INCEPTION OF JUNE 30, 1992 THROUGH MARCH 31,
1996, AN INVESTMENT OF $10,000 IN THE MARKET TRACKING FUND WOULD
HAVE GROWN TO $18,459, VERSUS $17,514, IF INVESTED IN THE S&P
500 INDEX. THE AVERAGE ANNUAL TOTAL RETURN IN THE MARKET
TRACKING FUND WAS 32.30% FOR THE ONE YEAR PERIOD, 16.57% FOR THE
THREE YEAR PERIOD, AND 17.74% FOR THE PERIOD SINCE INCEPTION.
In the first quarter of 1996, the stock market rally continued
unabated, with the S&P 500 index returning 5.37%, and the Market
Tracking Fund returning 5.90%. Interest rates however began
climbing during the first quarter fueled by investors' fears of
higher inflation in the future. The thirty year benchmark U.S.
Treasury yield rose from 5.96% in December 1995 to 6.66% on
March 31, 1996. Despite the climb in interest rates, investors
continued to expect strong earnings growth and accordingly were
willing to buy stocks at higher prices over the quarter.
The Market Tracking Fund can be viewed as comprising income and
equity segments: the income segment invests in a combination of
U.S. Government Agency mortgage securities, hedged to a low
level of interest rate risk, along with U.S. Treasury Bills,
while the equity segment invests in S&P 500 index futures
contracts with a notional value approximately the same as the
Fund's net assets. When the return on the income segment of the
portfolio exceeds the funding cost implicit in the price of the
S&P 500 futures contracts plus the operating expenses incurred
by the Fund, the Fund is able to outperform the S&P 500 index.
This strategy was successful in the year to March 31, 1996, with
the Fund providing a total return 0.20% in excess of the total
return of the S&P 500 index.
Mortgage securities held in the income segment of the portfolio
varied from 95% of net assets in March 1995 to a low of 80% in
November 1995, and stood at 89% in March 1996. The balance of
the income segment was invested in U.S. Treasury Bills. During
the year, the Fund's holdings of 9.5% to 13.5% coupon FNMA and
FHLMC fixed-rate mortgages were reduced, dropping from 38% of
net assets in March 1995 to 10% in March 1996. In their place
GNMA and FNMA adjustable-rate mortgage securities were
purchased, and holdings of these securities rose from 52% of net
assets to 78% of assets over the year. The change in portfolio
composition resulted from opportunities to sell securities at a
relatively low risk-adjusted yield and to purchase securities at
a higher risk-adjusted yield. Portfolio turnover, which is
calculated by dividing the lesser of purchases and sales by
average assets, was 107% for the year.
SMITH BREEDEN MARKET TRACKING FUND
SCHEDULE OF INVESTMENTS MARCH 31, 1996
Market
Face Amount Security Value
U.S. GOVERNMENT & AGENCY OBLIGATIONS - 99.61%
FEDERAL HOME LOAN MORTGAGE CORPORATION - 4.49% *
FHLMC:
$146,653 9.50%, due 7/1/02 ....................... $153,163
53,465 12.50%, due 2/1/14 ...................... 60,699
TOTAL FEDERAL HOME LOAN MORTGAGE CORPORATION
(Cost $212,374)......................... 213,862
FEDERAL NATIONAL MORTGAGE ASSOCIATION - 30.92% *
FNMA:
139,126 12.50%, due 9/1/12 ...................... 159,548
109,513 13.50%, due 11/1/14 to 1/1/15 ........... 125,483
FNMA ARM:
342,269 5.98%, due 9/1/25 ....................... 350,845
758,504 7.687%, due 9/1/18 ...................... 780,943
54,881 7.839%, due 12/1/26 ..................... 56,916
TOTAL FEDERAL NATIONAL MORTGAGE ASSOCIATION
(Cost $1,460,675)....................... 1,473,735
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION - 53.22% *
GNMA ARM:
1,010,000 5.50%, due 3/20/26 ...................... 998,082
325,955 6.75%, due 2/20/16 ...................... 330,601
136,926 7.00%, due 5/20/25 ...................... 139,611
1,047,808 7.375%, due 4/20/16 to 6/20/21 .......... 1,068,366
TOTAL GOVERNMENT NATIONAL MORTGAGE ASSOCIATION
(Cost $2,536,598)....................... 2,536,660
U.S. GOVERNMENT OBLIGATIONS - 10.98%
U.S. TREASURY BILL **
300,000 5.00%, due 6/27/96 ...................... 296,375
230,000 5.02%, due 6/27/96 ...................... 227,221
TOTAL U.S. GOVERNMENT OBLIGATIONS
(Cost $523,585) ........................ 523,596
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(Cost $4,733,232)....................... 4,747,853
THREE MONTH EURODOLLAR FUTURES PUT OPTIONS - 0.01%
Contracts
20 Expires 6/96, Strike Price $93.75 ....... 500
TOTAL EURODOLLAR PUT OPTIONS (Cost $1,590) 500
TOTAL INVESTMENTS (Cost $4,734,822) -
99.62% ................................. 4,748,353
CASH AND OTHER ASSETS LESS LIABILITIES -
0.38% .................................. 18,181
NET ASSETS - 100.00% .................... $4,766,534
* 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, 1996. 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, 1996
ASSETS:
Investments at market value
(identified cost $4,734,822)(Note 1).............. $4,748,353
Cash................................................. 35,919
Receivables:
Interest.......................................... 26,778
Maturities........................................ 4,329
Subscriptions..................................... 4,760
Other............................................. 848
Prepaid expenses..................................... 27
Deferred organization expenses (Note 1).............. 34,587
TOTAL ASSETS.................................... 4,855,601
LIABILITIES:
Variation margin on futures contracts................ 48,342
Due to adviser (Note 3).............................. 29,004
Accrued expenses..................................... 11,721
TOTAL LIABILITIES............................... 89,067
NET ASSETS:
(Applicable to outstanding shares of 388,529;
unlimited number of shares of beneficial
interest authorized; no stated par)................. $4,766,534
Net asset value, offering price and redemption
price per share ($4,766,534 / 388,529)............ $12.27
SOURCE OF NET ASSETS:
Paid in capital...................................... $4,416,541
Undistributed net investment income.................. 12,594
Accumulated net realized gain on investments......... 299,125
Net unrealized appreciation of investments........... 38,274
NET ASSETS...................................... $4,766,534
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, 1996
INVESTMENT INCOME:
Interest and discount earned, net of
premium amortization (Note 1).................. $199,564
EXPENSES:
Advisory fees (Note 3)......................... 21,727
Accounting and pricing services fees........... 25,000
Custodian fees................................. 8,455
Audit and tax preparation fees................. 4,800
Legal fees..................................... 2,250
Amortization of organization expenses (Note 1). 27,943
Transfer agent fees............................ 25,284
Registration fees.............................. 20,004
Trustees fees and expenses..................... 3,630
Insurance expense.............................. 2,793
Other.......................................... 150
TOTAL EXPENSES BEFORE REIMBURSEMENT........ 142,036
Expenses reimbursed by Adviser (Note 3).... (114,100)
NET EXPENSES............................... 27,936
NET INVESTMENT INCOME...................... 171,628
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized gain on investments............... 709,594
Change in unrealized appreciation of
investments.................................... (66,654)
Net realized and unrealized gain on
investments.................................... 642,940
Net increase in net assets resulting
from operations................................ $814,568
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN MARKET TRACKING FUND
STATEMENTS OF CHANGES IN NET ASSETS
FOR THE YEARS ENDED MARCH 31, 1996 AND 1995
Year Ended Year Ended
March 31, 1996 March 31, 1995
OPERATIONS:
Net investment income............ $171,628 $140,115
Net realized gain (loss) on
investments...................... 709,594 (64,050)
Change in unrealized appreciation
(depreciation) of investments.... (66,654) 229,458
Net increase in net assets
resulting from operations........ 814,568 305,523
DISTRIBUTIONS TO SHAREHOLDERS:
Dividends from net investment
income........................... (159,034) (104,085)
Dividends in excess of net
investment income................ - (251)
Distributions from net realized
gains on investments............. (371,974) (9,133)
Distributions in excess of
net realized gains on investments - (13,962)
Total distributions.............. (531,008) (127,431)
CAPITAL SHARE TRANSACTIONS:
Shares sold...................... 2,256,010 200,709
Shares issued on reinvestment of
distributions.................... 502,798 120,434
Shares redeemed.................. (383,180) (152,408)
Increase in net assets resulting
from capital share transactions
(a).............................. 2,375,628 168,735
TOTAL INCREASE IN NET ASSETS. 2,659,188 346,827
NET ASSETS:
Beginning of year................ 2,107,346 1,760,519
End of year...................... $4,766,534 $2,107,346
(a) Transactions in capital shares
were as follows:
Shares sold................. 183,531 19,300
Shares issued on reinvestment
of distributions............ 42,520 11,593
Shares redeemed............. (32,004) (14,689)
Net increase................ 194,047 16,204
Beginning balance .......... 194,482 178,278
Ending balance.............. 388,529 194,482
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN MARKET TRACKING FUND
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED MARCH 31, 1996
Year Ended
March 31, 1996
Cash Flows from Operating Activities:
Net increase in net assets resulting
from operations................................ $814,568
Net realized and unrealized gain on investments (642,940)
Net investment income........................ 171,628
Adjustments to reconcile net investment income
to net cash provided by operating activities:
Net paydown gains and losses................... 16,109
Increase in interest receivable................ (11,919)
Decrease in other assets....................... 31,562
Decrease in other liabilities.................. (19,935)
Net cash provided by operating activities.... 187,445
Cash Flows from Investing Activities:
Settlement payment on S&P 500 equity
swap contract.................................. 168,247
Proceeds from futures variations............... 554,718
Proceeds from sales of long-term investments... 2,826,874
Proceeds from maturities of short-term
investments.................................... 2,365,000
Proceeds from sales of short-term investments.. 2,627,509
Proceeds from paydowns of long-term investments 449,569
Purchases of long-term investments............. (5,625,270)
Purchases of short-term investments............ (5,439,093)
Net cash used in investing activities........ (2,072,446)
Cash Flows from Financing Activities:
Purchase of shares tendered.................... 1,868,070
Dividends from net investment income and
realized gains................................. (28,210)
Net cash provided by financing activities.... 1,839,860
Net decrease in cash......................... (45,141)
Cash at beginning of year......................... 81,060
Cash at end of year............................... $35,919
Noncash Financing Activities:
Market value of shares issued to stockholders
through reinvestment of dividends............ $502,798
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 Year Period
Ended Ended Ended Ended
March 31, 1996 March 31, 1995 March 31, 1994 March 31,1993*
Net Asset Value,
Beginning of Period $10.84 $9.88 $10.85 $10.00
Income From Investment
Operations
Net investment
income.......... 0.615 0.568 0.476 0.355
Net realized and
unrealized gain
(loss) on
investments..... 2.768 1.081 (0.216) 1.281
Total from
investment
operations.. 3.383 1.649 0.260 1.636
Less Distributions
Dividends from
net investment
income.......... (0.583) (0.568) (0.472) (0.311)
Dividends in excess
of net investment
income.......... - (0.001) - -
Distributions from
net realized gains
on investments.. (1.370) (0.047) (0.701) (0.420)
Distributions in
excess of net
realized gains on
investments..... - (0.073) (0.057) (0.055)
Total
distributions (1.953) (0.689) (1.230) (0.786)
Net Asset Value,
End of Period.... $12.27 $10.84 $9.88 $10.85
Total Return..... 32.30% 17.18% 2.19% 22.59%**
Ratios/Supplemental Data
Net assets, end
of period....... $4,766,534 $2,107,346 $1,760,519 $903,846
Ratio of expenses
to average net
assets (1)...... 0.90% 0.90% 0.90% 0.57%**
Ratio of net
investment income
to average net
assets (2)...... 5.53% 7.44% 8.02% 5.28%**
Portfolio
turnover rate... 107% 120% 119% 271%
______________________
(1) The annualized ratio of expenses to average net assets prior to
reimbursement of expenses by the Adviser was 4.58%, 7.75%, 7.08%,
and 28.48% for the years ended March 31, 1996, 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 1.85%, 0.59%,
1.84%, and (22.63%) for the years ended March 31, 1996, 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.
SMITH BREEDEN MARKET TRACKING FUND
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The 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.
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
carryforward. As of March 31, 1996, the Fund had no net capital
loss carryforward.
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 manage the
Fund's interest-rate risk relative to its benchmark. 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, held for
purposes other than trading, as of March 31, 1996:
Notional Expiration Unrealized
Type Amount Position Month Gain/(Loss)
Eurodollar $3,000,000 Short June, 1996 $ (88)
Eurodollar 5,000,000 Short September, 1996 (1,473)
Eurodollar 6,000,000 Short September, 1997 3,973
Eurodollar 6,000,000 Short September, 1998 (601)
Eurodollar 4,000,000 Short September, 1999 (418)
$ 1,393
The aggregate market value of investments pledged to cover
margin requirements for the open positions at March 31, 1996 was
$227,221.
B. Derivative Financial Instruments Held or Issued for Trading
Purposes: The Fund invests in Futures Contracts on the S&P 500
Index whose return is expected to track movements in the S&P 500
Index.
The Fund had fifteen open futures contracts on the S&P 500 Index
as of March 31, 1996:
Notional Expiration Unrealized
Type Amount Position Month Gain
S&P 500 $4,841,250 Long June, 1996 $23,350
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,
1996. For the year ended March 31, 1996, the Adviser received
fees of $21,727 and reimbursed the Fund $114,100.
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, 1996, purchases and proceeds
from sales of securities, other than short-term investments,
aggregated $5,597,637 and $2,831,265, respectively. The cost of
securities for federal income tax purposes is $4,734,822. Net
unrealized appreciation of investments and futures contracts
consists of:
Gross unrealized appreciation....... $47,183
Gross unrealized depreciation....... (8,909)
Net unrealized appreciation......... $38,274
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, 1996, and the related statements of operations and
cash flows for the year then ended, the statements of changes in
net assets for each of the years in the two-year period then
ended and the financial highlights for each of the years in the
three year period then ended and the period June 30, 1992
(commencement of operations) to March 31, 1993. These financial
statements and the financial highlights are the responsibility
of the Fund's management. Our responsibility is to express an
opinion on these financial statements and the financial
highlights based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements and the financial highlights are free
of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements. Our procedures included confirmation
of securities owned at March 31, 1996 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, the financial statements and financial
highlights referred to above 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, 1996,
the results of its operations and its cash flows, the changes in
its net assets, and the financial highlights for the respective
stated periods in conformity with generally accepted accounting
principles.
Deloitte & Touche LLP
Princeton, New Jersey
May 10, 1996
