As filed with the Securities and
Exchange Commission on December 16, 1997
File No. 33-44909
File No. 811-6520
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
F O R M N-1A
Registration Statement Under the
Securities Act of 1933
Post-Effective Amendment No. 13
and
Registration Statement Under the
Investment Company Act of 1940
Amendment No. 15
_____________________
SMITH BREEDEN TRUST
(Exact Name of Registrant as Specified in Charter)
100 Europa Drive, Suite 200
Chapel Hill, North Carolina 27514
(Address of Principal Executive Office)
(919) 967-7221
(Registrant's Telephone Number, Including Area Code)
MICHAEL J. GIARLA
100 Europa Drive, Suite 200
Chapel Hill, North Carolina 27514
(Name and Address of Agent for Service)
_______________
Please Send Copy of Communications to:
MARIANTHE S. MEWKILL
Smith Breeden Associates, Inc.
100 Europa Drive, Suite 200
Chapel Hill, NC 27514
(919)-967-7221
This filing shall become effective on December 22,
1997 pursuant to paragraph (b) (1) of Rule 485 under the
Securities Act of 1933.
The Registrant has previously registered an indefinite
number of shares of beneficial interest pursuant to
Rule 24f-2 under the Investment Company Act of 1940,
as amended. The Rule 24f-2 notice for the Registrant's
most recent fiscal year was filed on May 29, 1997.
_
SMITH BREEDEN TRUST
SMITH BREEDEN EQUITY MARKET PLUS FUND
(THE "EQUITY MARKET PLUS FUND")
AND
SMITH BREEDEN FINANCIAL SERVICES FUND
(THE "FINANCIAL SERVICES FUND")
CROSS REFERENCE SHEET
FORM N-1A
Part A: Information Required in Prospectus
N-1A
Item No. Item Location in the
Registration
Statement by
Prospectus Heading
1. Cover Page Cover Page
2. Synopsis Expense Table
3. Condensed Financial
Financial Highlights
Information
4. General Smith Breeden Mutual
Description of Funds; Equity Market
Registrant Plus Fund; Smith
Breeden Financial
Services Fund
5. Management Management of the Funds
of the Fund
5a. Management's Contained in the Funds'
Discussion Annual Report to
of Fund's Shareholders
Performance
6. Capital Stock Dividends and
and Other Distributions;
Securities Capital Structure
7. Purchase of How to Purchase
Securities Shares; Pricing of
Being Offered Fund Shares
8. Redemption or How to Redeem Shares;
Repurchase How to Exchange Shares
9. Pending Legal Not Applicable
Proceedings
DECEMBER 22, 1997
SMITH BREEDEN MUTUAL FUNDS PROSPECTUS
The Smith Breeden Mutual Funds consist of four no-load, diversified
Series (the "Funds") of two management investment companies-Smith Breeden
Trust and Smith Breeden Series Fund. The investment adviser for the
Funds is Smith Breeden Associates, Inc. (the "Adviser").
Smith Breeden Equity Market Plus Fund (the "Equity Market Plus Fund", a
series of the Smith Breeden Trust) seeks to provide a total return
exceeding the Standard & Poor's 500 Composite Stock Index without
additional equity market risk. The Fund does not invest principally in the
common stocks that make up the S&P 500 Index (the "Index") or any other
index. Instead, the Fund uses S&P 500 futures and swaps in an effort to
maintain an equity market exposure similar to that which would be achieved
if all of the Fund's assets were invested in the stocks comprising the
Index. Since the Equity Market Plus Fund utilizes index futures contracts
and equity swap contracts to track the S&P 500 Index, it can invest
substantially all of its cash in fixed-income securities and related
hedging instruments. Whether the Fund's total return equals or exceeds the
performance of the S&P 500 Index depends largely on whether the total
return on the Equity Market Plus Fund's fixed-income investments equals or
exceeds the Fund's total operating expenses, as well as other factors.
Smith Breeden Financial Services Fund (the "Financial Services Fund", a
series of the Smith Breeden Trust) seeks capital appreciation. To pursue
this goal, the Fund invests in U.S. and foreign financial services
companies. These include banks, thrift, finance and leasing companies,
brokerage, investment banking and advisory firms, real estate related firms
and insurance companies.
Smith Breeden Short Duration U.S. Government Fund (the "Short Fund", a
series of the Smith Breeden Series Fund) seeks a high level of current
income consistent with low volatility of net asset value. The Short Fund
seeks to match the duration, or interest-rate risk, of a portfolio that
invests exclusively in six month U.S. Treasury securities on a constant
maturity basis. The dollar weighted average maturity of the Fund's
securities may at times significantly exceed six months.
Smith Breeden Intermediate Duration U.S. Government Fund (the "Intermediate
Fund", a series of the Smith Breeden Series Fund) seeks a total return in
excess of the total return of the major market indices for mortgage-backed
securities. The major market indices for mortgage-backed securities
currently include, but are not limited to, the Salomon Brothers Mortgage
Index and the Lehman Brothers Mortgage Index. These indices include all
outstanding government sponsored fixed-rate mortgage-backed securities,
weighted in proportion to their current market capitalization. The
duration, or interest-rate risk, of these indices is similar to that of
intermediate-term U.S. Treasury Notes, and typically will range between
three and five years. The Intermediate Fund consistently seeks to achieve
a volatility of net asset value similar to that of a portfolio that invests
exclusively in mortgage-backed securities, as weighted in the major
mortgage market indices.
An investment in any of the Funds is neither insured nor guaranteed by the
U.S. Government. There can be no assurance that any of the Funds will meet
their investment objectives. This Prospectus sets forth concisely the
information about the Funds that you should know before investing. Please
read this Prospectus carefully and keep it for future reference.
Statements of Additional Information dated December 22, 1997, have been
filed with the Securities and Exchange Commission with respect to each
Trust and are legally part of this prospectus. The Statements of
Additional Information can be obtained without charge by writing to the
Funds at 100 Europa Drive, Chapel Hill, North Carolina 27514 or by calling
1-800-221-3138. 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 PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
<PAGE>
1
TABLE OF CONTENTS
Expense Table 3
Financial Highlights--Equity Market Plus Fund 5
Financial Highlights--Short Fund 6
Financial Highlights--Intermediate Fund 7
Smith Breeden Mutual Funds 8
Investment Objectives, Policies and Risk Considerations 8
Other Investment Practices and Risk Considerations 18
Management of the Funds 24
Pricing of Fund Shares 30
How to Purchase Shares 31
How to Exchange Shares 34
How to Redeem Shares 35
Dividends and Distributions 38
Shareholder Reports and Information 39
Retirement Plans 40
Service and Distribution Plans 40
Taxes 41
Capital Structure 42
Transfer, Dividend Disbursing Agent, Custodian and
Independent Accountants 43
Fund Performance 43
No person has been authorized to give any information or to make any
representations not contained in this Prospectus and, if given or made,
such information or representations must not be relied upon as having been
authorized by the Funds. The Prospectus does not constitute an offering by
the Funds in any jurisdiction in which such offering may not be lawfully
made.
<PAGE>
2
EXPENSE TABLE
The following table is designed to assist you in understanding the expenses
you will bear as a shareholder of a Fund. Shareholder Transaction
Expenses are charges that you pay when buying or selling shares of a Fund.
Annual Fund Operating Expenses are paid out of a Fund's assets and include
fees for portfolio management, maintenance of shareholder accounts,
shareholder servicing, accounting and other services. The annual fund
operating expenses shown below reflect expense limitations agreed to by the
Adviser, and are based on each Fund's expenses for the past fiscal year, if
applicable, or on good faith estimates provided by the Advisor.
Equity
Market Financial
Plus Services Short Intermediate
Fund Fund Fund Fund
Shareholder Transaction Expenses
Maximum Sales Load Imposed on
Purchases None None None None
Maximum Sales Load Imposed on
Reinvested Dividends None None None None
Deferred Sales Load Imposed on
Redemptions None None None None
Redemption Fees1 None None None None
Exchange Fees None None None None
Annual Fund Operating Expenses
(as a percentage of average net assets)
Management Fees2 0.70% 1.50% 0.70% 0.70%
Other Expenses
(net of reimbursement)3 0.18% 0.00% 0.08% 0.18%
Total Fund Operating Expenses
(net of reimbursement)3 0.88% 1.50% 0.78% 0.88%
_____________________________
1 A transaction charge of $9 may be imposed on redemptions by wire
transfer.
2 Pursuant to a distribution and services plan in respect of each Fund,
the Adviser may pay annual distribution and servicing fees of up to
0.25% of each of the Fund's net assets out of its management fee. See
"Service and Distribution Plans."
3 The Other Expenses and Total Fund Operating Expenses in the table
reflect undertakings by the Adviser to bear expenses of each of the
Funds and/or waive its fees to the extent necessary to limit Total
Fund Operating Expenses to 0.78% for the Short Fund and 0.88% for each
of the Equity Market Plus Fund and Intermediate Fund and to 1.50% for
the Financial Services Fund through August 1, 1998. Absent the
expense limitation, Other expenses and Total Fund Operating Expenses
for the past fiscal year would have been 0.23% and 0.93% for the Short
Fund, 0.46% and 1.16% for the Intermediate Fund, and 1.90% and 2.60%
for the Equity Market Plus Fund, and are estimated to be about 4.30%
and 5.00% for the Financial Services Fund.
<PAGE>
3
The following examples illustrate the expenses that apply to a $1,000
investment in each Fund over various time periods assuming: (1) a 5% annual
rate of return, and (2) redemption or no redemption at the end of each time
period. Except as noted in the table above, the Funds charge no redemption
fees.
Short Duration Fund
1 Year 3 Years 5 Years 10 Years
$ 8 $ 26 $ 45 $ 99
Intermediate Duration Fund and Equity Market Plus Fund
1 Year 3 Years 5 Years 10 Years
$ 9 $ 29 $ 50 $ 111
Financial Services Fund
1 Year 3 Years 5 Years 10 Years
$ 16 $ 49 $ 84 $ 184
These examples are based on the annual operating expenses shown above and
should not be considered a representation of past or future expenses or
performance. Actual expenses may be greater or less than those shown. The
annual rate of return may be more or less than 5%.
The Funds may be recommended to investors by registered investment
advisors. Such advisors customarily impose fees that would be in addition
to any fees and expenses presented in the above table. Certain broker-
dealers may also charge a fee for purchase or redemption of shares through
their network. Neither the Funds, nor the Adviser, exercise any control
over such advisory or broker-dealer fees and may not be informed of the
level of such fees.
<PAGE>
4
<TABLE>
EQUITY MARKET PLUS FUND
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
The following selected per share data and ratios cover the fiscal periods
from June 30, 1992, the date the Fund commenced operations, through September
30, 1997, and except for the six months ended September 30, 1997, are part of
the Fund's financial statements, which have been audited by Deloitte & Touche
LLP, independent auditors. This data should be read in conjunction with the
Fund's most recent annual audited financial statements and the report of
Deloitte & Touche LLP thereon, and unaudited semi-annual financial statements,
which appear in the Statement of Additional Information for the Smith Breeden
Trust.
<CAPTION>
Six Months Year Ended Year Ended Year Ended Year Ended Period
Ended March 31, March 31, March 31, March 31, Ended
September 1997 1996 1995 1994 March 31,
30, 1997 1993
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, $12.56 $12.27 $10.84 $9.88 $10.85 $10.00
Beginning of Period
Income From Investment
Operations
Net investment 0.250 0.592 0.615 0.568 0.476 0.355
income.................
Net realized and
unrealized gain (loss) 2.877 1.813 2.768 1.081 (0.216) 1.281
on Investments.........
Total from investment 3.127 2.405 3.383 1.649 0.260 1.636
operations.............
Less Distributions
Dividends from net (0.230) (0.590) (0.583) (0.568) (0.472) (0.311)
investment income......
Dividends in excess of -- -- -- (0.001) -- --
net investment income..
Distributions from net
realized gains on (0.247) (1.525) (1.370) (0.047) (0.701) (0.420)
Investments............
Distributions in excess
of net realized gains -- -- -- (0.073) (0.057) (0.055)
on Investments.........
Total distributions..... (0.477) (2.115) (1.953) (0.689) (1.230) (0.786)
Net Asset Value, End of $15.21 $12.56 $12.27 $10.84 $9.88 $10.85
Period..................
Total Return............ 25.08% 21.41% 32.30% 17.18% 2.19% 22.59%*
Ratios/Supplemental Data
Net assets, end of $61,086,390 $13,507,377 $4,766,534 $2,107,346 $1,760,519 $903,846
period.................
Ratio of expenses to
average net assets
Before expense 1.28%* 2.60% 4.58% 7.75% 7.08% 28.48%*
limitation..........
After expense 0.88%* 0.88% 0.90% 0.90% 0.90% 0.57%*
limitation..........
Ratio of net income to
average net assets
Before expense 4.54%* 3.58% 1.85% 0.59% 1.84% (22.63%)*
limitation..........
After expense 4.95%* 5.30% 5.53% 7.44% 8.02% 5.28%*
limitation..........
Portfolio turnover 196% 182% 107% 120% 119% 271%
rate...................
<FN>
<F1>
* Annualized
Additional performance information is presented in the Fund's Annual Report,
which is available without charge upon request.
</FN>
</TABLE>
<PAGE>
5
<TABLE>
SHORT DURATION FUND
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
The following selected per share data and ratios cover the fiscal periods
from March 31, 1992, the date the Fund commenced operations, through September
30, 1997 and except for the six months ended September 30, 1997, are part of
the Short Fund's financial statements which have been audited by Deloitte &
Touche LLP, independent auditors. This data should be read in conjunction
with the Short Fund's most recent annual audited financial statements and the
report of Deloitte & Touche LLP thereon, and unaudited semi-annual financial
statements, which appear in the Statement of Additional Information for the
Smith Breeden Series Fund.
<CAPTION>
Six Months Year Ended Year Ended Year Ended Year Ended Period
Ended March 31, March 31, March 31, March 31, Ended
September 1997 1996 1995 1994 March 31,
30, 1997 1993
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, $9.83 $9.74 $9.90 $9.90 $10.00 $10.00
Beginning of Period
Income From Investment
Operations
Net investment 0.261 0.476 0.621 0.628 0.432 0.552
income.................
Net gain (loss) on
securities 0.059 0.146 (0.148) -- (0.070) 0.002
(both realized and
unrealized)............
Total from investment 0.320 0.622 0.473 0.628 0.362 0.554
operations..............
Less Distributions
Dividends from net (0.260) (0.476) (0.621) (0.628) (0.462) (0.554)
investment income......
Dividends in excess of -- (0.056) (0.012) -- -- --
net investment income..
Total distributions..... (0.260) (0.532) (0.633) (0.628) (0.462) (0.554)
Net Asset Value, End of $9.89 $9.83 $9.74 $9.90 $9.90 $10.00
Period.................
Total Return............ 3.30% 6.57% 4.95% 6.58% 3.67% 5.67%
Ratios/Supplemental Data
Net assets, end of $103,238,834 $118,988,609 $221,825,136 $218,431,665 $218,167,491 $48,531,206
period.................
Ratio of expenses to
average net assets
Before expense 1.01%* 0.93% 0.93% 0.92% 1.00% 2.58%
limitation...........
After expense 0.78%* 0.78% 0.78% 0.78% 0.78% 0.78%
limitation...........
Ratio of net income to
average net assets
Before expense 5.39%* 4.90% 6.13% 6.18% 3.95% 2.73%
limitation...........
After expense 5.62%* 5.04% 6.29% 6.33% 4.17% 4.53%
limitation...........
Portfolio turnover 306% 556% 225% 47% 112% 3%
rate...................
<FN>
<F1>
*Annualized
Additional performance information is presented in the Short Fund's Annual
Report, which is available without charge upon request.
</FN>
</TABLE>
<PAGE>
6
<TABLE>
INTERMEDIATE DURATION FUND
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
The following selected per share data and ratios cover the fiscal periods
from March 31, 1992, the date the Fund commenced operations, through September
30, 1997, and except for the six months ended September 30, 1997, are part of
the Intermediate Fund's financial statements which have been audited by
Deloitte & Touche LLP, independent auditors. This data should be read in
conjunction with the Intermediate Fund's most recent annual audited financial
statements and the report of Deloitte & Touche LLP thereon, and unaudited semi-
financial statements, which appear in the Statement of Additional Information
for the Smith Breeden Series Fund.
<CAPTION>
Six Months Year Ended Year Ended Year Ended Year Ended Period
Ended March 31, March 31, March 31, March 31, Ended
September 1997 1996 1995 1994 March 31,
30, 1997 1993
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, $9.73 $10.01 $9.83 $10.01 $10.62 $10.00
Beginning of Period
Income From Investment
Operations
Net investment 0.284 0.599 0.660 0.664 1.05 0.826
income.................
Net gain (loss) on
securities 0.328 (0.024) 2.77 (0.049) (0.601) 0.621
(both realized and
unrealized)............
Total from investment 0.612 0.575 0.937 0.615 0.449 1.447
operations.............
Less Distributions
Dividends from net (0.280) (0.604) (0.656) (0.664) (1.044) (0.826)
investment income......
Dividends in excess of ---- ---- ---- (0.108) ---- --
net investment
income.................
Distributions from net
realized gains on -- (0.251) (0.101) -- (0.015) --
Investments............
Distributions in excess
of net realized gains -- -- -- (0.022) -- --
on Investments.........
Total distributions..... (0.280) (0.855) (0.757) (0.794) (1.059) (0.826)
Net Asset Value, End of 10.06 $9.73 $10.01 $9.83 $10.01 $10.62
Period.................
Total Return............ 6.33% 5.92% 9.69% 6.10% 4.11% 14.93%
Ratios/Supplemental Data
Net assets, end of $46,914,014 $37,735,525 $36,446,940 $34,797,496 $6,779,666 $2,923,913
period.................
Ratio of expenses to
average net assets
Before expense 1.04%* 1.16% 1.14% 2.33% 2.34% 17.52%
limitation...........
After expense 0.88%* 0.88% 0.90% 0.90% 0.90% 0.82%
limitation...........
Ratio of net income to
average net assets
Before expense 5.53%* 5.92% 6.26% 4.77% 6.30% (8.52%)
limitation...........
After expense 5.69%* 6.19% 6.49% 6.20% 7.74% 8.18%
limitation...........
Portfolio turnover 162% 409% 193% 557% 84% 42%
rate....................
<FN>
<F1>
*Annualized
Additional performance information is presented in the Intermediate Fund's
Annual Report, which is available without charge upon request.
</FN>
</TABLE>
<PAGE>
7
SMITH BREEDEN MUTUAL FUNDS
The Short and Intermediate Funds are funds of the Smith
Breeden Series Fund (the "Series Fund"), an open-end
diversified management investment company. The Equity Market
Plus and Financial Services Funds are series of the Smith
Breeden Trust (the "Trust"), an open-end diversified
management investment company.
Smith Breeden Associates, Inc. ("Smith Breeden" or the
"Adviser") acts as investment adviser to the Funds. Smith
Breeden is a money management and consulting firm founded in
1982 whose clients include pension funds, financial
institutions, corporations, government entities, and
charitable foundations.
INVESTMENT OBJECTIVES, POLICIES, AND RISK CONSIDERATIONS
Each of the Funds has a different investment objective and
different investment policies, and is designed to meet
different investment needs.
The investment objectives and certain investment policies
of the Short and Intermediate Funds are fundamental and may
not be changed without a vote of shareholders of the
relevant Fund. The investment objectives of the Equity
Market Plus and Financial Services Funds are not
fundamental. In order to comply with certain state
securities laws, the Smith Breeden Equity Market Plus Fund
had originally agreed to give its shareholders written
notification at least thirty days prior to any change in the
Fund's objective. As a result of the changes made by the
National Securities Market Improvement Act of 1996, however,
the Fund is no longer subject to such state securities law
requirements. Accordingly, while there is no current
intention to change the investment objective, this
prospectus constitutes notice that on or after January 21,
1998 the Equity Market Plus Fund may make changes to its
investment objective without giving shareholders written
notification.
Since shares of each Fund represent an investment in
securities with fluctuating market prices, the net asset
value per share of each Fund will vary as the aggregate
value of a Fund's portfolio securities increases or
decreases. Due to the risks inherent in all investments,
there can be no assurance that the objectives of the Funds
will be met. The descriptions that follow are designed to
help you choose the Fund or combination of Funds that best
fits your investment objectives.
Short Fund
The Short Fund's investment objective is to provide
investors with a high level of current income, consistent
with a volatility of net asset value similar to that of a
portfolio which invests exclusively in six-month U.S.
Treasury securities on a constant maturity basis. There is
no assurance that the Short Fund will be able to maintain a
<PAGE>
8
low volatility of net asset value.
The Short Fund will seek its investment objective by
investing, under normal circumstances, at least 70% of its
total assets in U.S. Government Securities (see "Investment
Objectives, Policies and Risk Considerations-Characteristics
and Risks of the Securities in which the Short and
Intermediate Funds and Fixed Income Segment of the Equity
Market Plus Fund Invest"). It is anticipated that the Short
Fund will invest primarily in mortgage-backed securities
issued by the U.S. Government, its agencies and
instrumentalities. The Fund will also invest in fixed-rate
and adjustable-rate mortgage-backed securities issued by non-
governmental issuers. The Fund may hold a portion of its
assets in money market instruments and in time and savings
deposits (including fixed-rate or adjustable certificates of
deposit) in commercial banks or institutions whose accounts
are insured by the FDIC, BIF or SAIF.
Under normal circumstances the Short Fund will seek to
achieve an interest-rate risk or option-adjusted duration
(See "Other Investment Practices and Risk Considerations-
Adjusting Investment and Interest Rate Risk Exposure")
similar to that of a six-month U.S. Treasury security on a
constant maturity basis. However, the Short Fund expects
that, under normal circumstances, the dollar-weighted
average life (or period until the next reset date) of its
portfolio securities will be longer than six months,
sometimes significantly longer.
The Adviser believes that by investing in mortgage
securities from a variety of market sectors on a selective
basis and adjusting the overall option-adjusted duration of
the portfolio to approximate that of a six-month U.S.
Treasury security, the Short Fund will achieve a more
consistent and less volatile net asset value than is
characteristic of mutual funds that invest primarily in
mortgage securities paying a fixed rate of interest or those
that invest exclusively in adjustable-rate mortgage
securities. The securities in which the Short Fund may
invest may not yield as high a level of income as other
securities in which other funds may invest. However, such
higher yielding securities may be more volatile and may be
issued by less creditworthy entities.
Intermediate Fund
The Intermediate Fund's investment objective is to provide
investors with a total return in excess of the total return
of the major market indices for mortgage-backed securities.
The Intermediate Fund will seek its investment objective by
investing, under normal circumstances, at least 70% of its
total assets in U.S. Government Securities. It is
anticipated that the Intermediate Fund will invest primarily
in mortgage-backed securities issued by the U.S. Government,
its agencies or instrumentalities. The Fund will also invest
in fixed-rate and adjustable rate mortgage-backed securities
issued by non-governmental issuers. The Fund may hold a
portion of its assets in money market instruments and in
<PAGE>
9
time and savings deposits (including fixed-rate or
adjustable-rate certificates of deposit) in commercial banks
or institutions whose accounts are insured by the FDIC, BIF,
or SAIF.
The major market indices for mortgage-backed securities
currently include, but are not limited to, the Salomon
Brothers Mortgage Index and the Lehman Brothers Mortgage
Index. These indices include all outstanding government
sponsored fixed-rate mortgage-backed securities, weighted in
proportion to their current market capitalization. Total
return is the change in value of the investment, assuming
reinvestment of all distributions. Under normal
circumstances, the Intermediate Fund will seek to achieve an
interest-rate risk or option-adjusted duration (see "Other
Investments and Risk Considerations") similar to that of a
portfolio that invests exclusively in mortgage-backed
securities, as weighted in the major market indices. The
duration, or interest-rate risk, of these indices is
believed by the Adviser to be similar to the that of
intermediate-term U.S. Treasury Notes, and typically will
range between three and five years. When market interest
rates decline, the value of a portfolio invested in
intermediate-term fixed-rate obligations can be expected to
rise. Conversely, when market interest rates rise, the
value of a portfolio invested in intermediate-term fixed-
rate obligations can be expected to fall.
There is no assurance that the Intermediate Fund will be
able to maintain a total return in excess of the total
return of major market indices for mortgage-backed
securities, or that it will match the interest rate risk of
a portfolio investing exclusively in these securities.
Fundamental Policies. As a matter of fundamental policy,
the Short and Intermediate Funds will limit purchases to
securities from the following classes of assets:
1.Securities issued directly or guaranteed by the U.S.
Government or its agencies or instrumentalities;
2.Mortgage-Backed Securities rated AAA by S&P or Aaa by
Moody's or unrated but deemed of equivalent quality by
the Adviser;
3. Securities fully collateralized by assets in either
of the above classes;
4.Assets which would qualify as liquidity items under
federal regulations if held by a commercial bank or
savings institution; and
5.Hedge instruments, which may only be used for risk
management purposes. Any securities described in the
"Hedging" section and any stripped Mortgage-Backed
Securities may only be used for risk management
purposes.
Equity Market Plus Fund
The Equity Market Plus Fund seeks to provide a total
return exceeding the Standard & Poor's 500 Composite Stock
Price Index (the "Index") without additional equity market
<PAGE>
10
risk. The Fund does not invest principally in the common
stocks that make up the Index or any other stock index.
Instead, the Fund uses S&P 500 futures and swaps in an
effort to maintain an equity market exposure similar to
that which would be achieved if all of the Fund's assets
were invested in the stocks comprising the Index. Since the
Equity Market Plus Fund utilizes index futures contracts and
equity swap contracts to track the S&P 500 Index, it can
invest substantially all of its cash in fixed-income
securities and related hedging instruments. Whether the
Fund's total return equals or exceeds the performance of the
S&P 500 Index depends largely on whether the total return on
the Equity Market Plus Fund's fixed-income investments
equals or exceeds the Fund's total operating expenses, as
well as other factors.
The S&P 500 Index is an unmanaged index composed of 500
common stocks, most of which are listed on the New York
Stock Exchange. Standard & Poor's, 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 Equity Market Plus Fund seeks its objective by dividing
its portfolio into two segments: an "S&P 500 Index Segment"
and a "Fixed Income Segment." Through the S&P 500 Index
Segment, the Fund invests in a combination of equity swap
contracts, futures contracts on the S&P 500 Index and on
other stock indices, including, but not limited to, the New
York Stock Exchange Composite Index, and common stocks whose
return (before deducting allocated costs) is expected to
track movements in the S&P 500 Index. By employing this
strategy, the Equity Market Plus Fund seeks to achieve the
same investment opportunity and risk profile for the S&P 500
Index Segment as that of a hypothetical portfolio, equal in
size to the Fund, invested in the common stocks comprising
the S&P 500 Index in proportion to their respective
weightings in the S&P 500 Index.
When index futures contracts and/or equity swap contracts
are, in the judgment of the Adviser, overpriced relative to
the common stocks underlying the S&P 500 Index, the Fund may
invest directly in the common stocks represented by the S&P
500 Index. The Fund will not own all 500 issues, but will
attempt to purchase a basket of common stocks which the
Adviser expects will, on average, match movements in the S&P
500 Index. Subject to limits on the Fund's investments 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
<PAGE>
11
expenses of the Fund.
Through the Fixed Income Segment, the Fund invests in
fixed-income securities and uses related hedging techniques
such as futures, options, floors, caps and swaps. The Fixed-
Income Segment will invest substantially all of its assets
in U.S. Government Securities, and may also invest in bank
certificates of deposit, corporate debt obligations, and
mortgage-backed and other asset-backed securities of non-
governmental issuers. The Fund may also engage in loans of
portfolio securities, dollar rolls, and reverse repurchase
agreements to enhance income and total return. With these
investments, the Fund seeks to generate income (consisting
primarily of interest income) and gains which exceed the
total costs of operating the Fund (including the costs
associated with the S&P 500 Index Segment). Thus, whether
the Fund's total return equals or exceeds the performance of
the S&P 500 Index depends largely on whether the total
return on the Fund's Fixed-Income Segment equals or exceeds
the Fund's total operating expenses, as well as other
factors described below.
The S&P 500 Index Segment's actual opportunities for gain or
loss may be greater than a hypothetical portfolio invested
in the stocks comprising the S&P 500 Index depending upon
the Fund's exposure to the S&P 500 Index, which could at
times be higher or lower than the Fund's total assets. For
example, the total net notional amount of the Fund's equity
swap contracts, S&P 500 or other stock index futures plus
the market value of common stocks owned by the Fund may
exceed the Fund's total net assets as a result of purchases
and redemptions of Fund shares. In addition, since S&P 500
Index futures can only be purchased for specific amounts,
the Fund might not be able to match accurately a notional
amount of futures contracts to the Fund's total net assets.
Under normal market conditions, the Fund expects that such
variations in S&P 500 Index exposure will generally be up to
5% greater or less than the Fund's total net assets. Also,
the ability of the S&P 500 Index Segment of the Fund's
portfolio to replicate the investment opportunity and risk
profile of a hypothetical stock portfolio may be diminished
by imperfect correlations between price movements of the S&P
500 Index with price movements of S&P 500 and other stock
index futures and/or the 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. Equity swap contracts require the Fund
to pay interest on the notional amount of the contract.
Therefore, assuming the Fund has successfully tracked the
movement of 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
(to the extent applicable) (1) the Fund's transaction costs
on S&P 500 and other stock index futures and common stock
transactions, (2) the interest payments under the Fund's
equity swap contracts and (3) the Fund's operating expenses
as described more fully under "Management of the Fund."
Example. Set forth below is an example of how the Equity
<PAGE>
12
Market Plus Fund might invest a $100 million portfolio:
1.Enter into an equity swap contract with a notional amount
of $50 million;
2.Purchase S&P 500 index futures contracts with a total
contract value 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.
Because equity swap contracts and futures contracts may
generally be initially entered into without making cash
payments, the Fixed Income Segment would have $95 million to
invest in various fixed income securities with appropriate
hedging strategies. 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 following would occur:
1.The counterparty to the equity swap contract would be
required to pay the Fund $4 million ($7 million
appreciation and dividends minus $3 million interest);
2The S&P 500 index futures contract would be closed out at
a gain of $3.6 million ($6.3 million S&P 500 Index
appreciation less $2.7 million for the S&P 500 Futures
implicit cost of carry);
3.Dividend income and gain on the common stocks would total
$0.7 million and in sum;
4.The S&P 500 Index Segment's return, before related
operating expenses, would total $8.3 million dollars or
8.3%.
The Fund's total operating expenses (other than brokerage
expenses and the interest on the notional amount of the
equity swap contract as described above) are 0.88% of total
net assets, or $0.88 million dollars. After consideration
of these expenses, the S&P 500 Index Segment's return would
total 7.42%. Therefore, 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 6.93% per annum. If the
Fixed Income Segment achieves this result, then the Fund's
total net assets would 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 were greater or less than
6.93% per annum, the Fund's total return would, in turn, be
greater or less than the S&P 500 Index.
Smith Breeden Financial Services Fund
The Financial Services Fund seeks capital appreciation. To
pursue this goal, the fund will invest at least 65% of its
assets in U.S. and foreign financial services companies.
These include banks, thrift, finance and leasing companies,
brokerage, investment banking and advisory firms, real
estate related firms and insurance companies. The Fund will
generally invest in common stock and in other equity
securities such as preferred stock and warrants. The Fund
may also engage in other investment practices. See "Other
<PAGE>
13
Investment Practices and Risk Considerations."
Because the Financial Services Fund invests in single
sector, its performance is largely dependent on the sector's
performance, which may differ from that of the overall stock
market. Changing interest rates or deteriorating economic
conditions can adversely affect the performance of financial
services companies' stocks. The Fund may buy or sell
interest rate futures and options to attempt to mitigate the
affect of changing interest rates upon the portfolio.
However, the use of interest rate futures in such a strategy
involves the risk that the price movements of the hedging
instrument will not accurately reflect price movements in
the security due to changing interest rates, so that the
hedge will not be fully effective or may result in losses.
The Fund may also buy or sell stock index futures or options
on such indices to adjust the risk and return
characteristics of the Fund's stock portfolio. If the
Adviser judges market conditions incorrectly or employs a
strategy that does not correlate well with the Fund's
investments, the use of stock index futures could result in
a loss, regardless of whether the intent was to reduce risk
or increase return. These techniques may also increase the
volatility of the Fund relative to the Financial Services
sector of the stock market. See also "Other Investment
Practices and Risk Considerations" and the Statement of
Additional Information for a discussion of the use of
financial futures and options and their risks.
Financial services companies are subject to extensive
government regulation which may limit both the amounts and
types of loans and other financial commitments they can
make, and the interest rates and fees they charge.
Profitability is largely dependent upon on the availability
and cost of capital funds, and can fluctuate significantly
when interest rates change. Credit losses resulting from
the financial difficulties of borrowers can negatively
impact the industry. Insurance companies may be subject to
severe price competition. Legislation is currently being
considered which would reduce the separation between
commercial and investment banking businesses. If enacted
this could significantly impact the financial services
sector and the Fund.
The Fund may purchase securities of foreign financial
services companies, which are subject to additional risks.
Currency fluctuations can adversely affect the returns on
investments held in foreign corporations. Other risks relate
to the fact that differences exist in accounting, auditing
and financial reporting standards. Political developments
may also have an adverse impact. There is also the
possibility of changes in investment or exchange control
regulations, restrictions on the flow of international
capital, and difficulties in pursuing legal remedies against
issuers. The Fund will primarily invest in foreign
financial securities through ADRs, which represent shares of
a foreign corporation held by an U.S. bank that entitles the
holder to all dividends and capital gains. ADRs are
<PAGE>
14
denominated in U.S. dollars and trade in the U.S. securities
markets. ADRs are still subject to the risks associated
with foreign investment generally described above. The
Financial Services Fund may hedge against fluctuations in
foreign exchange rates by entering into foreign currency
forward and futures contracts. For more discussion of these
contracts and their risks, see "Other Investment Practices
and Risk Considerations" and the Statement of Additional
Information.
Under regulations imposed by the Investment Company Act of
1940 and its rules (the "1940 Act"), the Fund may not
purchase more than 10% of the securities of any domestic or
foreign insurance company. The Fund may also not invest
more than 5% of its total assets in the equity securities of
any company that derives more than 15% of its revenues from
brokerage or investment management activities, unless such
investment is limited to not more than 5% of the equity
securities or 10% of the debt securities of such company,
and such investment represents not more than 5% of the net
assets of the Fund.
The Financial Services Fund intends to be a diversified
fund, as defined under the 1940 Act, and as such, with
respect to 75% of its assets, will not invest more than 5%
of its assets in any single issuer, and such 5% holding
cannot represent more than a 10% voting interest in the
acquired company.
Characteristics and Risks of the Securities in which the
Short and Intermediate Funds and Fixed Income Segment of the
Equity Market Plus Fund Invest
U.S. Government Securities. The U.S. Government Securities
in which the Funds may invest include U.S. Treasury Bills,
Notes, Bonds, discount notes and other debt securities
issued by the U.S. Treasury, and obligations issued or
guaranteed by the U.S. Government, its agencies and
instrumentalities including, but not limited to, the
Government National Mortgage Association ("GNMA"), Federal
National Mortgage Association ("FNMA") and Federal Home Loan
Mortgage Corporation ("FHLMC"). (Other U.S. Government
agencies or instrumentalities include Federal Home Loan
Banks, Bank for Cooperatives, Farm Credit Banks, Tennessee
Valley Authority, Federal Financing Bank, Small Business
Administration, and Federal Agricultural Mortgage
Corporation.) Mortgage-backed securities are explained more
fully below.
Credit Risks. While certain U.S. Government securities
such as U.S. Treasury obligations and GNMAs are backed by
the full faith and credit of the U.S. Government, other
securities in which the Funds may invest are subject to
varying degrees of risk of default. These risk factors
include the creditworthiness of the issuer and, in the case
of mortgage-backed and asset-backed securities, the ability
of the mortgagor or other borrower to meet its obligations.
The Short and Intermediate Funds will seek to minimize this
credit risk by investing in securities of the highest credit
<PAGE>
15
quality instruments, while the Equity Market Plus Fund will
seek to minimize this risk of default by investing in
securities of at least investment grade, except that the
Equity Market Plus Fund's investment in mortgage backed
securities will be rated at least A by Standard & Poors
("S&P"). The individual securities continue to be subject
to the risk that their prices can fluctuate, in some cases
significantly, due to changes in prevailing interest
rates.
Mortgage-Backed and Other Asset-Backed Securities. Mortgage-
backed securities are securities that directly or indirectly
represent a participation in, or are collateralized by and
payable from, mortgage loans secured by real property. The
term "mortgage-backed securities," as used herein, includes
adjustable-rate mortgage securities, fixed-rate mortgage
securities, and derivative mortgage products such as
collateralized mortgage obligations, stripped mortgage-
backed securities and other instruments described below.
There are currently three basic types of mortgage-backed
securities: (i) those issued or guaranteed by the U.S.
Government or one of its agencies or instrumentalities, such
as GNMA, FNMA and FHLMC; (ii) those issued by private
issuers that represent an interest in or are collateralized
by mortgage-backed securities issued or guaranteed by the
U.S. Government or one of its agencies or instrumentalities;
and (iii) those issued by private issuers that represent an
interest in or are collateralized by whole mortgage loans or
mortgage-backed securities without a government guarantee
but usually having some form of private credit enhancement.
The Short and Intermediate Funds may only invest in
mortgage-backed securities issued by private originators of,
or investors in, mortgage loans issued by private entities
that are rated AAA by S&P or Aaa by Moody's Investors
Service ("Moody's"), or, if unrated, determined by the
Adviser to be of comparable quality. The Short and
Intermediate Funds will not pay any additional fees for
credit support and will not invest in private mortgage pass-
through securities unless they are rated AAA by S&P or Aaa
by Moody's, or are unrated but deemed to be of comparable
credit quality by the Adviser. In addition, the Short and
Intermediate Funds will only purchase mortgage-backed
securities which constitute "Mortgage Related Securities"
for purposes of the Secondary Mortgage Market Enhancement
Act of 1984.
The Equity Market Plus Fund may invest in other mortgage-
backed and asset-backed securities. Its investment in
mortgage-backed and other asset-backed securities will be
rated at least A by Moody's or S&P. Asset-backed securities
are structured like mortgage-backed securities, but instead
of mortgage loans or interests in mortgage loans, the
underlying assets may include, but are not limited to, pools
of automobile loans, educational loans and credit card
receivables.
Mortgage-backed and asset-backed securities have yield and
<PAGE>
16
maturity characteristics corresponding to their underlying
assets. Unlike traditional debt securities, which may pay a
fixed rate of interest until maturity when the entire
principal amount comes due, payments on certain mortgage-
backed and asset-backed securities include both interest and
a partial payment of principal. This partial payment of
principal may be comprised of a scheduled principal payment
as well as an unscheduled payment from the voluntary
prepayment, refinancing, or foreclosure of the underlying
loans. As a result of these unscheduled payments of
principal, or prepayments on the underlying securities, the
price and yield of mortgage-backed securities can be
adversely affected. For example, during periods of
declining interest rates, prepayments can be expected to
accelerate, and the Funds would be required to reinvest the
proceeds at the lower interest rates then available.
Prepayments of mortgages which underlie securities purchased
at a premium could result in capital losses because the
premium may not have been fully amortized at the time the
obligation is prepaid. In addition, like other interest-
bearing securities, the values of mortgage-backed securities
generally fall when interest rates rise, but when interest
rates fall, their potential for capital appreciation is
limited due to the existence of the prepayment feature. In
order to hedge against possible prepayment, the Funds may
purchase certain options and options on futures contracts as
described more fully in "Other Investment Practices and Risk
Considerations" and the Statement of Additional Information.
Adjustable-Rate Securities. Adjustable-rate securities have
interest rates that are reset at periodic intervals, usually
by reference to some interest rate index or market interest
rate. Some adjustable-rate securities are backed by pools
of mortgage loans. The Short and Intermediate Funds will
only invest in adjustable-rate securities backed by pools of
mortgage loans ("ARMs"). The Fixed Income Segment of the
Equity Market Plus Fund may also invest in adjustable-rate
securities backed by assets other than mortgage pools.
Although the rate adjustment feature may act as a buffer to
reduce large changes in the value of adjustable-rate
securities, these securities are still subject to changes in
value based on changes in market interest rates or changes
in the issuer's creditworthiness. Because the interest rate
is reset only periodically, changes in the interest rate on
adjustable-rate securities may lag changes in prevailing
market interest rates. Also, some adjustable-rate
securities (or the underlying mortgages or other underlying
loans or receivables) are subject to caps or floors that
limit the maximum change in interest rate during a specified
period or over the life of the security. Because of the
resetting of interest rates, adjustable-rate securities are
less likely than non-adjustable-rate securities of
comparable quality and maturity to increase significantly in
value when market interest rates fall. Adjustable-rate
securities are also subject to the prepayment risks
associated generally with mortgage-backed securities.
Other Mortgage Backed Securities and Fixed Income
<PAGE>
17
Investments. The Short and Intermediate Funds and Fixed
Income Segment of the Equity Market Plus Fund may also
invest in other types of mortgage-backed and fixed income
securities including Collateralized Mortgage Obligations,
Stripped Securities, and zero coupon bonds. These types of
securities, including their risks, are described in detail
in the Statement of Additional Information. New instruments
and variations of existing mortgage-backed securities
continue to be developed. The Funds may invest in any such
instruments or variations to the extent consistent with
their investment objectives and policies and applicable
regulatory requirements.
OTHER INVESTMENT PRACTICES AND RISK CONSIDERATIONS
The Statement of Additional Information for each Fund
contains more detailed information about the following
practices, including limitations designed to reduce their
risks.
Adjusting Investment and Interest Rate Risk Exposure. A Fund
can use various techniques to increase or decrease its
exposure to changing security prices and indices, currency
exchange rates, interest rates or other factors that affect
security value, or to employ temporary substitutes for
anticipated future transactions. These techniques include
buying or selling financial futures contracts, purchasing
call or put options, or selling covered call options on such
futures or entering into currency exchange contracts or swap
agreements. Any or all of these techniques may be used at
one time, except that only the Financial Services Fund may
enter into currency exchange futures, forward or swap
contracts. Use of any particular transaction is a function
of market conditions. There is no overall limitation on the
percentage of a Fund's assets which may be subject to a
hedge position.
Swap agreements are two-party contracts entered into
primarily by institutional investors for periods ranging
from a few weeks to more than one year. In a standard swap
transaction, two parties agree to exchange the returns (or
differentials in rates of return) earned or realized on
particular predetermined investments or instruments, which
may be adjusted for an interest factor. The gross returns to
be exchanged or "swapped" between the two parties are
generally calculated with respect to a "notional amount",
i.e., the return on or increase in value of a particular
dollar amount invested at a particular interest rate, in a
particular foreign currency, or in a "basket" of securities
representing a particular index. Whether a Fund's use of
swap agreements will be successful in furthering its
investment objective will depend on the Advisor's ability to
predict correctly whether certain types of investments are
likely to produce greater returns than other investments.
Because they are two-party contracts and because they may
have terms of greater than seven days, swap agreements are
currently considered illiquid investments. Moreover, a Fund
bears the risk of loss of the amount expected to be received
<PAGE>
18
under a swap agreement in the event of the default or
bankruptcy of a swap agreement counterparty. The Funds will
enter into swap agreements only with counterparties that
meet certain standards for creditworthiness (generally such
counterparties would have to be eligible counterparties
under the terms of the Funds' repurchase agreement
guidelines). Certain restrictions imposed on the Funds by
the Internal Revenue Code may limit the Funds' ability to
use swap agreements. The swaps market is a relatively new
market and is largely unregulated. It is possible that
developments in the swaps market, including potential
government regulation, could adversely affect a Fund's
ability to terminate existing swap agreements or to realized
amounts to be received under such agreements.
Options and futures transactions involve costs and may
result in losses. The losses from investing in futures
transactions are potentially unlimited. In addition, the
effective use of options and futures strategies depends on a
Fund's ability to terminate options and futures positions at
times when the Adviser deems it desirable to do so. This
ability to terminate positions when the Adviser deems it
desirable to do so may be hindered by the lack of a liquid
secondary market. Although a Fund will take an options 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 a Fund will be able to
effect closing transactions at any particular time or at an
acceptable price.
The use of options and futures strategies also involves the
risk of imperfect correlation between movements in the
values of the securities underlying the futures and options
purchased and sold by a Fund, of the option and futures
contract itself, and of the securities which are the subject
of a hedge. For example, a Fund 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 for a Fund to incur a loss on both the hedged
securities and the hedging instrument. In the case of the
Short and Intermediate Funds, and the Fixed Income segment
of the Equity Market Plus Fund, this means that they may not
achieve, and may at times exceed, their targeted option-
adjusted durations.
Option-adjusted duration is a measure of the price
sensitivity of a portfolio to changes in interest rates.
The maturity of a security, another commonly used measure of
price sensitivity, measures only the time until final
payment is due, whereas option-adjusted duration takes into
account the pattern of all payments of interest and
principal on a security over time, including how these
payments are affected by prepayments and by changes in
interest rates. In computing the duration of a Fund's
portfolio, the Adviser will estimate the duration of
obligations that are subject to prepayment or redemption by
the issuer, taking into account the influence of changes in
<PAGE>
19
interest rates on prepayments and coupon flows.
At times, a Fund may sell interest rate futures in a
different dollar amount than the dollar amount of securities
being hedged, depending on the expected relationship between
the volatility of the prices of such securities and the
volatility of the futures contracts, based on duration
calculations by the Adviser. If the actual price movements
of the securities and futures are inconsistent with the
Adviser's estimates of their durations, the hedge may not be
effective.
The Short, Intermediate and Equity Market Plus Fund will not
maintain open short positions in interest rate futures
contracts if, in the aggregate, the value of the open
positions (marked to market) exceeds the current market
value of its fixed income securities portfolio plus or minus
the unrealized gain or loss on these open positions,
adjusted for the expected volatility relationship between
the portfolio and the futures contracts based on duration
calculations. If this limitation should be exceeded at any
time, a Fund will take prompt action to close out the
appropriate number of open contracts to bring its open
futures position into compliance with this limitation.
The Short and Intermediate Funds will not purchase a put or
call option on U.S. Government securities or mortgage-backed
securities if, as a result of such purchase, more than 10%
of its total assets would be invested in such options. The
Short and Intermediate Funds will engage in OTC option
transactions only with primary United States government
securities dealers recognized by the Federal Reserve Bank of
New York. The Short and Intermediate Funds will also not
sell options which are not covered.
The Equity Market Plus Fund will not purchase or sell 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 liquid securities in a segregated account with its
Custodian, in an amount which, together with the initial
margin deposit on the futures contract, is equal to the
current delivery or cash settlement value of the futures
contract. The Statement of Additional Information provides
additional information regarding equity swap contracts, S&P
500 and other stock index futures contracts and their
related risks.
In accordance with regulations established by the Commodity
Futures Trading Commission, each Funds' aggregate initial
margin and premiums on all futures and options contract
positions not held for bona fide hedging purposes, will not
exceed 5% of a Fund's net assets, after taking into account
unrealized profits and losses on such contracts.
The Funds' ability to engage in options and futures
<PAGE>
20
transactions and to sell related securities might also be
limited by tax considerations and by certain regulatory
requirements. See "Taxes" in the relevant Statement of
Additional Information.
Securities Lending, Repurchase Agreements and Forward
Commitments. The Funds may lend portfolio securities to
broker-dealers and may enter into repurchase agreements.
These transactions must be fully collateralized at all times
but involve some risk to the Funds if the other party should
default on its obligations and a Fund is delayed in or
prevented from recovering the collateral. None of the Funds
will lend portfolio securities if, as a result, the
aggregate of such loans exceeds 33 1/3% of the total asset
value (including such loans). The Funds will only enter into
repurchase agreements with or lend securities to (i) member
banks of the Federal Reserve System having total assets in
excess of $500 million and (ii) securities dealers, provided
such banks or dealers meet the creditworthiness standards
established by the Board of Trustees ("Qualified
Institutions"). The Adviser will monitor the continued
creditworthiness of Qualified Institutions, subject to the
oversight of the Board of Trustees.
The Funds may also purchase securities for future delivery,
which may increase overall investment exposure and involves
a risk of loss if the value of the securities declines prior
to the settlement date. At the time a Fund enters into a
transaction on a when-issued or forward commitment basis, a
segregated account consisting of liquid securities equal to
at least 100% of the value of the when-issued or forward
commitment securities will be established and maintained
with the Funds' custodian. Subject to this requirement, the
Funds may purchase securities on such basis without limit.
Settlements in the ordinary course, which may be
substantially more than three business days for mortgage-
backed securities, are not treated as when-issued or forward
commitment transactions, and are not subject to the
foregoing limitations, although some of the risks described
above may exist.
Reverse Repurchase Agreements, Dollar Roll Agreements and
Borrowing. The Funds may enter into reverse repurchase
agreements or dollar roll agreements with commercial banks
and registered broker-dealers in amounts up to 33 1/3% of
their assets. The Short and Intermediate Funds may only
enter into these transactions with commercial banks and
registered broker-dealers which are also Qualified
Institutions. The Statement of Additional Information for
each Trust contains a more detailed explanation of these
practices. Reverse repurchase agreements and dollar rolls
are considered borrowings by a Fund and require segregation
of assets with a Fund's custodian in an amount equal to the
Fund's obligations pending completion of such transactions.
Each Fund may also borrow money from banks in an amount up
to 33 1/3% of a Fund's total assets to realize investment
opportunities, for extraordinary or emergency purposes, or
for the clearance of transactions. Borrowing from banks
usually involves certain transaction and ongoing costs and
<PAGE>
21
may require a Fund to maintain minimum bank account
balances. Use of these borrowing techniques to purchase
securities is a speculative practice known as "leverage."
Depending on whether the performance of the investments
purchased with borrowed funds is sufficient to meet the
costs of borrowing, a Fund's net asset value per share will
increase or decrease, as the case may be, more rapidly than
if the Fund did not employ leverage.
Short Sales. The Funds may make short sales of securities.
A short sale is a transaction in which the Fund sells a
security it does not own in anticipation that the market
price of that security will decline. The Short,
Intermediate, and Equity Market Plus Funds expect to engage
in short sales as a form of hedging in order to shorten the
overall duration of the portfolio and maintain portfolio
flexibility. The Financial Services Fund may make short
sales of securities to reduce the risk of the portfolio to
the market or to increase return. While a short sale may act
as effective hedge to reduce the market or interest rate
risk of a portfolio, it may also result in losses which can
reduce the portfolio's total return.
When a Fund makes a short sale, it must borrow the security
sold short and deliver it to the broker-dealer through which
it made the short sale as collateral for its obligation to
deliver the security upon completion of the transaction. A
Fund may have to pay a fee to borrow particular securities,
and is often obligated to relinquish any payments received
on such borrowed securities.
Until a Fund replaces a borrowed security, it will maintain
daily a segregated account with its custodian into which it
will deposit liquid securities such that the amount
deposited in the account plus any amount deposited with the
broker as collateral will equal the current value of the
security sold short. Depending on arrangements made with
the broker, a Fund may not receive any payments (including
interest) on collateral deposited with the broker. If the
price of the security sold short increases between the time
of the short sale and the time a Fund replaces the borrowed
security, the Fund will incur a loss; conversely, if the
price declines, the Fund will realize a gain. Although a
Fund's gain is limited to the amount at which it sold the
security short, its potential loss is limited only by the
maximum attainable price of the security less the price at
which the security was sold.
A Fund will not make a short sale if, after giving effect
to such sale, the market value of all securities sold
exceeds 25% of the value of the Fund's total net assets. A
Fund may also effect short sales where the Fund owns, or has
the right to acquire at no additional cost, the identical
security (a technique known as a short sale "against the
box"). Such transactions might accelerate the recognition
of gain. See "Taxes" in the relevant Statement of
Additional Information.
Illiquid Securities. A Fund may invest up to 15% of its net
<PAGE>
22
assets in illiquid securities. The term illiquid securities
for this purpose means securities that cannot be disposed of
within seven days in the ordinary course of business. The
SEC staff takes the position that this includes non-
terminable repurchase agreements having maturities of more
than seven days.
The Financial Services Fund may invest in restricted
securities, which represent securities that can be sold in
privately negotiated transactions, pursuant to an exemption
from registration under the Securities Act of 1933, or in
registered public offering. Restricted securities deemed to
be liquid under procedures established by the Board are not
subject to the limitations on illiquid securities.
The determination of whether certain IO/PO Strips issued by
the U.S. Government and backed by fixed-rate mortgages or
any other securities in which a Fund desires to invest are
liquid shall be made by the Adviser under guidelines
established by the Trustees in accordance with applicable
pronouncements of the SEC. At present, all other IO/PO
Strips, other residual interests of CMOs and OTC options are
treated as illiquid securities. The SEC staff also
currently takes the position that the interest rate swaps,
caps and floors discussed in the Statement of Additional
Information, as well as equity swap contracts and reverse
equity swap contracts, are illiquid.
Portfolio Turnover. The Adviser buys and sells
securities for a Fund whenever it believes it is appropriate
to do so. Portfolio turnover generally involves some
expense to a Fund, including brokerage commissions or dealer
mark-ups and other transaction costs on the sale of
securities and reinvestment in other securities. Such
transactions may result in realization of taxable capital
gains. The portfolio turnover rate for each Fund's previous
fiscal periods is shown in the table under the heading
"Financial Highlights". The Adviser expects that for the
Financial Services Fund, the portfolio turnover rate will
not exceed 400%.
The portfolio turnover rates reported in the "Financial
Highlights" for the Short and Intermediate Funds for the
fiscal year ended March 31, 1997 were relatively high.
Since the Short and Intermediate Funds' portfolio holdings
are very liquid, the Funds may reposition its holdings
between different mortgage sectors relatively frequently,
but without generating substantial transaction costs. The
mortgage securities in which the Short, Intermediate and
Equity Market Plus Funds invest are generally traded on a
"net" basis with dealers acting as principals for their own
account without a stated commission.
The Funds will pay commissions in connection with options
and future transactions and, for the Equity Market Plus Fund
and Financial Services Fund, in relation to any purchase of
common stocks or other equity securities.
Until March 31, 1998, for the Short, Intermediate, and
<PAGE>
23
Equity Market Plus Funds only, another potential consequence
of high portfolio turnover is that if 30% or more of a
Fund's gross income for a taxable year is derived from gains
from the sale of securities held for less than three months,
the Fund will 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 these Funds and to adjust the
portfolio turnover, if necessary, to ensure that each Fund
will be eligible for treatment as a regulated investment
company.
MANAGEMENT OF THE FUNDS
Its Board of Trustees manages the business affairs of the
Funds. Each of the Funds has entered into an investment
advisory agreement with Smith Breeden Associates, Inc., 100
Europa Drive, Chapel Hill, North Carolina, 27514 (the
"Investment Advisory Agreements"). Pursuant to such
investment advisory agreements, the Adviser furnishes
continuous investment advisory services to each of the
Funds.
Trustees and Officers
The following is a listing of the Trustees and officers of
the Series Fund and Trust, the legal entities that have
issued shares in the Funds. Unless otherwise indicated, all
of the named individuals serve in their capacities for both
the Series Fund and Trust.
Douglas T. Breeden* Trustee and Chairman
Portfolio Manager, Financial
Services Fund
Dr. Breeden, the Chairman of the Board of Smith Breeden
Associates, co-founded the firm in 1982. In conjunction
with Michael J. Giarla and Robert B. Perry, he is
responsible for the day-to-day operations of the Financial
Services Fund. Dr. Breeden has served on business school
faculties at Duke University, Stanford University and the
University of Chicago, and as a visiting professor at Yale
University and at the Massachusetts Institute of Technology.
He is the Editor of the Journal of Fixed Income. Dr.
Breeden served as Associate Editor for five journals in
financial economics, and was elected to the Board of
Directors of the American Finance Association. He has
published several well-cited articles in finance and
economics journals. He holds a Ph.D. in Finance from the
Stanford University Graduate School of Business, and a B.S.
in Management Science from the Massachusetts Institute of
Technology. He serves as Chairman of Harrington Financial
Group, the holding company for Harrington Bank, F.S.B., of
Richmond, Indiana.
* Interested Person
<PAGE>
24
Michael J. Giarla* Trustee and President
Portfolio Manager, Financial
Services Fund
Mr. Giarla is Chief Operating Officer, President and
Director of Smith Breeden Associates. In conjunction with
Douglas T. Breeden and Robert B. Perry, he is responsible
for the day-to-day operations of the Financial Services
Fund. He also serves as a Director of Harrington Financial
Group, the holding company for Harrington Bank, F.S.B., of
Richmond, Indiana. Formerly Smith Breeden's Director of
Research, he was involved in research and programming,
particularly in the development and implementation of models
to evaluate and hedge mortgage securities. He also consults
with institutional clients and conducts special projects.
Before joining Smith Breeden Associates, Mr. Giarla was a
Summer Associate in Goldman Sachs & Company's Equity
Strategy Group in New York. Mr. Giarla has published a
number of articles and book chapters regarding MBS
investment, risk management and hedging. He served as an
Associate Editor of The Journal of Fixed Income from 1991-
1993. Mr. Giarla holds a Master of Business Administration
with Concentration in Finance from the Stanford University
Graduate School of Business, where he was an Arjay Miller
Scholar. He earned a Bachelor of Arts in Statistics, summa
cum laude, from Harvard University, where he was elected to
Phi Beta Kappa and was a Harvard Club of Boston Scholar.
Mr. Giarla is a Trustee of the Roxbury Latin School, West
Roxbury, Massachusetts.
* Interested Person
Stephen M. Schaefer Trustee
Stephen M. Schaefer is Esmee Fairbairn Professor of Finance
at the London Business School. Previously on the Faculty of
the Graduate School of Business of Stanford University, he
has also taught at the Universities of California
(Berkeley), Chicago, British Columbia and Venice. His
research interests focus on capital markets and financial
regulation. He served on the editorial board of a number of
professional journals including, currently, the Journal of
Fixed Income, the Review of Derivative Research, and
Ricerche Economiche. He consults for a number of leading
financial institutions and is a former Independent Board
Member of the Securities and Futures Authority of Great
Britain.
Myron S. Scholes Trustee
Myron S. Scholes is a Principal in the money management firm
Long-Term Capital Management Co. (since 1993). He is the
Frank E. Buck Professor of Finance Emeritus at the Graduate
School of Business at Stanford University (since 1983). He
is a member of the Econometric Society. Professor Scholes
was also a Managing Director and co-head of the fixed income
derivatives group at Salomon Brothers between 1991-1993.
Prior to coming to Stanford University in 1983, Professor
Scholes was the Edward Eagle Brown Professor of Finance at
<PAGE>
25
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 Ph.D. in 1969
from the Graduate School of Business, University of Chicago.
He has honorary Doctor of Law degrees from the University of
Paris and McMaster University. He is a past president of
the American Finance Association (1990).
Dr. Scholes has published numerous articles in academic
journals and in professional volumes. He is most noted as
the co-originator of the Black-Scholes Options Pricing Model
as described in the paper, "The Pricing of Options and
Corporate Liabilities," published in the Journal of
Political Economy (with Fischer Black, May 1973), for which
he was awarded the Nobel Prize in Economic Sciences in 1997.
His other papers include such topics as risk-return
relationships, the effects of dividend policy on stock
prices, and the effects of taxes and tax policy on corporate
decision making. His book with Mark Wolfson (Stanford
University) Taxes and Business Strategy: A Planning Approach
was published by Prentice Hall in 1991.
William F. Sharpe Trustee
William F. Sharpe is the STANCO 25 Professor of Finance at
Stanford University's Graduate School of Business. He is
best known as one of the developers of the Capital Asset
Pricing Model, including the beta and alpha concepts used in
risk analysis and performance measurement. He developed
the widely used binomial method for the valuation of options
and other contingent claims. He also developed the computer
algorithm used in many asset allocation procedures, a
procedure for estimating the style of an investment manager
from its historic returns, and the Sharpe ratio for
measuring investment performance. Dr. Sharpe has published
articles in a number of professional journals. He has also
written six books, including Portfolio Theory and Capital
Markets, (McGraw-Hill, 1970), Asset Allocation Tools,
(Scientific Press, 1987), Fundamentals of Investments (with
Gordon J. Alexander and Jeffery Bailey, Prentice-Hall, 1993)
and Investments (with Gordon J. Alexander and Jeffrey
Bailey, Prentice-Hall, 1990). Dr. Sharpe is a past
President of the American Finance Association. He also
served as consultant to a number of corporations and
investment organizations. He is Trustee of the Barr
Rosenberg mutual funds, a director of Stanford Management
Company and the Chairman of the Board of Financial Engines,
a company providing electronic portfolio advice. He
received the Nobel Prize in Economic Sciences in 1990.
Daniel C. Dektar Vice President, Smith Breeden
Series Fund
Portfolio Manager, Short and
Intermediate Funds
<PAGE>
26
Daniel C. Dektar is a Principal, Executive Vice President,
Director of Portfolio Management, and Director of Smith
Breeden Associates. Mr. Dektar has been primarily
responsible for the day-to-day management of the Short and
Intermediate Funds since their commencement of operations in
1992. On December 31, 1997, Timothy D. Rowe will join Mr.
Dektar as co-Portfolio Manager of the Intermediate Fund, and
will thereafter share responsibility for the day-to-day
management of that Fund. As head of Smith Breeden
Associates' portfolio management group, Mr. Dektar is
constantly in touch with developments on Wall Street.
He serves as a liaison among the portfolio management,
client service, and research groups to ensure accurate
analysis and timely execution of portfolio management
opportunities. Mr. Dektar consults with institutional
clients in the areas of investments and risk management.
He made several presentations on mortgage investments and
risk management at seminars for institutional
investors. Mr. Dektar was an Associate in the Mergers and
Acquisitions Group of Montgomery Securities in San Francisco,
California and a Financial Analyst in the Investment
Banking Division of Morgan Stanley & Co., Incorporated,
New York before joining Smith Breeden Associates. He
holds a Master of Business Administration with Concentration
in Finance from Stanford University Graduate School of
Business, where he was an Arjay Miller Scholar. Mr. Dektar
received a Bachelor of Science in Business Administration,
summa cum laude, from the University of California
at Berkeley, where he was University of California
Regent's Scholar, was elected to Phi Beta Kappa and Phi Eta
Sigma, and won the White Award as the top student in finance.
Timothy D. Rowe Portfolio Manager, Intermediate Fund
(Effective December 31, 1997)
Timothy D. Rowe is a Principal, Director, and Vice President of
Smith Breeden Associates. Effective December 31, 1997, Mr. Rowe,
in conjunction with Daniel C. Dektar, will be responsible for the
day-to-day management of the Intermediate Fund. Mr. Rowe is a
senior portfolio manager working primarily with discretionary
separate account clients. He implements investment strategies
designed to generate portfolio returns superior to the broad
investment grade and mortgage market indices. Mr. Rowe joined
Smith Breeden in 1988. His prior experience includes three years
as Assistant Economist at the Federal Reserve Bank of Richmond,
Virginia. While at the Bank, he co-edited the sixth edition of
Instruments of the Money Market, and produced research papers for
publication in the Bank's Economic Review magazine. He holds a
Master of Business Administration with specialization in Finance
from the University of Chicago Graduate School of Business, and a
Bachelor of Arts in Economics and History from Duke University.
He graduated from Duke magna cum laude, earned Class Honors and
was a National Merit Scholar.
John B. Sprow Vice President, Smith Breeden
Trust
Portfolio Manager, Equity Market
Plus Fund
<PAGE>
27
John B. Sprow is a Principal, Director and Executive Vice
President of Smith Breeden Associates. Mr. Sprow has been
primarily responsible for the day-to-day management of the
Equity Market Plus Fund from the commencement of its
operations in 1992. Mr. Sprow is a senior portfolio manager
who works primarily with discretionary pension accounts. In
addition to traditional mortgage accounts, he also manages
S&P 500 indexed accounts. Prior to directly managing
discretionary accounts, Mr. Sprow assisted in the
development of the Adviser's models for pricing and hedging
mortgage-related securities, risky commercial debt, and
forecasting mortgage prepayment behavior. Mr. Sprow came to
Smith Breeden Associates from the Fuqua School of Business,
Duke University, where he was Research Assistant.
Previously, Mr. Sprow was a Research Assistant to the
Department Head of the Materials Science Department, Cornell
University. He received a Master of Business Administration
with Emphasis in Finance from the Fuqua School of Business,
Duke University. Mr. Sprow holds a Bachelor of Science in
Materials Science and Engineering from Cornell University,
where he was awarded the Carpenter Technology Scholarship
three successive years.
Robert B. Perry Vice President, Smith Breeden
Trust
Portfolio Manager, Financial
Services Fund
Robert B. Perry is a Principal at Smith Breeden Associates,
providing hedging and investment advice to Smith Breeden's
financial services clients. He is also responsible for
calculating market-to-market values and projected income of
institutions, and assesses the effects of interest rate and
economic changes. In conjunction with Douglas T. Breeden
and Michael J. Giarla, Mr. Perry is responsible for the day-
to-day operations of the Financial Services Fund. Prior to
joining Smith Breeden, Mr. Perry served as an interest rate
risk analyst for Centura Bank, and secretary to the ALCO
committee. He has also served as a Director for Community
First Financial Group, a multi-bank holding company located
in Indianapolis, Indiana. Mr. Perry earned his Bachelor of
Arts in Business Administration from North Carolina State
University.
Marianthe S. Mewkill Vice President, Secretary,
Treasurer, and
Chief Accounting Officer
Marianthe S. Mewkill is a Principal, Vice President and
Chief Financial Officer of Smith Breeden Associates. Ms.
Mewkill handles financial reporting, budgeting, tax research
and planning for the Smith Breeden Mutual Funds and for
Smith Breeden Associates, Inc. She ensures compliance with
agency regulations and administers the Adviser's internal
trading and other policies. She was previously employed as
a Controller for the Hunt Alternatives Fund, as an Associate
at Goldman Sachs & Co., and as a Senior Auditor at Arthur
Andersen & Co. She earned a Master of Business
Administration with Concentrations in Finance and Accounting
<PAGE>
28
from New York University and graduated from Wellesley
College, magna cum laude with a Bachelor of Arts degree in
History and French and a Minor in Economics.
Investment Adviser
Smith Breeden Associates, Inc., a registered investment
adviser, acts as investment adviser to the Funds.
Approximately 66% of the Adviser's voting stock is owned by
Douglas T. Breeden, its Chairman. Under its Investment
Advisory Agreement with each Fund, the Adviser, subject to
the general supervision of the Board of Trustees, manages
the Funds' portfolios and provides for the administration of
all of the Funds' other affairs. For these services, the
Adviser receives a fee, computed daily and payable monthly,
at the annual rate of 0.70% of the Short, Intermediate and
Equity Market Plus Funds' average daily net assets. The
Adviser receives a fee at the rate of 1.50% for its
management of the Financial Services Fund. Until the renewal
date of its contracts with the Funds, August 1, 1998, the
Adviser has voluntarily agreed to reduce its compensation,
and to the extent necessary absorb other expenses of the
Funds, such that the total expenses (exclusive of ordinary
brokerage commissions, investment transaction taxes and
extraordinary expenses) do not exceed 0.88% of the average
net assets for each of the Equity Market Plus Fund and the
Intermediate Fund, 0.78% of the average net assets of the
Short Fund and 1.50% of the Financial Services Fund.
The Adviser places all orders for purchases and sales of the
Funds' securities. Subject to seeking the most favorable
price and execution available, the Adviser may consider
sales of shares of the Funds as a factor in the selection of
broker-dealers.
Distribution
FPS Broker Services, Inc. (the "Principal Underwriter") acts
as distributor for the Funds for which the Adviser pays the
Principal Underwriter an annual fee of $30,000. Shares may
also be sold by authorized dealers who have entered into
dealer agreements with the Principal Underwriter or the
Adviser.
Expenses
The Funds pay all of their own expenses, including, without
limitation, the cost of preparing and printing their
registration statements required under the Securities Act of
1933 and the 1940 Act and any amendments thereto, the
expense of registering their shares with the Securities and
Exchange Commission and the various states, the printing and
distribution costs of prospectuses mailed to existing
investors, reports to investors, reports to government
authorities and proxy statements, fees paid to directors who
are not interested persons of the Adviser, interest charges,
<PAGE>
29
taxes, legal expenses, association membership dues, auditing
services, insurance premiums, brokerage commissions and
expenses in connection with portfolio transactions, fees and
expenses of the custodian of their assets, printing and
mailing expenses and charges and expenses of dividend
disbursing agents, accounting services agents, registrars
and stock transfer agents.
PRICING OF FUND SHARES
The price you pay when buying a Fund's shares, and the price
you receive when selling (redeeming) a Fund's shares, is the
net asset value of the shares next determined after receipt
of a purchase or redemption request in proper form. No front-
end sales charge or commission of any kind is added by the
Fund upon a purchase, and no charge is deducted upon
redemption. These charges may apply if you purchase or sell
shares through certain broker-dealers. The Funds currently
charge a $9 fee for each redemption made by wire. See "How
to Redeem Shares."
The per share net asset value of a Fund is determined by
dividing the total value of its assets, less its
liabilities, by the total number of its shares outstanding
at that time. The net asset value is determined as of the
close of regular trading (usually at 4:00 p.m. Eastern time)
each day that the Adviser and Transfer Agent are open for
business and on which there is a sufficient degree of
trading in a Fund's securities such that the net asset value
of a Fund's shares might be affected. Accordingly, Purchase
Applications accepted or redemption requests received in
proper form by the Transfer Agent, or other agent designated
by the Funds, prior to the close of regular trading each day
that the Adviser and Transfer Agent are open for business,
will be confirmed at that day's net asset value. Purchase
Applications accepted or redemption requests received in
proper form after the close of regular trading by the
Transfer Agent, or other agent designated by the Funds, will
be confirmed at the net asset value of the following
business day.
Current holiday schedules indicate that the Funds' net
asset values will not be calculated on New Year's Day,
Martin Luther King Day, President's Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day,
the day following Thanksgiving, Christmas Eve and Christmas
Day. The Short and Intermediate Funds will also not be
priced on Columbus Day and Veterans' Day.
Under procedures approved by the Board of Trustees, a Fund's
securities for which market quotations are readily available
are valued at current market value provided by a pricing
service, bank or broker-dealer experienced in such matters.
Short-term investments that will mature in 60 days or less
are generally valued at amortized cost, which approximates
market value. All other securities and assets are valued at
fair market value as determined by following procedures
approved by the Board of Trustees.
<PAGE>
30
HOW TO PURCHASE SHARES
All of the Funds are no-load, so you may purchase, redeem
or exchange shares directly at net asset value without
paying a sales charge. Because the Funds' net asset value
changes daily, your purchase price will be the next net
asset value determined after the Funds' Transfer Agent, or
other agent designated by the Funds, receives and accepts
your purchase order. See "Pricing of Fund Shares."
Initial Minimum Additional Minimum
Type of Account Investment Investment
Regular $1000 $50
Automatic
Investment Plan None $50
Individual
Retirement
Account $250 $50
Gift to Minors $250 $50
Each Fund reserves the right to reject any orders for the
purchase of its shares or to limit or suspend, without prior
notice, the offering of its shares. The required minimum
investments may be waived in the case of qualified
retirement plans.
How to Open Your Account by Mail. Please complete the
Purchase Application. You can obtain additional copies of
the Purchase Application and a copy of the IRA Purchase
Application from the Funds by calling 1-800-221-3138.
Your completed Purchase Application should be mailed
directly to:
Smith Breeden Mutual Funds
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA 19406-0903
All applications must be accompanied by payment in the
form of a check or money order made payable to "Smith
Breeden Mutual Funds." All purchases must be made in U.S.
dollars, and checks must be drawn on U.S. banks. No cash,
credit cards or third party checks will be accepted. When a
purchase is made by check and a redemption is made shortly
thereafter, the Funds will delay the mailing of a redemption
check until the purchase check has cleared your bank, which
may take up to 15 calendar days from the purchase date. If
you contemplate needing access to your investment shortly
after purchase, you should purchase the shares by wire as
discussed below.
How to Open Your Account by Wire. You may make purchases
by direct wire transfers. To ensure proper credit to your
account, please call the Funds at 1-800-221-3137 for
<PAGE>
31
instructions prior to wiring funds. Funds should be wired
through the Federal Reserve System as follows:
United Missouri Bank
A.B.A. Number 10-10-00695
For the account of FPS Services, Inc.
Account Number 98-7037-071-9
For credit to (identify which Fund to purchase)
For further credit to: (investor account number)
(name or account registration)
(Social Security or Tax Identification Number)
Following such wire transfer, you must promptly complete a
Purchase Application and mail it to the Funds at the
following address: Smith Breeden Mutual Funds, 3200 Horizon
Drive, P.O. Box 61503, King of Prussia, PA 19406-0903.
Shares will be redeemed with Federal tax withheld if the
Funds do not receive a properly completed and executed
Purchase Application.
Telephone Transactions. The privilege to initiate
redemption or exchange transactions by telephone is made
automatically available to shareholders when opening an
account, unless they indicate otherwise by checking the
appropriate boxes on the Purchase Application. Each Fund
will employ reasonable procedures to ensure that
instructions communicated by telephone are genuine. If
reasonable procedures are not implemented, the Funds may be
liable for any loss due to unauthorized or fraudulent
transactions. In all other cases, you are liable for any
loss due to unauthorized transactions. The Funds reserve
the right to refuse a telephone transaction if they believe
it is advisable to do so.
If you have any questions, please call the Funds at 1-800-
221-3138.
How to Add to Your Account. You may make additional
investments by mail or by wire in an amount equal to or
greater than $50. When adding to an account by mail, you
should send the Funds your check, together with the
additional investment form from a recent statement. If this
form is unavailable, you should send a signed note giving
the full name of the account and the account number. For
additional investments made by wire transfer, you should use
the wiring instructions listed above. Be sure to include
your account number.
Automatic Investment Plan. You may make purchases of
shares of each Fund automatically on a regular basis ($50
minimum per transaction). You have two options under the
Plan to make investments. One is by automatic payroll
deduction. Under this method, you authorize your employer
to direct a portion of each paycheck to be invested in the
Fund of your choice. Your employer must be using direct
deposit to process its payroll in order for you to elect
this method. Under the other method, your bank debits a pre-
authorized amount from your checking or savings account each
month and applies the amount to your investment in Fund
<PAGE>
32
shares. In order to have your bank account debited
automatically for investment into the Funds, your financial
institution must be a member of the Automated Clearing
House. No service fee is currently charged by the Funds for
participation in either method under the Plan. A $20 fee
will be imposed by the Funds if sufficient funds are not
available in your bank account, or if your bank account has
been closed at the time of the automatic transaction. You
may adopt either method under the Plan at the time an
account is opened by completing the appropriate section of
the Purchase Application. Enclosed with the application are
the necessary forms to deliver to your employer to set up
the payroll deduction. You may obtain an application to
establish the Automatic Investment Plan after an account is
opened by calling the Funds at 1-800-221-3138. In the event
you discontinue participation in the Plan, the Funds reserve
the right to redeem your Fund account involuntarily, upon
sixty days' written notice, if the account's net asset value
is $1000 or less.
Purchasing Shares Through Other Institutions. The Funds
have authorized dealers besides the Principal Underwriter to
accept on its behalf purchase and redemption orders. If you
purchase shares through a program of services offered or
administered by one of these broker-dealers, financial
institutions, or other service provider, you should read the
program materials, including information relating to fees,
in addition to this Prospectus. Certain services of a Fund
may not be available or may be modified in connection with
the program of services provided, and service providers may
establish higher minimum investment amounts. The Funds may
only accept requests to purchase additional shares into a
broker-dealer street name account from the broker-
dealer.
Certain broker-dealers, financial institutions, or other
service providers that have entered into an agreement with
the Adviser or Principal Underwriter may enter purchase and
redemption orders on behalf of their customers by phone,
with payment to follow within several days as specified in
the agreement. These broker-dealers and service providers
may designate other intermediaries to accept purchase and
redemption orders on the Funds' behalf. The Funds will be
deemed to have effected such purchase or redemption orders
at the net asset value next determined after acceptance of
the telephone purchase order by the authorized broker or the
authorized broker's designee. It is the responsibility of
the broker-dealer, financial institution, or other service
provider to place the order with the Funds on a timely
basis. If payment is not received within the time specified
in the agreement, the broker-dealer, financial institution,
or other service provider could be held liable for any
resulting fees or losses.
Miscellaneous. The Funds will charge a $20 service fee
against your account for any check or electronic funds
transfer that is returned unpaid. You will also be
responsible for any losses suffered by the Funds as a
result. In order to relieve you of responsibility for the
<PAGE>
33
safekeeping and delivery of stock certificates, the Funds do
not currently issue certificates.
HOW TO EXCHANGE SHARES
Shares of any Fund may be exchanged for shares of another
Fund at any time. This exchange offer is available only in
states where shares of such other Fund may be legally sold.
You may open a new account, or purchase additional shares in
an existing account, by making an exchange from an
identically registered Smith Breeden Fund account. A new
account will have the same registration as the existing
account from which the exchange was made, and is subject to
the same initial investment minimums.
Exchanges may be made either in writing or by telephone.
Written instructions should be mailed to 3200 Horizon Drive,
King of Prussia, PA 19406 and must be signed by all account
owners, and accompanied by any properly endorsed outstanding
share certificates, if applicable. The telephone exchange
is automatically accepted unless checked otherwise. The
telephone exchange privilege is available only for
uncertificated shares. During periods of drastic economic
or market changes, it is possible that exchanges by
telephone may be difficult to implement. In this event,
shareholders should follow the written exchange procedures.
The telephone exchange privilege may be modified or
discontinued by the Funds at any time upon a 60-day notice
to the shareholders. To exchange by telephone, you must
follow the instructions below under "How to Redeem by
Telephone."
The Funds will accept exchange orders by telephone or other
means of electronic transmission from broker-dealers,
financial institutions or other service providers who
execute an agreement with the Adviser or Principal
Underwriter. It is the responsibility of the broker-dealer,
financial institution or other service provider to place the
exchange order on a timely basis.
Exchanges are made on the basis of the Funds' relative
net asset values. Because the exchange is considered a
redemption and purchase of shares, the shareholder may
recognize a gain or loss for federal income tax purposes.
Backup withholding and information reporting may also apply.
Additional information regarding the possible tax
consequences of such an exchange is included under the
caption "Taxes" in the Funds' Statements of Additional
Information.
There are differences among the Funds. When exchanging
shares, shareholders should be aware that the Funds might
have different dividend payment dates. The dividend payment
schedules should be checked before exchanging shares. The
amount of any accumulated, but unpaid, dividend is included
in the net asset value per share.
If you buy shares by check, you may not exchange those
<PAGE>
34
shares for up to 15 calendar days to ensure your check has
cleared. If you intend to exchange shares soon after their
purchase, you should purchase the shares by wire or contact
the Funds at 1-800-221-3137 for further information.
The Funds reserve the right to temporarily or permanently
terminate, with or without advance notice, the exchange
privilege of any investor who makes excessive use of the
exchange privilege (e.g., more than four exchanges per
calendar year).
Additional documentation may be required for exchange
requests if shares are registered in the name of a
corporation, partnership or fiduciary. Please contact the
Funds for additional information concerning the exchange
privilege.
HOW TO REDEEM SHARES
You may redeem shares of the Funds at any time. The price at
which the shares will be redeemed is the net asset value per
share next determined after proper redemption instructions
are received by the Transfer Agent or other agent designated
by the Funds. See "Pricing of Fund Shares." There are no
charges for the redemption of shares, except that a fee of
$9 is charged for each wire redemption. Depending upon the
redemption price you receive, you may realize a capital gain
or loss for federal income tax purposes.
How to Redeem by Mail to Receive Proceeds by Check. To
redeem shares by mail, simply send an unconditional written
request to the Funds specifying the number of shares or
dollar amount to be redeemed, the name of the Fund, the
name(s) on the account registration and the account number.
A request for redemption must be signed exactly as the
shares are registered. If the amount requested is greater
than $25,000, or the proceeds are to be sent to a person
other than the recordholder or to a location other than the
address of record, each signature must be guaranteed by a
commercial bank or trust company in the United States, a
member firm of the National Association of Securities
Dealers, Inc. or other eligible guarantor institution. A
notary public is not an acceptable guarantor. Guarantees
must be signed by an authorized signatory of the bank, trust
company, or member firm, and "Signature Guaranteed" must
appear with the signature. Additional documentation may be
required for the redemption of shares held in corporate,
partnership or fiduciary accounts. In case of any questions,
please contact the Funds in advance.
A Fund will mail payment for redemption within seven days
after receiving proper instructions for redemption. However,
the Funds will delay payment for 15 calendar days on
redemptions of recent purchases made by check. This allows
the Funds to verify that the check used to purchase Fund
shares will not be returned due to insufficient funds and is
intended to protect the remaining investors from loss.
<PAGE>
35
How to Redeem by Telephone. The redemption of shares by
telephone is available automatically unless you elected to
refuse this redemption privilege on your Purchase
Application. Shares may be redeemed by calling the Funds at
1-800-221-3137. Proceeds redeemed by telephone will be
mailed to your address, or wired or credited to your pre-
authorized bank account. To establish wire redemption
privileges, you must select the appropriate box on the
Purchase Application and enclose a voided check.
In order to arrange for telephone redemptions after your
account has been opened, or to change the bank account or
address designated to receive redemption proceeds, you must
send a written request to your Fund. The request must be
signed by each registered holder of the account with the
signatures guaranteed by a commercial bank or trust company
in the United States, a member firm of the National
Association of Securities Dealers, Inc. or other eligible
guarantor institution. A notary public is not an acceptable
guarantor. Further documentation as provided above may be
requested from corporations, executors, administrators,
trustees and guardians.
Payment of the redemption proceeds for Fund shares redeemed
by telephone where you request wire payment will normally be
made in federal funds on the next business day. The Funds
reserve the right to delay payment for a period of up to
seven days after receipt of the redemption request. There is
currently a $9 fee for each wire redemption, which will be
deducted from your account.
The Funds reserve the right to refuse a telephone redemption
or exchange transaction if they believe it is advisable to
do so. Procedures for redeeming or exchanging shares of the
Funds by telephone may be modified or terminated by the
Funds at any time. In an effort to prevent unauthorized or
fraudulent redemption or exchange requests by telephone, the
Funds have implemented procedures designed to reasonably
assure that telephone instructions are genuine. These
procedures include: requesting verification of certain
personal information; recording telephone transactions;
confirming transactions in writing; and restricting
transmittal of redemption proceeds only to pre-authorized
designations. Other procedures may be implemented from time
to time. If reasonable procedures are not implemented, the
Funds may be liable for any loss due to unauthorized or
fraudulent transactions. In all other cases, you are liable
for any loss for unauthorized transactions.
You should be aware that during periods of substantial
economic or market change, telephone or wire redemptions may
be difficult to implement. If you are unable to contact the
Funds by telephone, you may also redeem shares by delivering
or mailing the redemption request to: Smith Breeden Mutual
Funds, 3200 Horizon Drive, P.O. Box 61503, King of Prussia,
PA 19406-0903.
The Funds reserve the right to suspend or postpone
redemptions during any period when trading on the New York
<PAGE>
36
Stock Exchange ("Exchange") is restricted as determined by
the Securities and Exchange Commission ("SEC"), or the
Exchange is closed for other than customary weekend and
holiday closing; the SEC has by order permitted such
suspension; or an emergency, as determined by the SEC,
exists, making disposal of portfolio securities or valuation
of net assets of a Fund not reasonably practicable.
Due to the relatively high cost of maintaining small
accounts, if your account balance falls below $1000 as a
result of a redemption or exchange, or if you discontinue
the Automatic Investment Plan before your account balance
reaches $1000, you may be given a 60-day notice to bring
your balance to $1000 or reactivate an Automatic Investment
Plan. If this requirement is not met, your account may be
closed and the proceeds sent to you.
Check Writing. In addition to telephone and written
redemption requests, the Short Fund offers redemption
through check writing. Shareholders electing this option
will receive checks that may be used like personal or
business checks. Checks are not ordered to be mailed to the
shareholder until 15 days after the account is opened, if
the account is opened by check by the shareholder. This
allows the Fund to verify that the check used to open the
account will not be returned due to insufficient funds.
There is no limit on the number of checks you may write.
Checks must be written for at least $100. There is a $30
fee for returned checks. Because dividends declared on
shares held in a shareholder's account, prior redemptions,
and possible changes in net asset value may cause the
value of the account to change, shareholders should not
write a check for the entire value of the account or close
the account by writing a check.
In using the check writing privilege, shareholders bear the
responsibility of ensuring that the check amount does not
exceed the value of their account on the day the check is
presented to the Transfer Agent for payment. The day the
check is presented for payment is the day the redemption of
Fund shares takes place. If insufficient shares are in the
account, the check will be returned and no shares will be
redeemed. The clearing agent for the check writing facility
is United Missouri Bank. Shareholders utilizing check
writing are subject to United Missouri Bank's rules
governing checking accounts. However, this check writing
facility is purely a means to redeem Fund shares. No
facilities characteristic of bank accounts, such as deposit
insurance, are provided along with the check writing option.
If you would like to initiate check writing, please call
Shareholder Services at 1-800-221-3137 or check the
appropriate box on the Purchase Application.
Systematic Withdrawal Plan. A shareholder may establish a
Systematic Withdrawal Plan to receive regular periodic
payments from the account. An initial balance of $10,000 is
required to establish a Systematic Withdrawal Plan. There
are no service charges for establishing or maintaining a
<PAGE>
37
Systematic Withdrawal Plan. The minimum amount which the
shareholder may withdraw periodically is $100. Capital gain
distributions and income dividends to the shareholder's
account are received in additional shares at net asset
value. Payments are then made from the liquidation of
shares at net asset value to meet the specified withdrawals.
Liquidation of shares may reduce or possibly exhaust the
shares in the shareholder's account, to the extent
withdrawals exceed shares earned through dividends and
distributions, particularly in the event of a market
decline. No payment pursuant to a Systematic Withdrawal
Plan will be made if there are insufficient shares on
deposit on the date of the scheduled distribution. A
subsequent deposit of shares will not result in a payment
under the plan retroactive to the distribution date. As
with other redemptions, a liquidation to make a withdrawal
payment is a sale for federal income tax purposes. The
entire Systematic Withdrawal Plan payment cannot be
considered as actual yield or income since part of the
Plan's payment may be a return of capital.
A Systematic Withdrawal Plan may be terminated upon written
notice by the shareholder, or by a Fund on a 30 day written
notice, and it will terminate automatically if all shares
are liquidated or withdrawn from the account or upon the
Fund's receipt of notification of the death or incapacity of
the shareholder. Shareholders may change the amount (but
not below the specified minimums) and schedule of withdrawal
payments, or suspend such payments, by giving written notice
to the Transfer Agent at least five business days prior to
the next scheduled payment. Share certificates may not be
issued while a Systematic Withdrawal Plan is in effect.
DIVIDENDS AND DISTRIBUTIONS
The Short and Intermediate Funds intend to make monthly
distributions to their shareholders of net investment
income. The Equity Market Plus Fund intends to make
quarterly distributions of net investment income. All Funds
will distribute net realized gains at least annually. The
Financial Services Fund will most likely make only this
annual distribution of net realized gains, and at this time,
will also distribute any net investment income. Each Fund
may make additional distributions if necessary to avoid
imposition of a 4% excise tax or other tax on undistributed
income and gains.
The monthly distributions for the Short Fund's shares are
quoted ex-dividend on the business day after record date
(the "ex-date"). Record date is usually the first or second
business day of the month. If a shareholder elects to
reinvest dividends, the date the dividends are reinvested is
also the ex-date. Dividends are paid in cash by the Short
Fund generally one week after the ex-date.
The Intermediate Fund will declare daily dividends for
shareholders of record. The Intermediate Fund's dividend
payable date, and the day that dividends are reinvested for
<PAGE>
38
shareholders who have made this election, is the last
business day of the month. Shares begin accruing dividends
on the business day after federal funds (funds credited to a
member bank's account at the Federal Reserve Bank) are
available from the purchase payment for such shares, and
continue to accrue dividends through and including the day
the redemption order for the shares is executed. If an
investor closes his account, any accrued dividends through
and including the day of redemption will be paid as part of
the redemption proceeds.
Dividends and capital gains distributions may be declared
more or less frequently at the direction of the Trustees.
In order to be entitled to a dividend or a distribution, an
investor must acquire a Fund's shares on or before the
record date. Caution should be exercised, however, before
purchasing shares immediately prior to a distribution record
date. Since the value of a Fund's shares is based directly
on the amount of its net assets, rather than on the
principle of supply and demand, any distribution of income
or capital gain will result in a decrease in the value of
its shares equal to the amount of the distribution. While a
dividend or capital gain distribution received shortly after
purchasing shares represents, in effect, a return of the
shareholder's investment, it may be taxable as dividend
income or capital gain. You may separately elect to
reinvest income dividends and capital gains distributions in
shares of a Fund or receive cash as designated on the
Purchase Application. You may change your election at any
time by sending written notification to your Fund. The
election is effective for distributions with a dividend
record date on or after the date that the Funds receive
notice of the election. If you do not specify an election,
all income dividends and capital gains distributions will
automatically be reinvested in full and fractional shares of
the Fund from which they were paid. Shareholders may also
elect to have dividends automatically reinvested in a fund
different than the one from which the dividends were paid. A
shareholder may write the transfer agent, or complete the
appropriate section of the Purchase Application, to
designate such an election, but must have already
established an account in the other fund. The transfer
agent's address is on the back of the Prospectus. Reinvested
dividends and distributions receive the same tax treatment
as those paid in cash.
SHAREHOLDER REPORTS AND INFORMATION
The Funds will provide the following statements and reports:
Confirmation and Account Statements. After each transaction
that affects the account balance or account registration,
including the payment of dividends, you will receive a
confirmation statement.
Form 1099. By January 31 of each year, all shareholders will
receive Form 1099, which will report the amount and tax
status of distributions paid to you by the Funds for the
<PAGE>
39
preceding calendar year.
Financial Reports. Financial reports are provided to
shareholders semiannually. Annual reports will include
audited financial statements. To reduce the Funds' expenses,
one copy of each report will be mailed to each Taxpayer
Identification Number even though the investor may have more
than one account in a Fund.
Reports to Depository Institutions. Shareholders of the
Short or Intermediate Funds who are financial institutions
may request receipt of monthly or quarterly reports which
provide information about the Short or Intermediate Fund's
investments considering regulatory risk-based asset
categories.
If you need additional copies of previous statements, you
may order statements for the current and preceding year at
no charge. Call 1-800-221-3137 to order past statements. If
you need information on your account with the Funds or if
you wish to submit any applications, redemption requests,
inquiries or notifications, please contact: Smith Breeden
Mutual Funds, 3200 Horizon Drive, P.O. Box 61503, King of
Prussia, PA 19406-0903 or call 1-800-221-3137.
RETIREMENT PLANS
The Funds have a program under which you may establish an
Individual Retirement Account ("IRA") with the Funds and
purchase shares through such account. Shareholders wishing
to establish an IRA should consult their tax adviser
regarding (1) their individual qualifying status and (2) the
tax regulations governing these accounts. The minimum
initial investment in each Fund for an IRA is $250. There is
a $12 annual maintenance fee charged to process an account.
This fee is waived for accounts greater than $10,000. You
may obtain additional information regarding establishing
such an account by calling the Funds at 1-800-221-3138.
The Funds may be used as investment vehicles for established
defined contribution plans, including simplified employee,
401(k), 403(b), profit-sharing, money purchase, and simple
pension plans ("Retirement Plans"). For details concerning
Retirement Plans, please call 1-800-221-3138.
SERVICE AND DISTRIBUTION PLANS
Each Fund has adopted a Distribution and Services Plan (the
"Plans") pursuant to Rule 12b-1 under the 1940 Act. The
purpose of the Plans is to permit the Adviser to compensate
investment dealers and other persons involved in servicing
shareholder accounts for services provided and expenses
incurred in promoting the sale of shares of the Funds,
reducing redemptions, or otherwise maintaining or improving
services provided to shareholders by such dealers or other
persons. The Plans provide for payments by the Adviser out
of its advisory fee to dealers and other persons at an
<PAGE>
40
annual rate of up to 0.25% of a Fund's average net assets,
subject to the authority of the Trustees to reduce the
amount of payments permitted under the Plan or to suspend
the Plan for such periods as they may determine. Subject to
these limitations, the Adviser shall determine the amount of
such payments and the purposes for which they are made.
Any distribution and service related payments made by the
Adviser to investment dealers or other persons are subject
to the continuation of the Plans, the terms of any related
service agreements, and any applicable limits imposed by the
National Association of Securities Dealers, Inc.
TAXES
Each Fund intends to qualify as a regulated investment
company under the Internal Revenue Code. In each taxable
year that a Fund so qualifies, such Fund (but not its
shareholders) will be relieved of federal income tax on the
part of its net investment income and net capital gain that
is distributed to shareholders. Each Fund will distribute
at least annually substantially all of the sum of its
taxable net investment income, its net tax-exempt income and
the excess, if any, of net short-term capital gains over the
net long-term capital losses for such year.
All Fund distributions from net investment income
(whether paid in cash or reinvested in additional shares)
will be taxable to its shareholders as ordinary income,
except that any distributions of a Fund's net long-term
capital gain will be taxable to its shareholders as long-
term capital gain, regardless of how long they have held
their Fund shares. Pursuant to the Taxpayer Relief Act of
1997, long-term capital gains are taxed at a maximum of 28%
or 20%, depending on the Fund's holding period in the
portfolio investments. Each Fund provides federal tax
information to its shareholders annually about distributions
paid during the preceding year.
It is not anticipated that any of the Funds' distributions
will qualify for either the corporate dividends-received
deduction or tax-exempt interest income. Distributions will
also probably be subject to state and local taxes, depending
on each shareholder's tax situation. While many states
grant tax-free status to mutual fund distributions paid from
interest income earned from direct obligations of the U.S.
Government, none of the Short or Intermediate Fund's
distributions are expected to qualify for such tax-free
treatment, and only an insignificant amount of the Equity
Market Plus Fund's distributions are expected to so qualify.
The Funds will be required to withhold federal income tax at
a rate of 31% ("backup withholding") from distribution
payments and redemption and exchange proceeds if you fail to
properly complete the Purchase Application.
The foregoing is only a summary of some of the important
federal tax considerations generally affecting each Fund and
<PAGE>
41
its shareholders. See "Taxes" in the relevant Statement of
Additional Information for further discussion. There may be
other federal, state or local tax considerations applicable
to you as an investor. You therefore are urged to consult
your tax adviser regarding any tax-related issues.
CAPITAL STRUCTURE
The Smith Breeden Trust and the Smith Breeden Series Fund
are both Massachusetts business trusts. The Trust was
organized under an Agreement and Declaration of Trust, dated
December 18, 1991. The Series Fund was organized under an
Agreement and Declaration of Trust dated October 3, 1991.
Copies of both Agreements, which are governed by
Massachusetts law, are on file with the Secretary of State
of the Commonwealth of Massachusetts. The Trust and the
Series Fund have the same Trustees.
The Trustees have the authority to issue shares in an
unlimited number of funds of either the Series Fund or
Trust. Each such fund's shares may be further divided into
classes. The assets and liabilities of each such fund will
be separate and distinct. All shares when issued are fully
paid, non-assessable and redeemable, and have equal voting,
dividend and liquidation rights.
Shareholders of the separate funds of the Series Fund or
Trust will vote together in electing trustees and in certain
other matters. Shareholders in each fund of the Series Fund
should be aware that the outcome of the election of trustees
and of certain other matters could be controlled by the
shareholders of another fund. The shares have non-
cumulative voting rights, which means that holders of more
than 50% of the shares voting for the election of the
trustees can elect 100% of the trustees if they choose to do
so.
Although neither the Series Fund nor the Trust is 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
respective Declaration of Trust. Upon written request by
the holders of at least 1% of the outstanding shares stating
that such shareholders wish to communicate with the other
shareholders for the purpose of obtaining the signatures
necessary to demand a meeting to consider the removal of a
trustee, both the Series Fund and Trust have undertaken to
provide a list of shareholders or to disseminate appropriate
materials (at the expense of the requesting shareholders).
Under Massachusetts law, shareholders of a business trust
may, under certain circumstances, be held personally liable
as partners for its obligations. However, the risk of a
shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which
both (i) any liability was greater than a Fund's insurance
coverage and (ii) a Fund itself was unable to meet its
obligations.
<PAGE>
42
TRANSFER AND DIVIDEND DISBURSING AGENT, CUSTODIAN AND
INDEPENDENT ACCOUNTANTS
FPS Services, Inc. ("FPS Services" or the "Transfer Agent"),
3200 Horizon Drive, King of Prussia, PA 19406, acts as each
Fund's Transfer and Dividend Disbursing Agent. See
"Management of the Funds." The Bank of New York acts as the
custodian of each Fund's assets. The Bank of New York's
address is 48 Wall Street, New York, New York 10286. Neither
the Transfer and Dividend Disbursing Agent nor the Custodian
has any part in deciding the Funds' investment policies or
which securities are to be purchased or sold for the Funds'
portfolios. Deloitte & Touche, LLP, has been selected to
serve as independent auditors of the Company for the fiscal
year ending March 31, 1998.
FUND PERFORMANCE
Each Fund may quote the Fund's average annual total and/or
aggregate total return for various time periods in
advertisements or communications to shareholders. An
average annual total return refers to the rate of return
which, if applied to an initial investment at the beginning
of a stated period and compounded over that period, would
result in the redeemable value of the investment at the end
of the period assuming reinvestment of all dividends and
distributions and reflecting the effect of all recurring
fees. An investor's principal in each Fund and the Fund's
return are not guaranteed and will fluctuate according to
market conditions. When considering "average" total return
figures for periods longer than one year, you should note
that a Fund's annual total return for any one year in the
period might have been greater or less than the average for
the entire period. Each Fund also may use "aggregate" total
return figures for various periods, representing the
cumulative change in value of an investment in the Fund for
a specific period (again reflecting changes in the Fund's
share price and assuming reinvestment of dividends and
distributions).
The Short and Intermediate Funds may also advertise current
yield and distribution rate information. Current yield
reflects the income per share earned by the Short or
Intermediate Fund's portfolio investments, and is calculated
by dividing a Fund's net investment income per share during
a recent 30-day period by a Fund's net asset value on the
last day of that period and annualizing the result. The
current yield (or "SEC Yield"), which is calculated
according to a formula prescribed by the SEC (see the
relevant Statement of Additional Information), is not
indicative of the dividends or distributions which were or
will be paid to a Fund's shareholders. SEC regulations
require that net investment income be calculated on a "yield-
to-maturity" basis, which has the effect of amortizing any
premiums or discounts in the current market value of fixed
income securities. Dividends or distributions paid to
shareholders are reflected in the current distribution rate
which may be quoted to shareholders, and may not reflect
<PAGE>
43
amortization in the same manner.
A Fund may also compare its performance to that of other
mutual funds and to stock and other relevant indices, or to
rankings prepared by independent services or industry
publications. For example, a Fund's total return may be
compared to data prepared by Lipper Analytical Services,
Inc., Morningstar, Inc., Value Line Mutual Fund Survey and
CDA Investment Technologies, Inc. Total return data as
reported in such national financial publications as The Wall
Street Journal, The New York Times, Investor's Business
Daily, USA Today, Barron's, Money and Forbes, as well as in
publications of a local or regional nature, may be used in
comparing Fund performance.
The Equity Market Plus Fund's total return may also be
compared to the return of the Standard & Poor's 500
Composite Stock Price Index. For purposes of showing the
returns of large company stocks versus small company stocks,
or to compare returns versus inflation, the Equity Market
Plus Fund's total return may also be compared to the total
return of the Nasdaq Composite OTC Index, Nasdaq Industrials
Index, Russell 2000 Index, or the Consumer Price Index. The
Short Fund's total return may also be compared to that of
taxable money funds as quoted in Donaghue's Money Fund
Report and other suppliers, and to total returns for the six
month U.S. Treasury as published by Merrill Lynch or others.
The Intermediate Fund's return will most likely be compared
to the total return of the Salomon Brothers Mortgage Index,
or the total return of intermediate U.S. Treasury Notes as
published by various brokerage firms and others. The
Financial Services Fund's return may be compared to the S&P
500 Index return, an investment of 80% in the S&P Financial
Composite Index and 20% in money market funds, the Keefe,
Bruyette & Woods Index, or the average of the mutual funds
in the Morningstar Specialty Financial Category. Further
information on performance measurement may be found in the
relevant Statement of Additional Information.
Performance quotations of a Fund represent the Fund's past
performance and should not be considered representative of
future results. The investment return and principal value of
an investment in a Fund will fluctuate so that an investor's
shares, when redeemed, may be worth more or less than their
original cost. The methods used to compute a Fund's total
return and yield are described in more detail in the
relevant Statement of Additional Information.
<PAGE>
44
Part B: Information Required in
Statement of Additional Information
N-1A
Item No. Item Location in the
Registration
Statement
10. Cover Page Cover Page
11. Table of Contents Contents
12. General Information
and History See Part A Item 4.
13. Investment Objective Miscellaneous
and Policies Investment Practices
and Risk
Considerations;
Investment
Restrictions of the
Funds; Hedging and
Other Strategies
Using Derivative
Contracts
14. Management of the Management of the
Registrant Funds
15. Control Persons and Principal Holders
Principal Holders of of Securities and
Securities Controlling Persons
16. Investment Advisory The Investment
and Other Services Advisory Agreement
and Other Services
17. Brokerage Allocation The Investment
Advisory Agreement
and Other Services
18. Capital Stock and Additional Information
Other Securities Regarding Purchases
and Redemptions of
Fund Shares
19. Purchase, Redemption Additional Information
and Pricing of Regarding Purchases
Securities Being and Redemptions of
Offered Fund Shares
20. Tax Status Taxes
21. Underwriters Additional Information
Regarding Purchases
and Redemptions of
Fund Shares
22. Calculation of Standard Performance
Performance Data Measures
23. Financial Statements Experts; Report of
Independent Auditors and
Financial Statements
SMITH BREEDEN TRUST
SMITH BREEDEN EQUITY MARKET PLUS FUND
SMITH BREEDEN FINANCIAL SERVICES FUND
STATEMENT OF ADDITIONAL INFORMATION
DECEMBER 22, 1997
100 Europa Drive, Suite 200
Chapel Hill, North Carolina 27514-2310
(919) 967-7221
This Statement of Additional Information contains information
pertaining to Smith Breeden Equity Market Plus Fund and the Smith
Breeden Financial Services Fund, which may be useful to investors
and is not included in the Prospectus of the Smith Breeden Mutual
Funds. This Statement is not a Prospectus and is only authorized
for distribution when accompanied or preceded by the Prospectus
of the Smith Breeden Mutual Funds dated December 22, 1997, as may
be amended from time to time. The Statement should be read
together with the Prospectus.
Contents Page
DEFINITIONS 2
INVESTMENT RESTRICTIONS OF THE FUNDS 2
MISCELLANEOUS INVESTMENT PRACTICES AND RISK CONSIDERATIONS 3
HEDGING AND OTHER STRATEGIES USING DERIVATIVE CONTRACTS 10
TAXES 17
FUND CHARGES AND EXPENSES 19
MANAGEMENT OF THE FUNDS 19
THE INVESTMENT ADVISORY AGREEMENT AND OTHER SERVICES 20
PRINCIPAL HOLDERS OF SECURITIES AND CONTROLLING PERSONS 24
DETERMINATION OF NET ASSET VALUE 24
ADDITIONAL INFORMATION REGARDING PURCHASES
AND REDEMPTIONS OF FUND SHARES 25
SHAREHOLDER INFORMATION 26
SUSPENSION OF REDEMPTIONS 26
SHAREHOLDER LIABILITY 26
STANDARD PERFORMANCE MEASURES 27
INDEPENDENT AUDITORS 29
EXPERTS 30
REPORT OF INDEPENDENT AUDITORS AND FINANCIAL STATEMENTS 30
<PAGE>
1
SMITH BREEDEN TRUST
SMITH BREEDEN EQUITY MARKET PLUS FUND
SMITH BREEDEN FINANCIAL SERVICES FUND
Statement of Additional Information
DEFINITIONS
The "Trust" -- Smith Breeden Trust
The "Funds" -- Smith Breeden Equity Market Plus Fund and the
Smith Breeden Financial Services Fund
The "Adviser" -- Smith Breeden Associates, Inc., the
Fund's investment adviser.
The "Custodian" -- The Bank of New York, the Funds'
custodian.
"FPS Services" -- FPS Services, Inc., the Fund's investor
servicing agent.
INVESTMENT RESTRICTIONS OF THE FUNDS
Subject to the Funds' 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, a Fund may
not and will not engage in the following activities. The
Investment Company Act of 1940 (the "Investment Company Act")
provides that a "vote of a majority of the outstanding voting
securities" of a 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.)
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
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.
<PAGE>
2
3. 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.
4. 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.)
5. Invest in interests in oil, gas, mineral leases or other
mineral exploration or development program.
6. Invest in companies for the purpose of exercising control or
management.
7. Purchase securities of other investment companies, except to
the extent permitted by the Investment Company Act.
8. 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).
9. 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.
10. 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.
In addition to the items listed above, the Equity Market Plus
Fund will not, as a matter of fundamental policy:
1. 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.
2. Purchase any security, other than mortgage-backed
securities, obligations of the U.S. Government, its agencies
or instrumentalities or collateralized mortgage obligations,
<PAGE>
3
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.
It is contrary to the Funds' present policy, which may be changed
without shareholder approval, to:
(a) sell over-the-counter options which it does not own; or
(b) sell options on futures contracts which options it does not
own.
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 exist immediately after
and as a result of such investment.
MISCELLANEOUS INVESTMENT PRACTICES AND RISK CONSIDERATIONS
Unless so indicated, each Fund may engage in each of the
following investment practices or make the following investments.
However, the fact that a Fund may engage in a particular practice
does not necessarily mean that it will actually do so.
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 Funds' present intention to enter into
repurchase agreements only with commercial banks and registered
broker-dealers. Repurchase agreements may also be viewed as loans
made by a 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, a 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, a Fund may incur delay and costs in selling the
underlying security or may suffer a loss of principal and
interest if a Fund is treated as an unsecured creditor and
required to return the underlying collateral to the seller's
estate.
Forward Commitments. A forward commitment represents a contract
to purchase securities for a fixed price at a future date beyond
customary settlement time (referred to as "forward commitments"
or "when issued" or "delayed delivery" securities) if, when
entering into a forward commitment, a Fund will hold until the
settlement date, in a segregated account, liquid securities in an
amount sufficient to meet the purchase price, or the Fund will
enter 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
<PAGE>
4
of the security to be purchased declines prior to the settlement
date. Where such purchases are made through dealers, a 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 a 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, a Fund may dispose of a commitment
prior to settlement if the Adviser deems it appropriate to do so.
A Fund may realize short-term profits or losses upon the sale of
forward commitments.
Securities Loans. The Fund may make secured loans of 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 the Funds' policy, securities loans are made to
broker-dealers pursuant to an 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. A Fund may also call such loans in order to sell the
securities involved.
Borrowing. The Funds may borrow from banks and enter into
reverse repurchase agreements or dollar rolls 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 Funds may pledge up to 33 1/3% of its total
assets to secure these borrowings. If a 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. A 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 a 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
<PAGE>
5
money borrowed) to a 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."
Reverse Repurchase Agreements and Dollar Roll Agreements. The
Funds 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.
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 Funds 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 a 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 and result in
leverage.
Foreign Securities. The Financial Services Fund may hold
securities of foreign issuers that are not registered with
Securities and Exchange Commission ("SEC"), and foreign issuers
may not be subject to SEC reporting requirements. Accordingly,
there may be less publicly available information concerning
foreign issuers of securities held by Funds than is available
concerning U.S. companies. Foreign companies are not generally
subject to uniform accounting, auditing and financial reporting
standards or to other regulatory requirements comparable to those
applicable to U.S. companies. The securities of some foreign
companies are less liquid and at times more volatile than
securities of comparable U.S. companies.
The Financial Services Fund may invest in foreign securities by
purchasing American Depository Receipts ("ADRs"), European
<PAGE>
6
Depository Receipts ("EDRs"), Global Depository Receipts ("GDRs")
or other securities convertible into securities of issuers based
in foreign countries and may also purchase the securities
directly in the foreign markets. ADRs are generally in
registered form and are denominated in U.S. dollars and are
designed for use in U.S. securities markets. EDRs are similar to
ADRs but generally are in bearer form, may be denominated in
other currencies, and are designed for use in European securities
markets. GDRs are similar to EDRs and are designed for use in
several international markets. ADRs are typically receipts
issued by a U.S. Bank or trust company evidencing ownership of
the underlying securities. For purposes of the Fund's investment
policies, ADRs, EDRs and GDRs are deemed to have the same
classification as the underlying securities they represent.
Thus, an ADR, EDR, or GDR representing ownership of common stock
will be treated as common stock.
The Financial Services Fund anticipates that its brokerage
transactions involving foreign securities of companies
headquartered outside of the United States will be conducted
primarily on the principal exchanges of such countries.
Transactions on foreign exchanges are subject to fixed
commissions that are generally higher than negotiated commissions
on U.S. transactions, although the Fund will endeavor to achieve
the best net results in effecting its portfolio transactions.
There is generally less government supervision and regulation of
exchanges and brokers in foreign countries than in the United
States and as a result trade and settlement procedures in foreign
securities may involve certain risks or expenses not present in
the settlement of domestic transactions (such as delay in payment
or delivery of securities or in the recovery of the Fund's assets
held abroad).
Investment income on certain foreign securities in which the
Financial Services Fund may invest may be subject to foreign
withholding or other taxes that could reduce the return on these
securities. In addition, with respect to certain foreign
countries, there is a possibility of nationalization or
expropriation of assets, imposition of currency exchange
controls, confiscatory taxation, political or financial
instability, and domestic developments which could affect the
value of investments in those countries. In certain countries,
legal remedies available to investors may be more limited than
those available with respect to investments in the United States
or other countries. The laws of some foreign countries may limit
the Fund's ability to invest in securities of certain issuers
located in those countries.
Foreign Currency Transactions. The Financial Services Fund may
conduct foreign currency transactions on a spot (i.e. cash) or
forward basis (i.e. by entering into forward contracts to
purchase or sell foreign currencies). Although foreign exchange
dealers generally do not charge a fee for such conversions, they
do realize a profit based on the difference between the prices at
which they are buying and selling various currencies. Thus a
dealer may offer to sell a foreign currency at one rate, while
offering a lesser rate of exchange should the counterparty desire
to resell that currency to the dealer. Forward contracts are
customized transactions that require a specified amount of a
<PAGE>
7
currency to be delivered at a specific exchange rate on a
specific date or range of dates in the future. Forward contracts
are generally traded in an interbank market directly between
currency traders (usually large commercial banks) and their
customers. The parties to a forward contract may agree to offset
or terminate the contract before its maturity, or may hold the
contract to maturity and complete the contemplated currency
exchange.
The Financial Services Fund may use currency forward contracts to
hedge against a decline in the value of its investments
denominated in foreign currency. For example, if the Fund owned
securities denominated in pounds sterling, it could enter into a
forward contract to sell pounds sterling in return for U.S.
dollars to hedge against possible declines in the pound's value.
Such a hedge, called a "position hedge" would tend to offset both
positive and negative currency fluctuations, but would not offset
changes in the value of its investment caused by other factors.
Under certain conditions, SEC guidelines require mutual funds to
set aside liquid assets in a segregated custodial account to
cover currency forward contracts, if done for speculative
purposes. Currently, the Fund does not expect to use currency
forward contracts for speculative purposes. The Fund will not
segregate assets to cover its forward contracts entered into for
hedging, such as the position hedge described above.
Collateralized Mortgage Obligations ("CMOs"). The Fixed Income
Segment of the Equity Market Plus Fund may invest in 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. Payments of interest or principal on some
classes or series of CMOs may be subject to contingencies, or
some classes or series may bear some or all of the risk of
default on the underlying mortgages. CMOs of different classes
are generally retired in sequence as the underlying mortgage
loans in the mortgage pools 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 a CMO held by the Funds would have the same
effect as the prepayment of mortgages underlying a mortgage-
backed pass-through security. Another type of CMO is a real
estate mortgage investment conduit ("REMIC") which qualifies for
special tax treatment under the Internal Revenue Code and invests
in certain mortgages principally secured by interests in real
property and other permitted investments.
CMOs also include securities 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"). Residuals
<PAGE>
8
have value only to the extent that 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 classes or series of the CMOs. 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.
In reliance on an interpretation by the SEC, the Funds'
investments in certain qualifying CMOs and REMICs are not subject
to the 1940 Investment Company Act's limitations on acquiring
interests in other investment companies. CMOs and REMICs issued
by an agency or instrumentality of the U.S. Government are
considered U.S. Government securities for the purposes of this
Prospectus.
Stripped Securities ("STRIPS"). The Fixed Income Segment of the
Equity Market Plus Fund may invest in STRIPS. STRIPS are usually
structured with two classes that receive different proportions of
the interest and principal distributions from a pool of
underlying assets. A common type of STRIP will have one class
receiving all of the interest from the underlying assets
("interest-only" or "IO" class), while the other class will
receive all of the principal ("principal-only" or "PO" class).
However, in some instances, one class will receive some of the
interest and most of the principal while the other class will
receive most of the interest and the remainder of the principal.
STRIPS are unusually volatile in response to changes in interest
rates. The yield to maturity on an IO class of STRIPS is
extremely sensitive not only to changes in prevailing interest
rates but also to the rate of principal payments (including
prepayments) on the underlying assets. A rapid rate of principal
prepayments may have a measurably adverse effect on the Fund's
yield to maturity to the extent it invests in IOs. Conversely,
POs tend to increase in value if prepayments are greater than
anticipated and decline if prepayments are slower than
anticipated. Thus, if the underlying assets experience greater
than anticipated prepayments of principal, the Fund may fail to
fully recover its initial investment in these securities, even if
the STRIPS were rated of the highest credit quality by S&P or
Moody's, respectively. The Adviser will seek to manage these
risks (and potential benefits) by investing in a variety of such
securities and by using certain hedging techniques, as described
in "Other Investment Practices and Risk Considerations" in the
Prospectus. In addition, the secondary market for STRIPS may be
less liquid than that for other mortgage-backed or asset-backed
securities, potentially limiting the Fund's ability to buy or
sell those securities at any particular time.
The Adviser expects that interest-only STRIPS will be
purchased for their hedging characteristics. Because of their
structure, interest-only STRIPS will most likely move differently
than typical fixed income securities in relation to changes in
interest rates. For example, with increases in interest rates,
these securities will typically increase rather than decrease in
value. As a result, since they move differently to changes in
interest rates than the typical investments held by a Fund,
interest-only STRIPS can be used as hedging instruments to reduce
the variance of a Fund's net asset value from its targeted
<PAGE>
9
option-adjusted duration. There can be no assurance that the use
of interest-only STRIPS will be effective as a hedging technique,
in which event, a Fund's overall performance may be less than if
the Fund had not purchased the STRIPS. It is not anticipated
that STRIPS will constitute more than 5% of a Fund's net assets.
The determination of whether certain IO and PO STRIPS issued
by the U.S. Government and backed by fixed-rate mortgages are
liquid shall be made by the Trustees in accordance with
applicable pronouncements of the SEC. At present all other IO
and PO STRIPS are treated as illiquid securities for the purposes
of the 15% limitation on illiquid securities as a percentage of a
Fund's net assets.
Zero Coupon Securities. The Fixed Income Segment of the Equity
Market Plus 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. Zero coupon securities tend to be more
volatile than other securities with similar stated maturities,
but which make regular payments of either principal or interest.
The Fund is required to accrue and distribute income from zero
coupon securities on a current basis, even though it does not
receive the income currently. Thus, the Fund may have to sell
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.
HEDGING AND OTHER STRATEGIES USING DERIVATIVE CONTRACTS
Futures Contracts. When a fund purchases a futures contract it
agrees to purchase a specified underlying instrument at a
specified future date. When a fund sells a futures contract, it
agrees to sell the underlying instrument at a specified future
date. The price at which the purchase and sale take place is
fixed when the fund enters the contract. Some currently
available futures contracts are based on specific securities,
such as U.S. Treasury bonds or notes, and some are based on
indices of securities prices, such as the Standard and Poor's 500
Index (S&P 500). Futures can be held until their delivery dates,
or can be closed out before then if a liquid secondary market is
available.
The value of a futures contract tends to increase and decrease in
tandem with the value of its underlying instrument. Therefore,
purchasing futures contracts will tend to increase a fund's
exposure to positive and negative price fluctuations in the
underlying instrument, much as if it had purchased the underlying
instrument directly. When a fund sells a future contract, by
contrast, the value of its futures position will tend to move in
a direction contrary to the market. Selling futures contracts,
therefore, will tend to offset both positive and negative market
price changes, much as if the underlying instrument had been
sold.
The Funds will not use futures contracts for leverage.
<PAGE>
10
Futures Margin Payments. The purchaser or seller of a futures
contract is not required to deliver or pay for the underlying
instrument unless the contract is held until delivery date, and
it is not cash settled. However, when the contract is entered
into, a purchaser or seller is required to deposit "initial
margin" with a futures broker, known as a futures commission
merchant ("FCM"). Initial margin deposits are typically a
percentage of the contract's value. If the value of either
party's position declines, that party will be required to make
additional "variation margin" payments to settle the change in
value on a daily basis. The party that has a gain may be
entitled to receive all or a portion of this amount. Initial and
variation margin payments do not constitute purchasing securities
on margin for purposes of a Fund's investment limitations. In
the event of the bankruptcy of an FCM that holds margin on behalf
of a fund, the fund may be entitled to return of the margin owed
to it only in proportion to the amount received by the FCM's
other customers, potentially resulting in losses to a Fund.
Asset Coverage and Limitations on Futures and Options
Transactions. The Funds will comply with guidelines established
by the SEC with respect to coverage of options and futures
strategies by mutual funds, and if the guidelines so require,
will set aside liquid assets in a segregated custodial account in
the amount prescribed. Securities held in a segregated account
cannot be sold while the futures and options strategy is
outstanding, unless they are replaced with other suitable assets.
As a result there is a possibility that segregation of a large
percentage of a Fund's assets could impede portfolio management
or a Fund's ability to meet redemption requests.
In accordance with regulations established by the Commodity
Futures Trading Commission, each Fund's aggregate initial margin
and premiums on all futures and options contract positions not
held for bona fide hedging purposes, will not exceed 5% of a
Fund's net assets, after taking into account unrealized profits
and losses on such contracts.
Risks Associated with Correlation of Price Changes. Because
there are a limited number of types of exchange-traded option and
future contracts, it is likely that the standardized contracts
available will not match a Fund's current or anticipated
investments directly. The Funds may invest in options and
futures contracts based on securities with different maturities
or other characteristics from the securities in which they
typically invest, which involves a risk that the options or
futures position will not track the performance of the Funds'
investment.
Options and futures prices can also diverge from the prices of
their underlying instruments, even if the underlying instruments
match a Fund's investments well. Options and futures prices are
affected by such factors as current and anticipated short-term
interest rates, changes in volatility of the underlying
instrument, and the time remaining until expiration of the
contract, which may not affect security prices the same way.
Imperfect correlation may also result from differing levels of
demand in the options and futures markets versus the securities
markets, from structural differences in how options and futures
<PAGE>
11
and securities are traded, or from the imposition of daily price
fluctuation limits or trading halts. A fund may purchase or sell
options or futures contracts with a greater or lesser value than
the securities it wishes to hedge or intends to purchase in order
to attempt to compensate for differences in volatility between
the contract and the securities, although this may not be
successful in all cases. If price changes in a Fund's options or
futures positions are poorly correlated with its other
investments, the positions may fail to produce anticipated gains
or result in losses that are not offset by gains in other
investments.
Liquidity of Options and Futures Contracts. There is no
assurance a liquid secondary market will exist for any particular
options or futures contract at any particular time. Options may
have relatively low trading volume and liquidity if their strike
prices are not close to the underlying instrument's current
price. In addition, exchanges may establish daily price
fluctuation limits for options and futures contracts, and may
halt trading if a contract's price moves upward or downward more
than the limit in a given day. On volatile trading days when the
price fluctuation limit is reached or a trading halt is imposed,
it may be impossible for a Fund to enter into new positions or
close out existing positions. If the secondary market for a
contract is not liquid because of price fluctuation limits or
otherwise, it could prevent prompt liquidation of unfavorable
positions, and potentially could require a Fund to continue to
hold a position until delivery or expiration regardless of
changes in its value. As a result, a Fund's access to other
assets held to cover its option or futures positions could also
be impaired.
OTC Options. Unlike exchange traded options, which are
standardized with respect to the underlying instrument,
expiration date, contract size and strike price, the terms of
over-the-counter (OTC) options (options not traded on exchanges)
generally are established through negotiation with the other
party to the option contract. While this type of arrangement
allows the Funds greater flexibility to tailor an option to its
needs, OTC options generally involve greater credit risk than
exchange traded options, which are guaranteed by the clearing
organization of the exchanges where they are traded.
The staff of the SEC currently considers OTC options to be
illiquid for purposes of the 15% limitation on illiquid
securities as a percentage of a Fund's net assets unless certain
arrangements have been made with the other party to the option
contract that permit the prompt liquidation of the option
position.
Purchasing Put and Call Options. By purchasing a put option, a
Fund obtains the right (but not the obligation) to sell the
option's underlying instrument at a fixed strike price. In
return for this right, a Fund pays the current market price for
the option (known as the option premium). Options have various
types of underlying instruments, including specified securities,
indices of securities prices, and futures contracts. A Fund may
terminate its position in a put option it has purchased by
allowing it to expire or by exercising the option. If the option
<PAGE>
12
is allowed to expire, a Fund will lose the entire premium it
paid. If a Fund exercises the option, it completes the sale of
the underlying instrument at the strike price. A Fund may also
terminate a put option position by closing it out in the
secondary market at its current price, if a liquid secondary
market exists.
The buyer of a typical put option can expect to realize a gain if
security prices fall substantially. However, if the underlying
instrument's price does not fall enough to offset the cost of
purchasing the option, a put buyer can expect to suffer a loss
(limited to the amount of the premium paid, plus related
transaction costs).
The features of call options are essentially the same as those of
put options, except that the purchaser of a call option obtains
the right to purchase, rather than sell, the underlying
instrument at the option's strike price. A call buyer typically
attempts to participate in potential price increases of the
underlying instrument with risk limited to the cost of the
option if security prices fall. At the same time, the buyer can
expect to suffer a loss if security prices do not rise
sufficiently to offset the cost of the option.
Writing Put and Call Options. When a Fund writes a put option,
it takes the opposite side of the transaction from the option's
purchaser. In return for receipt of the premium, the Fund
assumes the obligation to pay the strike price for the option's
underlying instrument if the other party to the option chooses to
exercise it. When writing an option on a futures contract, a
Fund will be required to make margin payments to an FCM as
described above for futures contracts. A Fund may seek to
terminate its position in a put option it writes before exercise
by closing out the option in the secondary market at its current
price. If the secondary market is not liquid for a put option
the Fund has written, however, the Fund must continue to be
prepared to pay the strike price while the option is outstanding,
regardless of price changes, and must continue to set aside
assets to cover its position.
If security prices rise, a put writer would generally expect to
profit although its gain would be limited to the amount of the
premium it received. If security prices remain the same over
time, it is likely that the writer will also profit, because it
should be able to close out the option at a lower price. If
security prices fall, the put writer would expect to suffer a
loss. This loss should be less than the loss from purchasing the
underlying instrument directly, however, because of the premium
received for writing the option.
Writing a call option obligates a Fund to sell or deliver the
option's underlying instrument, in return for the strike price,
upon exercise of the option. The characteristics of writing call
options are similar to those of writing put options, except that
writing calls generally is a profitable strategy if prices remain
the same or fall. Through receipt of the option premium, a call
writer mitigates the effects of a price decline. At the same
time, because a call writer must be prepared to deliver the
underlying instrument in return for the strike price, even if its
<PAGE>
13
current value is greater, a call writer gives up its ability to
participate in security price increases and will suffer a loss in
the event of an increase.
Combined Positions. A Fund may purchase and write options in
combination with each other, or in combination with futures or
forward contracts, to adjust the risk and return characteristics
of the overall position. For example, a Fund may purchase a put
option and write a call option on the same underlying instrument,
in order to construct a combined position whose risk and return
characteristics are similar to selling a futures contract.
Another possible combined position would involve writing a call
option at one strike price and buying a call option at a lower
price, in order to reduce the risk of the written call option in
the event of a substantial price increase. Because combined
positions involve multiple trades, they result in higher
transaction costs and may be more difficult to open and close
out.
Options and Futures Relating to Foreign Currencies. The
Financial Services Fund may utilize currency futures contracts.
Currency futures contracts are similar to forward currency
exchange contracts, except that they are traded on exchanges (and
have margin requirements) and are standardized as to contract
size and delivery date. Most currency futures contracts call for
payment or delivery in U.S. dollars. The underlying instrument
of a currency option may be a foreign currency, which generally
is purchased or delivered in exchange for U.S. dollars, or may be
a futures contract. The purchaser of a currency call obtains the
right to purchase the underlying currency, and the purchaser of a
currency put obtains the right to sell they underlying currency.
The Financial Services Fund may purchase and sell currency
futures and purchase and write currency options to increase or
decrease its exposure to different foreign currencies in order to
hedge against the currency risk implicit in the investments which
it owns that are denominated in other than U.S. dollars.
Currency futures and options values can be expected to correlate
with exchange rates, but may not reflect other factors that
affect the Fund's investments, such as a decline in an issuer's
creditworthiness. Because the value of the Financial Services
Fund's foreign denominated investments changes in response to
many factors other than exchange rates, it may not be possible to
march the amount of currency options and futures to the value of
the Fund's investments exactly over time.
Equity Swap Contracts. Both the Equity Market Plus Fund and the
Financial Services Fund may enter into equity swap contracts.
The counterparty to an equity swap contract will typically be a
bank, investment banking firm or broker-dealer. The counterparty
generally agrees 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 basket of stocks comprising
the S&P 500 Index, plus the dividends that would have been
received on those stocks. The Fund agrees 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
<PAGE>
14
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 Funds will enter into equity swap contracts only on
a net basis, i.e., where the two parties' obligations are netted
out, with the Fund paying or receiving, as the case may be, only
the net amount of any payments. Payments under an equity swap
contract may be made at the conclusion of the contract or
periodically during its term. If there is default by the
counterparty to an equity swap contract, a Fund will be limited
to contractual remedies pursuant to the agreements related to the
transaction. There is no assurance that the equity swap contract
counterparties will be able to meet their obligations or that, in
the event of default, the Funds will succeed in pursuing
contractual remedies. A Fund thus assumes the risk that it may
be delayed in or prevented from obtaining payments owed to it
pursuant to these contracts. The Funds will closely monitor the
credit of equity swap contract counterparties in order to
minimize this risk. The Funds will not use equity swap contracts
for leverage.
The Funds 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. These positions are sometimes
referred to as "reverse equity swap contracts".
The Funds will not enter into any 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 ("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 net
assets.
The Adviser and Funds do not believe that a Fund's obligations
under equity swap contracts or reverse equity swap contracts are
senior securities, so long as such a segregated account is
maintained, and accordingly, the Funds will not treat them as
being subject to its borrowing restrictions. The net amount of
the excess, if any, of a 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 liquid
securities having an aggregate market value at least equal to the
accrued excess will be maintained in a segregated account by a
Fund's custodian.
Interest Rate and Mortgage Swaps, Caps, Floors and Collars.
Interest rate swaps involve the exchange by a Fund with another
party of their respective commitments to pay or receive interest,
for example, an exchange of floating-rate payments for fixed-rate
<PAGE>
15
payments. Mortgage swaps are similar to interest rate swaps in
that they represent commitments to pay and receive interest. The
notional principal amount, however, is tied to a reference pool
or pools of mortgages.
The purchase of an interest rate cap entitles the purchaser, to
the extent that a specified index exceeds a predetermined
interest rate, to receive payments of interest on a notional
principal amount from the party selling such interest rate cap.
The purchase of an interest rate floor entitles the purchaser, to
the extent that a specified index falls below a predetermined
interest rate, to receive payments of interest on a notional
principal amount from the party selling such interest rate floor.
An interest rate collar combines the elements of purchasing a cap
and selling a floor. The collar protects against an interest
rate rise above the maximum amount, but gives up the benefits of
an interest rate decline below the minimum amount. There can be
no assurance that the Funds will be able to enter into interest
rate swaps, caps, floors or collars on favorable terms.
Furthermore, there can be no assurance that any of the Funds will
be able to terminate an interest rate swap or sell or offset
interest rate caps, floors or collars notwithstanding any terms
in the agreements providing for such termination.
Inasmuch as these transactions are entered into for hedging
purposes, the Adviser and the Funds believe swaps, caps, floors
and collars 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 a 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 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.
The Funds will enter into these transactions with counter parties
who are rated at least A by Moody's and S&P at the time of
entering into a contract.
If there is default by the other party to such a transaction, the
Funds will have contractual remedies pursuant to the agreements
related to the transaction. There is no assurance that
interest-rate swap, cap, floor or collar counterparties will be
able to meet their obligations pursuant to their contracts, or
that, in the event of default, a Fund will succeed in pursuing
contractual remedies. The Funds thus assume the risk that one of
them may be delayed in or prevented from obtaining payments owed
to it pursuant to interest rate swaps, caps, floors or collars.
The swap, cap, floor and collar 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 documentation. As a result, this market has become
relatively liquid, although the Funds will still treat these
instruments as illiquid investments subject to the limitation on
such investments described under "Illiquid Securities" in the
Prospectus.
<PAGE>
16
TAXES
Taxation of the Funds. Each 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) for the Equity Market Plus Fund, and only
until March 31, 1998, 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 the sum of its taxable net
investment income, its net tax-exempt income, and the
excess, if any, of net short-term capital gains over
net long-term capital losses 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 a 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 a 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
<PAGE>
17
substantial taxes and interest and make substantial distributions
before requalifying as a regulated investment company that is
accorded special tax treatment.
If a 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, plus any
retained amount from the prior year, the Fund will be subject to
a 4% excise tax on the undistributed amounts. Each Fund intends
generally to make distributions sufficient to avoid imposition of
the 4% excise tax. In calculating its income, each 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.
Sale or redemption of shares. The sale, exchange, or
redemption of Fund Shares may give rise to a gain or loss. In
general, any gain realized upon a taxable disposition of shares
will be treated as mid-term capital gain if the shares have been
held for 12 months, but not more than 18 months, and as adjusted
net long-term capital gains if the shares have been held for more
than 18 months. Otherwise the gain on the sale, exchange, or
redemption of Fund shares will be treated as short-term capital
gain or loss. In addition, any loss (not already disallowed as
provided in the next sentence) realized upon a taxable
disposition of shares held for six months or less will be treated
as long-term, rather than short-term, to the extent of any long-
term capital gain distributions received by the shareholder with
respect to the shares. All or a portion of any loss realized
upon a taxable disposition of Fund shares will be disallowed if
other Fund shares are purchased within 30 days before or after
the disposition. In such a case, the basis of the newly
purchased shares will be adjusted to reflect the disallowed
loss.
Return of capital distributions. If a 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.
Hedging Transactions. If a Fund engages in hedging
transactions, including hedging transactions in option, futures
contracts, and straddles, or similar transactions, it will be
subject to special tax rules (including constructive sale, market-
to-market, straddle, wash sales, and short sale rules), the
effect of which may be to accelerate income to the Fund, defer
losses to the Fund, cause adjustments in the holding periods of
the Fund's securities, or convert short-term capital losses into
long-term capital losses. These rules could therefore affect the
amount, timing and character of distributions to
shareholders.
Tax Implications of Certain Investments. Certain of a Fund's
investments, including investments in stripped securities, will
create taxable income in excess of the cash they generate. In
<PAGE>
18
such cases, a Fund may be required to sell assets (including when
it is not advantageous to do so) to generate the cash necessary
to distribute as dividends to its shareholders all of its income
and gains and therefore to eliminate any tax liability at the
Fund level.
FUND CHARGES AND EXPENSES
Management Fees. The Equity Market Plus 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%. The fee for the Financial Services
Fund is 1.50%. Advisory fees paid by Equity Market Plus Fund for
the fiscal year ended March 31, 1997 were $53,341. Advisory fees
paid by the Equity Market Plus Fund for each of the last three
fiscal years ended March 31 were $11,056, $21,727, and $53,341
respectively. For each of the last three fiscal years ended March
31, the Adviser reimbursed the Equity Market Plus Fund $128,959,
$114,100 and $131,965, respectively, under expense limitation
provisions. The Financial Services Fund commenced operations
December 22, 1997,and as such has not paid as yet any advisory
fees for its prior fiscal years.
Other Expenses. Each 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 FPS Services which
serves as the Funds' shareholder servicing and accounting agent
are determined by contract as approved by the Board of Trustees.
MANAGEMENT OF THE FUNDS
The Board of Trustees has the responsibility for the overall
management of the Funds, including general supervision and review
of its investment activities. The Trustees, in turn, elect the
officers of the Funds who are responsible for administering the
day-to-day operations of the Funds. Trustees and officers of the
Funds 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. The Trustees do not receive pension or
retirement benefits from the Funds. The table below shows the
fees paid by the Equity Market Plus Fund to each independent
Director for the fiscal year ended March 31, 1997 and total fees
paid by the entire Fund complex for the fiscal year ended March
31, 1997. There are two other funds in the complex besides the
Equity Market Plus Fund and the Financial Services Fund.
Director Total Compensation Total Compensation
Paid by Smith Breeden From Smith Breeden
Equity Market Plus Equity Market Plus
and Fund Complex
William F. Sharpe $ 1,400 $38,750
Myron S. Scholes $ 0 $38,750
Stephen M. Schaefer $ 3,373 $38,750
<PAGE>
19
The Financial Services Fund expects to pay $1,667 to each Trustee
listed above prior to March 31, 1998.
The Agreement and Declaration of Trust of the Funds provides that
the Funds 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
Funds, 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 Funds or that such indemnification
would relieve any officer or Trustee of any liability to the
Funds 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 Funds 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 approximately 70% of the common stock of
Harrington Financial Group ("HFGI"), the holding company for
Harrington Bank, FSB of Richmond, Indiana (the "Bank"). As of
October 31, 1997, HFGI had total assets of $505 million. HFGI and
the Bank may invest in assets of the same types as those to be
held by the Funds.
Douglas T. Breeden, in combination with immediate family members,
controls over 75% of the common stock of Community First
Financial Group, Inc. ("CFFG"), the holding company for certain
banks and thrifts, to which the Adviser renders Investment
Advisory services. CFFG and its subsidiaries invest in assets of
the same types as those to be held by the Funds.
The Adviser may also manage advisory accounts with investment
objectives similar to or the same as those of the Funds, or
different from the Funds but trading in the same type of
securities and instruments as the Funds. Portfolio decisions and
results of the Funds' 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 Funds.
THE INVESTMENT ADVISORY AGREEMENT AND OTHER SERVICES
The investment manager of the Funds 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 Agreements between the Funds and
the Adviser, subject to such policies as the Trustees may
determine, the Adviser, at its expense, furnishes continuously an
<PAGE>
20
investment program for the Funds and makes investment decisions
on behalf of the Funds. Subject to the control of the Trustees,
the Adviser also manages, supervises and conducts the other
affairs and business of the Funds, furnishes office space and
equipment, provides bookkeeping and clerical services and places
all orders for the purchase and sale of the Funds' portfolio
securities.
For details of the Adviser's compensation under the Investment
Advisory Agreements, see "Fund Charges and Expenses" in this
Statement. Under the Investment Advisory Agreements, the Adviser
may reduce its compensation to the extent that the Funds'
expenses exceed such lower expense limitation as the Adviser may,
by notice to the Funds, 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 limitations currently in effect are
described in the Prospectus and on the following page. The Funds
pay 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 Agreements provide that the Adviser shall
not be subject to any liability to the Funds or to any
shareholder of the Funds for any act or omission in the course of
or connected with rendering services to the Funds 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 Agreements may be terminated without
penalty by vote of the Trustees or the shareholders of either
Fund, or by the Adviser, on 60 days written notice. They may be
amended only by a vote of the shareholders of each Fund. The
Investment Advisory Agreements also terminate without payment of
any penalty in the event of its assignment as defined in the
Investment Company Act. The Investment Advisory Agreements
provide that they will continue in effect after their 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 Funds. 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 Agreements, the
Adviser performs certain administrative services as follows: (1)
coordinates with the Funds' custodian and transfer agent and
monitors the services they provide to the Funds; (2) coordinates
with and monitors other third parties furnishing services to the
Funds; (3) provides the Funds with necessary office space,
telephones and other communications facilities and personnel
competent to perform administrative and clerical functions for
the Funds; (4) supervises the preparation by third parties of all
Federal, state and local tax returns and reports of the Funds
required by applicable law; (5) prepares and, after approval by
the Funds, files and arranges for the distribution of proxy
materials and periodic reports to shareholders of the Funds as
required by applicable law; (6) prepares and, after approval by
<PAGE>
21
the Funds, 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 Funds for their approval invoices or other
requests for payment of Fund expenses; and (8) takes such other
actions with respect to the Funds as may be necessary in the
opinion of the Advisor to perform its duties under the
agreements.
The Adviser has voluntarily undertaken to bear normal
operating expenses (excluding litigation, indemnification and
other extraordinary expenses) of the Funds, and, if necessary, to
waive its advisory fee, for the period ending August 1, 1998 such
that total operating expenses would not exceed 0.88% of the
average net assets of the Equity Market Plus Fund and 1.50% of
the Financial Services 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 Funds 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 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 Funds 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 Funds usually includes
an undisclosed dealer commission or mark-up. In underwritten
offerings, the price paid by the Funds includes a disclosed,
fixed commission or discount retained by the underwriter or
dealer. The Equity Market Plus Fund paid approximately $3,000 in
brokerage commissions on futures and options transactions for the
last fiscal year and approximately $1,000 for each of the two
prior fiscal years ended March 31. The Financial Services Fund
<PAGE>
22
commenced operations December 22, 1997, and as of the date of
this Statement had not incurred any commission expense. For a
discussion of brokerage issues relating to investments by the
Financial Services Fund in foreign securities, see "Miscellaneous
Investment Practices and Risk Considerations-Foreign Securities".
The Adviser places all orders for the purchase and sale of
portfolio investments for the Funds and may buy and sell
investments for the Funds through a substantial number of brokers
and dealers. In so doing, the Adviser uses its best efforts to
obtain for the Funds the most favorable price and execution
available. In seeking the most favorable price and execution,
the Adviser, having in mind the Funds' 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 Funds (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
Funds.
The Adviser conducts extensive proprietary research. 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
FPS Services is each Fund's investor servicing agent (transfer,
plan and dividend disbursing agent), for which it receives fees
which are paid monthly by each Fund as an expense of all its
shareholders. See "Fund Charges and Expenses" in this Statement
for information on fees and reimbursements received by FPS
Services. FPS Services is also investor-servicing agent for the
<PAGE>
23
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 each
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 each Fund's cash and securities, handling the
receipt and delivery of securities and collecting interest and
dividends on each Fund's investments. Each Fund pays the
Custodian an annual fee based on the assets of the Fund and the
Fund's securities transactions. Each 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, to the Equity Market Plus Fund's best knowledge, as of
November 30, 1997, owned 5% or more of the shares of the Fund.
NFSC FEBO
Texas Commerce Bank Pledged Co.
PO Box 2558
Houston, TX 77252 7.95%
Each Fund Trustee owns less than 1% of the shares of the
Equity Market Plus Fund as of November 30, 1997.
DETERMINATION OF NET ASSET VALUE
Each Fund determines net asset value as of the close of
regular trading on the New York Stock Exchange usually at 4 p.m.
If any securities held by a 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
<PAGE>
24
regarding the issuer.
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. Because regular trading in most foreign securities
markets is completed simultaneously with, or prior to, the close
of regular trading on the New York Stock Exchange, closing prices
for foreign securities usually are available for purposes of
computing the Financial Services Fund's net asset value.
However, in the event that the closing price of a foreign
security is not available in time to calculate the Financial
Services Fund's net asset value on a particular day, the Fund's
Board of Trustees has authorized the use of the market price for
the security obtained from an approved pricing service at an
established time during the day which may be prior to the close
of regular trading in the security. The value of all of the
Financial Services Fund's assets and liabilities expressed in
foreign currencies will be converted into U.S. dollars at the
spot rate of such currencies against U.S. dollars provided by an
approved pricing service. Because of the amount of time required
to collect and process trading information of 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 that will
not be reflected in the computation of a 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.
ADDITIONAL INFORMATION REGARDING PURCHASES
AND REDEMPTIONS OF FUND SHARES
All checks, drafts, wires and other payment mediums used for
purchasing or redeeming shares of a Fund must be denominated in
U.S. Dollars. A 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 a 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 Funds are committed 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 a Fund's net assets at the
beginning of such period. Such commitment is irrevocable without
<PAGE>
25
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 a Fund in case of any
emergency, or if the payment of such redemption in cash would be
detrimental to the existing shareholders of a Fund. In such
circumstances, the securities distributed would be valued at the
price used to compute the Fund's net assets. Should a Fund do
so, a shareholder may incur brokerage fees or other transaction
costs in converting the securities to cash.
Principal Underwriter. FPS Broker Services, Inc. (the "Principal
Underwriter"), 3200 Horizon Drive, P.O. Box 61503, King of
Prussia, PA 194060903, is the principal underwriter for the Funds
and is acting on a best efforts basis. 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 Funds' shares is
continuous.
The Funds' underwriting agreement with the Principal
Underwriter provides that the Funds will pay all fees and
expenses in connection with: registering and qualifying their
shares under the various state "blue sky" laws; preparing,
setting in type, printing, and mailing its prospectuses and
reports to shareholders; and issuing their shares, including
expenses of confirming purchase orders. The Principal Underwriter
acts as the agent of the Funds in connection with the sale of
their 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 Principal
Underwriter may accept orders for Funds' shares at their offering
prices. For these services for the two Funds, the Adviser pays
the Principal Underwriter approximately $15,000. The Principal
Underwriter may enter into agreements with other broker-dealers
for the sale of the Funds' 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 Funds may pay certain financial
institutions that maintain accounts with the Funds on behalf of
numerous beneficial owners for record keeping 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 Funds
also send annual and semiannual reports that keep shareholders
informed about each Fund's portfolio and performance, and year-
end tax information to simplify their recordkeeping. Shareholders
<PAGE>
26
may call FPS Services toll-free at 1-800 221-3137 for more
information, including account balances.
SUSPENSION OF REDEMPTIONS
The Funds 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 Funds to dispose of their
securities or to determine fairly the value of their 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 Funds. However, the Agreement and Declaration of Trust
disclaims shareholder liability for acts or obligations of the
Funds and requires that notice of such disclaimer be given in
each agreement, obligation, or instrument entered into or
executed by the Funds 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 a Fund. Thus, the risk
of a shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which a Fund
would be unable to meet its obligations. The likelihood of such
circumstances is remote.
STANDARD PERFORMANCE MEASURES
Total return data for the Funds may from time to time be
presented in this Statement and in advertisements. Total return
for the one-year period and for the life of a Fund is determined
by calculating the actual dollar amount of investment return on a
$1,000 investment in a 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, 1997, the
average annual total return for the Equity Market Plus Fund since
inception is 18.50% and the average annual total return for the
one-year period ended March 31, 1997 is 21.41%. For the five year
period, the average annual return was 21.3%. Since the Financial
Services Fund commenced operations as of the date of this
Statement, annualized total return information is not yet
available. At times, the Adviser may reduce its compensation or
assume expenses of a Fund in order to reduce a Fund's expenses.
The per share amount of any such fee reduction or assumption of
expenses for the life of a Fund, will be reflected in the
<PAGE>
27
Prospectus as updated. Any such fee reduction or assumption of
expenses would increase a Fund's total return during the period
of the fee reduction or assumption of expenses.
Independent statistical agencies measure a Fund's investment
performance and publish comparative information showing how the
Fund, and similar investment companies, performed in specified
time periods. The agencies whose reports are commonly used are
Morningstar, Inc, Lipper Analytical Services and Wiesenberger
Investment Companies Service. From time to time, a Fund may
distribute these comparisons to its shareholders or to potential
investors.
Both Funds' performance may also from time to time be compared
to Standard & Poor's 500 Composite Stock Price Index (the "S&P
500 Index"). 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.
The Financial Services Fund's performance may also be compared to
the Standard & Poor's Financial Composite, an investment of 80%
in the S&P Financial Composite Index and 20% in Money Market
funds, the Keefe Bruyette & Woods Index, or the average of the
mutual funds in Morningstar's Specialty Financial category.
Because each 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 that 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.
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.
<PAGE>
28
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 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.
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 Funds' independent auditors, providing audit
services, tax return review and preparation services and
<PAGE>
29
assistance and consultation in connection with the review of
various Securities and Exchange Commission filings.
EXPERTS
The annual financial statements of the Equity Market Plus Fund
and related notes thereto attached to this Statement of
Additional Information have been so attached in reliance upon the
report of Deloitte & Touche LLP, independent auditors, given on
the authority of said firm as experts in auditing and accounting.
The semi-annual financial statements of the Equity Market Plus
Fund and related notes thereto attached to this Statement of
Additional Information have not been audited by Deloitte & Touche
LLP. As the Financial Services Fund commenced operations
December 22, 1997, the date of this Statement, there are no
financial statements (audited or unaudited) yet available for
that Fund.
REPORT OF INDEPENDENT AUDITORS AND FINANCIAL STATEMENTS
Attached are the audited financial statements for the fiscal
year ended March 31, 1997 and the unaudited financial statements
for the six-month period ended September 30, 1997, for the Equity
Market Plus Fund (formerly known as the Equity Plus Fund). As
the Financial Services Fund commenced operations December 22,
1997, there are no such statements for this Fund yet
available.
<PAGE>
30
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
SCHEDULE OF INVESTMENTS (UNAUDITED) SEPTEMBER 30, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
MARKET
FACE AMOUNT SECURITY VALUE
- ----------- -------- -----------
<C> <S> <C>
U.S. GOVERNMENT & AGENCY OBLIGATIONS -- 69.17%
FEDERAL HOME LOAN MORTGAGE CORPORATION -- 11.78%*
FHLMC:
$ 6,983,120 7.50%, due date to be announced.............................................................. $ 7,106,416
83,392 9.50%, due 7/1/02............................................................................ 86,615
-----------
TOTAL FEDERAL HOME LOAN MORTGAGE CORPORATION
(COST $7,136,710).......................................................................... 7,193,031
-----------
FEDERAL NATIONAL MORTGAGE ASSOCIATION -- 1.20%*
FNMA:
101,671 12.50%, due 9/1/12........................................................................... 117,405
63,560 13.50%, due 1/1/15........................................................................... 75,988
FNMA ARM:
519,184 7.837%, due 9/1/18........................................................................... 541,095
-----------
TOTAL FEDERAL NATIONAL MORTGAGE ASSOCIATION (COST $714,843).................................. 734,488
-----------
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION -- 52.59%*
GNMA:
1,996,814 8.00%, due 4/15/27........................................................................... 2,065,601
GNMA ARM:
3,514,500 5.00%, due 9/20/27........................................................................... 3,469,034
22,273,555 5.50%, due 2/20/27 to 9/20/27................................................................ 22,250,777
839,359 6.50%, due 10/26/27.......................................................................... 859,024
1,621,509 7.00%, due 2/20/16 to 2/20/21................................................................ 1,674,976
203,818 7.125%, due 9/20/21 to 9/20/22............................................................... 209,708
1,544,630 7.375%, due 6/20/16 to 5/20/22............................................................... 1,595,705
-----------
TOTAL GOVERNMENT NATIONAL MORTGAGE ASSOCIATION
(COST $31,904,869)......................................................................... 32,124,825
-----------
U.S. GOVERNMENT OBLIGATIONS -- 3.60%
U.S. TREASURY BILL **
100,000 5.21%, due 11/13/97***....................................................................... 99,421
830,000 5.52%, due 5/28/98***........................................................................ 801,842
100,000 5.32%, due 5/28/98***........................................................................ 96,608
750,000 5.20%, due 5/28/98***........................................................................ 724,108
500,000 5.25%, due 8/20/98***........................................................................ 476,717
-----------
TOTAL U.S. GOVERNMENT OBLIGATIONS (COST $2,195,991).......................................... 2,198,696
-----------
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS (COST $41,952,413)................................ 42,251,040
-----------
<CAPTION>
CONTRACTS OPTION CONTRACTS -- 0.03%
- -----------
<C> <S> <C>
85 Call on Ten-Year US Treasury Note futures, expires 12/97, strike price $112.................. 15,938
74 Put on Ten-Year US Treasury Note futures, expires 12/97, strike price $105.5................. 4,625
-----------
TOTAL OPTION CONTRACTS (COST $60,309)........................................................ 20,563
-----------
TOTAL INVESTMENTS (COST $42,012,722) -- 69.20%............................................... 42,271,603
-----------
<CAPTION>
FACE AMOUNT REPURCHASE AGREEMENTS -- 30.12%:
- -----------
<C> <S> <C>
$13,000,000 Morgan Stanley, 5.58%, due 10/1/97 dated 9/24/97............................................. 13,000,000
5,400,000 Dresdner, 5.60%, due 10/6/97 dated 9/29/97................................................... 5,400,000
-----------
TOTAL REPURCHASE AGREEMENTS (COST $18,400,000)............................................... 18,400,000
-----------
CASH AND OTHER ASSETS LESS LIABILITIES -- 0.68%.............................................. 414,787
-----------
NET ASSETS -- 100.00%........................................................................ $61,086,390
-----------
-----------
</TABLE>
19
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
SCHEDULE OF INVESTMENTS (CONTINUED) (UNAUDITED) SEPTEMBER 30, 1997
- --------------------------------------------------------------------------------
- ---------------
* 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 September 30, 1997. 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.
*** Security is segregated as collateral.
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.
20
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
STATEMENT OF ASSETS AND LIABILITIES
SEPTEMBER 30, 1997 (UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
ASSETS:
Investments at market value (identified cost $42,012,722)(Note 1)........................................... $42,271,603
Cash........................................................................................................ 759,321
Repurchase Agreements (Cost $18,400,000)) (Note 1).......................................................... 18,400,000
Receivables:
Subscriptions............................................................................................ 7,661,442
Interest................................................................................................. 197,890
Maturities............................................................................................... 3,229
Securities sold.......................................................................................... 7,568,995
Other Assets................................................................................................ 25,365
-----------
TOTAL ASSETS............................................................................................. 76,887,845
-----------
LIABILITIES:
Variation margin on futures contracts (Note 2).............................................................. 467,645
Payables:
Redemptions.............................................................................................. 621,824
Securities purchased..................................................................................... 14,655,973
Due to adviser (Note 3)..................................................................................... 29,492
Accrued expenses............................................................................................ 26,521
-----------
TOTAL LIABILITIES........................................................................................ 15,801,455
-----------
NET ASSETS:
(Applicable to outstanding shares of 4,015,310; unlimited number of shares of beneficial interest
authorized; no stated par)............................................................................... $61,086,390
-----------
-----------
Net asset value, offering price and redemption price per share ($61,086,39044,015,310)...................... $ 15.21
-----------
-----------
SOURCE OF NET ASSETS:
Paid in capital............................................................................................. $56,240,220
Undistributed net investment income......................................................................... 217,425
Accumulated net realized gain on investments................................................................ 4,017,695
Net unrealized appreciation of investments.................................................................. 611,050
-----------
NET ASSETS............................................................................................... $61,086,390
-----------
-----------
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
21
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
INVESTMENT INCOME:
Interest and discount earned, net of premium amortization (Note 1)........................................... $ 919,615
EXPENSES:
Advisory fees (Note 3)....................................................................................... 110,914
Accounting and pricing services fees......................................................................... 13,312
Custodian fees............................................................................................... 8,875
Audit and tax preparation fees............................................................................... 2,855
Legal fees................................................................................................... 3,895
Amortization of organization expenses (Note 1)............................................................... 6,929
Transfer agent fees.......................................................................................... 18,329
Registration fees............................................................................................ 18,655
Trustees fees and expenses................................................................................... 7,195
Insurance expense............................................................................................ 3,448
Other........................................................................................................ 9,712
----------
TOTAL EXPENSES BEFORE REIMBURSEMENT....................................................................... 204,119
Expenses reimbursed by Adviser (Note 3)................................................................... (64,685)
----------
NET EXPENSES.............................................................................................. 139,434
----------
NET INVESTMENT INCOME..................................................................................... 780,181
----------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gain on investments............................................................................. 3,582,275
Change in unrealized appreciation (depreciation) of investments.............................................. 1,099,360
----------
Net realized and unrealized gain on investments.............................................................. 4,681,635
----------
Net increase in net assets resulting from operations......................................................... $5,461,816
----------
----------
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
22
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED
SEPTEMBER 30, 1997 MARCH 31, 1997
(UNAUDITED) (AUDITED)
------------------ --------------
<S> <C> <C>
OPERATIONS:
Net investment income................................................................ $ 780,181 $ 406,086
Net realized gain on investments..................................................... 3,582,275 1,374,343
Change in unrealized appreciation (depreciation) of investments...................... 1,099,360 (526,585)
------------------ --------------
Net increase in net assets resulting from operations................................. 5,461,816 1,253,844
------------------ --------------
DISTRIBUTIONS TO SHAREHOLDERS:
Dividends from net investment income................................................. (598,989) (382,446)
Distributions from net realized gains on investments................................. (429,677) (808,371)
------------------ --------------
Total distributions.................................................................. (1,028,666) (1,190,817)
------------------ --------------
CAPITAL SHARE TRANSACTIONS:
Shares sold.......................................................................... 50,138,951 8,844,701
Shares issued on reinvestment of distributions....................................... 930,749 1,125,870
Shares redeemed...................................................................... (7,923,837) (1,292,755)
------------------ --------------
Increase in net assets resulting from capital share transactions (a)................. 43,145,863 8,677,816
------------------ --------------
TOTAL INCREASE IN NET ASSETS...................................................... 47,579,013 8,740,843
NET ASSETS:
Beginning of year.................................................................... 13,507,377 4,766,534
------------------ --------------
End of year.......................................................................... $ 61,086,390 $ 13,507,377
------------------ --------------
------------------ --------------
(a) Transactions in capital shares were as follows:
Shares sold....................................................................... 3,404,871 695,525
Shares issued on reinvestment of distributions.................................... 63,589 93,492
Shares redeemed................................................................... (528,659) (102,037)
------------------ --------------
Net increase...................................................................... 2,939,801 686,980
Beginning balance................................................................. 1,075,509 388,529
------------------ --------------
Ending balance.................................................................... 4,015,310 1,075,509
------------------ --------------
------------------ --------------
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
23
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
The following average per share data, ratios and supplemental information
has been derived from information provided in the financial statements.
<TABLE>
<CAPTION>
SIX MONTHS
ENDED YEAR YEAR YEAR YEAR PERIOD
SEPTEMBER 30, ENDED ENDED ENDED ENDED ENDED
1997 MARCH 31, MARCH 31, MARCH 31, MARCH 31, MARCH 31,
(UNAUDITED) 1997 1996 1995 1994 1993 (1)
------------- ----------- ---------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF
PERIOD.......................... $ 12.56 $ 12.27 $ 10.84 $ 9.88 $ 10.85 $ 10.00
------------- ----------- ---------- ---------- ---------- ---------
INCOME FROM INVESTMENT
OPERATIONS
Net investment income........... 0.250 0.592 0.615 0.568 0.476 0.355
Net realized and unrealized gain
(loss) on investments........ 2.877 1.813 2.768 1.081 (0.216) 1.281
------------- ----------- ---------- ---------- ---------- ---------
Total from investment
operations................. 3.127 2.405 3.383 1.649 0.260 1.636
------------- ----------- ---------- ---------- ---------- ---------
LESS DISTRIBUTIONS
Dividends from net investment
income....................... (0.230) (0.590) (0.583) (0.568) (0.472) (0.311)
Dividends in excess of net
investment income............ -- -- -- (0.001) -- --
Distributions from net realized
gains on investments......... (0.247) (1.525) (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.......... (0.477) (2.115) (1.953) (0.689) (1.230) (0.786)
------------- ----------- ---------- ---------- ---------- ---------
NET ASSET VALUE, END OF PERIOD.... $ 15.21 $ 12.56 $ 12.27 $ 10.84 $ 9.88 $ 10.85
------------- ----------- ---------- ---------- ---------- ---------
TOTAL RETURN...................... 25.08% 21.41% 32.30% 17.18% 2.19% 16.52%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period....... $ 61,086,390 $13,507,377 $4,766,534 $2,107,346 $1,760,519 $ 903,846
Ratio of expenses to average net
assets (1)................... 0.88%* 0.88% 0.90% 0.90% 0.90% 0.57%*
Ratio of net investment income
to average net assets (2).... 4.95%* 5.30% 5.53% 7.44% 8.02% 5.28%*
Portfolio turnover rate......... 196% 182% 107% 120% 119% 271%
Ratio of expenses to average net
assets before reimbursement
of expenses by the Adviser... 1.28%* 2.60% 4.58% 7.75% 7.08% 28.48%*
Ratio of net investment income
to average net assets before
reimbursement of expenses by
the Adviser.................. 4.54%* 3.58% 1.85% 0.59% 1.84% -22.63%*
</TABLE>
- ---------------
(1) Commenced operations June 30, 1992.
* Annualized
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
24
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Breeden Equity Plus 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: Dividends to shareholders are recorded on the
ex-dividend date. 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, 1997, 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.
Discounts and premiums on securities purchased are amortized over the life of
the respective 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
25
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED)
- --------------------------------------------------------------------------------
2. FINANCIAL INSTRUMENTS -- CONTINUED
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 September 30, 1997:
<TABLE>
<CAPTION>
NOTIONAL EXPIRATION UNREALIZED
TYPE AMOUNT POSITION MONTH GAIN/(LOSS)
----- ------------ --------- ---------------- -----------
<S> <C> <C> <C> <C>
3 Month Eurodollar.................................. $ 88,000,000 Long December, 1997 $ 17,716
3 Month Eurodollar.................................. (31,000,000) Short March, 1998 (22,602)
3 Month Eurodollar.................................. (34,000,000) Short September, 1998 (33,003)
3 Month Eurodollar.................................. (30,000,000) Short March, 1999 (20,885)
3 Month Eurodollar.................................. (36,000,000) Short September, 1999 (40,362)
3 Month Eurodollar.................................. (31,000,000) Short March, 2000 (22,039)
3 Month Eurodollar.................................. (36,000,000) Short September, 2000 (30,137)
3 Month Eurodollar.................................. (32,000,000) Short March, 2001 (23,169)
3 Month Eurodollar.................................. (36,000,000) Short September, 2001 (35,837)
5 Year Treasury..................................... (21,000,000) Short December, 1997 (12,781)
10 Year Treasury.................................... (38,000,000) Short December, 1997 (38,171)
-----------
Total $ (261,270)
-----------
-----------
</TABLE>
B. DERIVATIVE FINANCIAL INSTRUMENTS HELD OR ISSUED FOR TRADING PURPOSES: The
Fund invests in futures contracts on the S&P 500 Index whose returns are
expected to track movements in the S&P 500 Index.
The Fund had the following open futures contracts on the S&P 500 Index as of
September 30, 1997:
<TABLE>
<CAPTION>
NOTIONAL EXPIRATION UNREALIZED
TYPE AMOUNT POSITION MONTH GAIN
----- ----------- --------- --------------- -----------
<S> <C> <C> <C> <C>
S&P 500............................................... $11,912,500 Long December, 1997 $ 372,284
S&P 500............................................... 3,853,200 Long March, 1998 241,155
-----------
Total $ 613,439
-----------
-----------
</TABLE>
The aggregate market value of investments pledged to cover margin requirements
for the open positions at September 30, 1997 was $2,198,696.
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 reduce or otherwise limit the expenses of
the Fund to 0.88% 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
0.88% through August 1, 1998. For the six-months ended September 30, 1997, the
Adviser received fees of $110,914 and reimbursed the Fund $64,685.
26
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED)
- --------------------------------------------------------------------------------
3. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES -- CONTINUED
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 of 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 six-months ended September 30, 1997, purchases and proceeds from
sales of securities, other than short-term investments, aggregated $77,305,082
and $47,990,202, respectively. The cost of securities for federal income tax
purposes is $42,012,723. Net unrealized depreciation of investments and futures
contracts consists of:
<TABLE>
<S> <C>
Gross unrealized appreciation................................................ $650,797
Gross unrealized depreciation................................................ (39,747)
--------
Net unrealized depreciation.................................................. $611,050
--------
--------
</TABLE>
27
Smith Breeden Equity Plus Fund Annual Report and Performance
Review
(Effective December 22, 1997, the name of the Equity Plus
Fund
will be changed to the Equity Market Plus Fund)
Performance Review
The Smith Breeden Equity Plus Fund provided a total
return of
21.41% in the year ending March 31, 1997. The Fund's
return exceeded
the 19.84% return of its benchmark, the S&P 500 Index, by
1.57%. Since
the Fund's inception on June 30, 1992, its return has
exceeded that of its
benchmark by 14.22%, and on an annualized basis by 1.62%.
The graph
below plots the Fund's return versus its benchmark and
versus the average
return of Morningstar Inc.'s Growth and Income fund
category.
THE LINE GRAPH DETAILING PERFORMANCE VERSUS THE EQUITY PLUS'
INDEX
ACCORDING TO 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 VERSUS THE S&P 500 AND VERSUS THE AVERAGE OF
THE FUNDS IN MORNINGSTAR'S GROWTH AND INCOME CATEGORY.
THE EQUITY PLUS' AVERAGE ANNUAL RETURN WAS 21.41% FOR THE
ONE YEAR PERIOD,
23.47% THE THREE YEAR PERIOD, 18.50% FOR THE PERIOD
SINCE INCEPTION. THE AVERAGE ANNUAL RETURN OF THE S&P 500
WAS 19.84%
FOR THE ONE YEAR PERIOD, 22.31% FOR THE THREE YEAR PERIOD,
16.88% FOR THE
PERIOD FROM INCEPTION. THE AVERAGE ANNUAL
RETURN OF THE AVERAGE OF THE FUNDS IN MORNINGSTAR'S GROWTH
AND INCOME
CATEGORY WAS 16.10% FOR THE ONE YEAR PERIOD, 18.35% FOR THE
THREE YEAR PERIOD,
AND 14.87% FOR THE FIVE YEAR AND SINCE INCEPTION RETURNS.
FROM INCEPTION THROUGH MARCH 31, 1997, AN INVESTMENT
OF $10,000 IN THE EQUITY PLUS WOULD HAVE GROWN TO $22,411,
VERSUS
$20,988 IN ITS BENCHMARK, AND $19,320 OF THE AVERAGE OF THE
FUNDS IN
MORNINGSTAR'S GROWTH AND INCOME CATEGORY.
The S&P 500 index return was produced by strong
corporate
earnings rather than by falling interest rates in the year
ending March 31,
1997. Corporate earnings were approximately 15% higher in
the year
ending December 1996 over a year earlier. First quarter
1997 earnings
were also generally strong, in many cases exceeding
analysts' expectations.
The growth in corporate earnings, combined with low
unemployment
rates, caused some concern that the U.S. economy is growing
too fast and
this led to moderately rising interest rates due to
increased fears of
inflation. The thirty-year U.S. Treasury bond yield rose
from 6.66% in
March 1996 to 7.09% in March 1997. Rising interest rates in
turn
produced several small sell-offs in the stock market,
resulting in declines in
the S&P 500 Index in three out of the last twelve months.
It is by no
means clear that inflation is on the rise however, and much
of the gain in
corporate earnings can be explained by the high levels of
productive
investment made by corporations during this economic
expansion.
The strategy employed by the Equity Plus Fund to achieve its
goal
of providing a return in excess of the S&P 500 index has two
components.
The Fund uses equity index futures contracts to track the
S&P 500 index,
and it uses a hedged bond portfolio to provide income to
cover the
operating costs of the fund as well as the financing costs
of the equity index
futures contracts. Equity index futures contracts are
available with
different maturity dates. Because the fund controls when it
sells one equity
futures contract and buys a new one, it can take advantage
of times when
one futures contract is cheap relative to another.
Approximately 0.30% of
the Fund's return in excess of its benchmark for the year
ending March
1997 was due to purchasing equity index futures at favorable
prices relative
to the price of the contracts sold.
U.S. Government agency mortgage securities produced
excellent
hedged returns in the year ended March 31, 1997, and the
Equity Plus
Fund was able to take advantage of this performance to
generate the rest of
the Fund's excess return over the S&P 500 index. One factor
explaining
the superior performance by mortgages was a decline in
interest rate
volatility. Mortgage buyers demand a yield premium when
they purchase
mortgage bonds against the risk that interest rates will
move in an
unfavorable direction. Because interest rate volatility
measures the
likelihood of changes in the level of interest rates, when
volatility falls
mortgage buyers demand a smaller premium and consequently
the yield on
mortgages falls relative to the yield on U.S. Treasury
securities. The
Equity Plus Fund held approximately 60% of its assets in
adjustable-rate
mortgages during the year ended on March 31, 1997, and about
20% in
fixed-rate mortgages. The remaining assets were invested in
U.S. Treasury
Bills.
SMITH BREEDEN EQUITY PLUS FUND
SCHEDULE OF INVESTMENTS MARCH 31, 1997
Market
Face Amount Security
Value
U.S. GOVERNMENT & AGENCY OBLIGATIONS - 121.45%
FEDERAL HOME LOAN MORTGAGE CORPORATION - 7.92% *
FHLMC:
$983,120 7.50%, due (a) ...................................
$963,150
103,239 9.50%, due 7/1/02 ................................
106,178
TOTAL FEDERAL HOME LOAN MORTGAGE CORPORATION
(Cost $1,090,669) 1,069,328
FEDERAL NATIONAL MORTGAGE ASSOCIATION - 6.94% *
FNMA:
110,165 12.50%, due 9/1/12 ..............................
126,541
104,722 13.50%, due 11/1/14 to 1/1/15 ..................
120,635
FNMA ARM:
660,968 7.753%, due 9/1/18..............................
689,968
TOTAL FEDERAL NATIONAL MORTGAGE ASSOCIATION
(Cost $916,731)
937,144
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION - 66.09%
*
GNMA ARM:
2,020,000 5.00%, due 3/20/27 ...........................
1,953,136
1,990,000 5.50%, due (a) ...............................
1,944,294
2,632,161 6.50%, due 2/20/16 to 10/20/26 ...............
2,676,380
2,295,509 7.125%, due 4/20/16 to 9/20/22 ...............
2,353,002
TOTAL GOVERNMENT NATIONAL MORTGAGE ASSOCIATION
(Cost $8,904,340) 8,926,812
U.S. GOVERNMENT OBLIGATIONS - 40.50%
U.S. TREASURY BILL **
20,000 5.38%, due 5/29/97 .............................
19,832
1,000,000 5.05%, due 5/29/97 .............................
991,622
600,000 4.94%, due 5/29/97*** ..........................
594,973
2,000,000 5.12%, due 5/29/97 .............................
1,983,244
600,000 5.08%, due 5/29/97 .............................
594,973
700,000 5.06%, due 5/29/97 .............................
694,136
500,000 5.02%, due 5/29/97 .............................
495,812
100,000 5.21%, due 11/13/97*** .........................
96,566
TOTAL U.S. GOVERNMENT OBLIGATIONS (Cost
$5,472,482) 5,471,158
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(Cost $16,384,222) 16,404,442
Contracts OPTION CONTRACTS - 0.13%
3 Call on 5 Year US Treasury Note futures, expires
5/97,
strike price $110 47
37 Put on 5 Year US Treasury Note futures, expires
5/97,
strike price $104 17,922
TOTAL OPTION CONTRACTS (Cost $10,196)
................ 17,969
TOTAL INVESTMENTS (Cost $16,394,418) - 121.58%
.... 16,422,411
CASH AND OTHER ASSETS LESS LIABILITIES - (21.58%)
(2,915,034)
NET ASSETS - 100.00% ........................
$13,507,377
* 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 in the rate in
effect at March 31,
1997. 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.
*** Security is segregated as collateral.
(a) To be Announced
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 EQUITY PLUS FUND
STATEMENT OF ASSETS AND LIABILITIES
31-Mar-97
ASSETS:
Investments at market value (identified cost $16,394,418)
(Note 1) $16,422,411
Cash........................................................
62,780
Receivables:
Subscriptions............................................
180,877
Interest.................................................
53,648
Maturities...............................................
2,590
Securities
sold.........................................
2,925,313
Deferred organization expenses (Note
1)................... 6,796
TOTAL
ASSETS..........................................
19,654,415
LIABILITIES:
Variation margin on futures contracts (Note
2).............. 192,294
Payables:
Redemptions
..............................................
50,041
Securities
purchased......................................
5,876,144
Due to adviser (Note
3)..................................... 8,343
Accrued
expenses.............................................
20,216
TOTAL
LIABILITIES.........................................
6,147,038
NET ASSETS:
(Applicable to outstanding shares of 1,075,509; unlimited
number of shares
of beneficial interest authorized; no stated
par)....... $13,507,377
Net asset value, offering price and redemption
price per share ($13,507,377/
1,075,509)................ $12.56
SOURCE OF NET ASSETS:
Paid in
capital.............................................
$13,094,357
Undistributed net investment
income.......................... 36,234
Accumulated net realized gain on
investments................. 865,097
Net unrealized depreciation of
investments................... (488,311)
NET
ASSETS............................................
$13,507,377
The accompanying notes are an integral part of these
financial statements.
SMITH BREEDEN EQUITY PLUS FUND
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1997
INVESTMENT INCOME:
Interest and discount earned, net of premium
amortization
(Note 1)...... $473,488
EXPENSES:
Advisory fees (Note
3)........................................... 53,341
Accounting and pricing services
fees........................... 25,141
Custodian
fees.................................................
13,067
Audit and tax preparation
fees.................................... 10,250
Legal
fees.......................................................
2,799
Amortization of organization expenses (Note 1)..........
27,791
Transfer agent
fees..............................................
29,506
Registration
fees...............................................
27,132
Trustees fees and
expenses................................... 3,751
Insurance expense....................................
6,549
Other.......................................................
....... 40
TOTAL EXPENSES BEFORE REIMBURSEMENT............
199,367
Expenses reimbursed by Adviser (Note
3)....................... (131,965)
NET
EXPENSES................................................
67,402
NET INVESTMENT
INCOME....................................... 406,086
REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gain on
investments............................... 1,374,343
Change in unrealized appreciation (depreciation) of
investments (526,585)
Net realized and unrealized gain on
investments................ 847,758
Net increase in net assets resulting from
operations......... $1,253,844
The accompanying notes are an integral part of these
financial statements.
SMITH BREEDEN EQUITY PLUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
Year Ended Year Ended
March 31, 1997 March 31, 1996
OPERATIONS:
Net investment income.......................
$406,086 $171,628
Net realized gain on investments...............
1,374,343 709,594
Change in unrealized appreciation (depreciation)
of investments..... (526,585)
(66,654)
Net increase in net assets resulting from
operations.................. 1,253,844
814,568
DISTRIBUTIONS TO SHAREHOLDERS:
Dividends from net investment income..........
(382,446) (159,034)
Distributions from net realized gains on
investments............ (808,371)
(371,974)
Total distributions........................
(1,190,817) (531,008)
CAPITAL SHARE TRANSACTIONS:
Shares sold................................
8,844,701 2,256,010
Shares issued on reinvestment of distributions
1,125,870 502,798
Shares redeemed.......................... (1,292,755)
(383,180)
Increase in net assets resulting from capital
share transactions (a) 8,677,816
2,375,628
TOTAL INCREASE IN NET ASSETS..... 8,740,843
2,659,188
NET ASSETS:
Beginning of year..........................
4,766,534 2,107,346
End of year.................................
$13,507,377 $4,766,534
(a) Transactions in capital shares were as follows:
Shares sold...........................
695,525 183,531
Shares issued on reinvestment of distributions
93,492 42,520
Shares redeemed........................
(102,037) (32,004)
Net increase...........................
686,980 194,047
Beginning balance .....................
388,529 194,482
Ending balance........................
1,075,509 388,529
The accompanying notes are an integral part of these
financial statements.
SMITH BREEDEN EQUITY PLUS FUND
FINANCIAL HIGHLIGHTS
<TABLE>
The following average per share data, ratios and
supplemental information has been derived from information
provided in the
financial statements.
<CAPTION>
Year Year Year Year Period
Ended Ended Ended Ended Ended
31-Mar-97 31-Mar-96 31-Mar-95 31-Mar-94 31-Mar-93*
<S>
<C> <C> <C> <C> <C>
Net Asset Value, Beginning of
Period...........................$12.27 $10.84
$9.88 $10.85 $10.00
Income From Investment Operations
Net investment
income......................................... 0.592
0.615 0.568 0.476 0.355
Net realized and unrealized gain (loss) on
investments.........1.813 2.768 1.081
(0.216) 1.281
Total from investment
operations.......................... 2.405 3.383
1.649 0.26 1.636
Less Distributions
Dividends from net investment
income.......................... (0.59) (0.583)
(0.568) (0.472) (0.311)
Dividends in excess of net investment
income.................. - - 0.001
- - -
Distributions from net realized gains on
investments......... (1.525) (1.37) (0.047)
(0.701) (0.42)
Distributions in excess of net realized gains on
investments. - - (0.073)
(0.057) (0.055)
Total
distributions........................................(2.115)
(1.953) (0.689) (1.23) (0.786)
Net Asset Value, End of Period..............................
$12.56 $12.27 $10.84 $9.88
$10.85
Total
Return....................................................
21.41% 32.30% 17.18% 2.19% 22.59%**
Ratios/Supplemental Data
Net assets, end of period................................
$13,507,377 $4,766,534 $2,107,346 $1,760,519
$903,846
Ratio of expenses to average net assets
<F1>................. 0.88% 0.90% 0.90%
0.90% 0.57%**
Ratio of net investment income to average net assets
<F2>.......5.30% 5.53% 7.44% 8.02%
5.28%**
Portfolio turnover
rate.........................................182%
107% 120% 119% 271%
<FN>
<F1>
The annualized ratio of expenses to average net assets prior
to reimbursement of expenses by the Adviser was 2.60%,
4.58%,
7.75%, 7.08%, and 28.48% for the years ended March 31, 1997,
March 31, 1996, March 31, 1995, March 31, 1994, and the
period ended
March 31, 1993, respectively.
</FN>
<FN>
<F2> The annualized ratio of net investment income to
average net assets prior to reimbursement of expenses by the
Adviser was
3.58%, 1.85%, 0.59%, 1.84%, and (22.63%) for the years ended
March 31, 1997, March 31, 1996, March 31, 1995, March 31,
1994,
and the period ended March 31, 1993, respectively.
</FN>
</TABLE>
* Commenced operations June 30, 1992.
** Annualized
The accompanying notes are an integral part of these
financial
statements.
SMITH BREEDEN EQUITY PLUS FUND
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Breeden Equity Plus 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: Dividends to shareholders are
recorded on the ex-dividend date. 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, 1997,
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.
NOTES TO FINANCIAL STATEMENTS (cont.)
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. Discounts and premiums
on
securities purchased are amortized over the life of the
respective
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.
NOTES TO FINANCIAL STATEMENTS (cont.)
The Fund had the following open futures contracts as of
March 31,
1997:
Type Notional Position Expiration
Unrealized
Amount Month
Gain/(Loss)
3 Month Eurodollar $18,000,000 Long June, 1997
$(6,781)
3 Month Eurodollar 9,000,000 Short March, 1998
8,297
3 Month Eurodollar 9,000,000 Short September,
1998 2,210
3 Month Eurodollar 13,000,000 Short March, 1999
9,692
3 Month Eurodollar 9,000,000 Short September,
1999 584
3 Month Eurodollar 12,000,000 Short March, 2000
8,322
3 Month Eurodollar 1,000,000 Short June, 2000
1,845
3 Month Eurodollar 10,000,000 Short September,
2000 10,705
3 Month Eurodollar 13,000,000 Short March, 2001
10,016
10 Year Treasury 400,000 Short June,
1997 5,982
Total
$50,872
B. Derivative Financial Instruments Held or Issued for
Trading Purposes:
The Fund invests in futures contracts on the S&P 500 Index
and New
York Stock Exchange Index whose returns are expected to
track
movements in the S&P 500 Index and New York Stock Exchange
Index.
The Fund had the following open futures contracts on the S&P
500
and New York Stock Exchange Indices as of March 31, 1997:
Type Notional Position Expiration Unrealized
Amount Month Gain/Loss
S&P 500 $10,599,680 Long June, 1997 $(423,940)
S&P 500 2,271,360 Long September, 1997 (134,280)
NYSE 199,275 Long June, 1997 (8,956)
Total $(567,176)
The aggregate market value of investments pledged to cover
margin
requirements for the open positions at March 31, 1997 was
$691,539.
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
NOTES TO FINANCIAL STATEMENTS (cont.)
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 reduce or otherwise
limit the
expenses of the Fund to 0.88% 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 0.88% through March
31,
1997. For the year ended March 31, 1997, the Adviser
received fees
of $53,341 and reimbursed the Fund $131,965.
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 of 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, 1997, purchases and proceeds
from
sales of securities, other than short-term investments,
aggregated
$19,129,765 and $11,798,195, respectively. The cost of
securities for
federal income tax purposes is $16,394,418. Net unrealized
depreciation of investments and futures contracts consists
of:
Gross unrealized appreciation $ 81,061
Gross unrealized depreciation (569,372)
Net unrealized depreciation $ (488,311)
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders,
Smith Breeden Equity Plus Fund of the Smith Breeden Series
Trust:
We have audited the accompanying statement of assets and
liabilities,
including the schedule of investments, of the Smith Breeden
Equity
Plus Fund of the Smith Breeden Series Trust as of March 31,
1997, 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 four-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, 1997
by
correspondence with the custodian and brokers. 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 Equity Plus Fund of the Smith Breeden
Series Trust
as of March 31, 1997, 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 12, 1997
SMITH BREEDEN TRUST
SMITH BREEDEN EQUITY MARKET PLUS
SMITH BREEDEN FINANCIAL SERVICES FUND
FORM N-1A PART C.
OTHER INFORMATION
Item 24. Financial Statements and Exhibits.
(a) Financial Statement filed with Part B
(b) Exhibits:
(1) Declaration of Trust: Incorporated by
Reference for the Smith Breeden Equity
Market Plus Fund; amendment thereto filed
herein for the Smith Breeden
Financial Services Fund
(2) By-Laws:Incorporated by Reference
(3) Voting Trust Agreement: Not Applicable
(4) Specimen Share Certificate: Not
Applicable
(5) Form of Investment Advisory Agreement for Smith
Breeden Trust: Incorporated by
Reference
(6) Form of Underwriting or Distribution Agreement:
Incorporated by Reference
(7) Bonus, Profit Sharing, Pension and Other
Similar Arrangements: Not Applicable
(8) Custodian Agreement: Incorporated by Reference
(9)(a)(b)Accounting and Shareholder Services Agreement:
Incorporated by Reference for the
Smith Breeden Equity Market Plus Fund;
filed herein for the Smith Breeden
Financial Services Fund
(9)(c) Sub-Administration Agreement: Not Applicable
(10) Opinion and Consent of Counsel: Incorporated
by Reference to Pre-Effective Amendment
Number 2 filed April 14, 1992
(11) Independent Auditor's Consent
(12) Financial Statements Omitted from Item 23:
Not Applicable
(13) Letter of Understanding relating to initial
capital: Incorporated by Reference
(14) Model Retirement Plan: Not Applicable
(15) Form of Rule 12b-1 Plan for Smith Breeden
Trust: Incorporated by Reference
(16) Performance Calculation: Not Applicable
(17) Financial Data Schedule
(18) 18f-3 Multiclass Plan: Not Applicable
Item 25. Persons Controlled by or under Common
Control with Registrant.
There were no persons controlled by or under Common
Control with Registrant as of 11/30/97.
Item 26. Number of Holders of Securities.
NUMBER OF RECORD HOLDERS
TITLE OF CLASS AS OF NOVEMBER 30, 1997
Smith Breeden Equity
Market Plus Fund 3,517
Shares of Beneficial Interest
As of November 30, 1997, the Smith Breeden
Financial Services Fund had no record holders.
Item 27. Indemnification.
Reference is made to Article IV,Sections 4.2 and 4.3
of Registrant's Declaration of Trust with respect to
indemnification of the Trustees and officers of
Registrant against liabilities which may be incurred
by them in such capacities.
Insofar as indemnification for liability arising under
the Securities Act of 1933, as amended (the "Act"),
may be permitted to directors, officers and controlling
persons of the Registrant pursuant to the foregoing
provisions, or otherwise, the Registrant has been
advised that, in the opinion of the Securities and
Exchange Commission ("SEC"), such indemnification is
against public policy as expressed in the Act, and is
therefore, unenforceable. In the event that a claim
for indeminfication against such liabilities (other
than the payment by the Registrant of expenses incurred
or paid by a trustee, an officer or a controlling
person of the Registrant in the successful defense of
any action, suit or proceeding) is asserted by such
trustee, officer or controlling person in connection
with the securities being registered, the Registrant
will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a
court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as
expressed in the Act and will be governed by the final
adjudication of such issue.
Each disinterested Trustee has entered into an
indemnity agreement with the Adviser whereby the
Adviser indemnifies each disinterested Trustee against
defense costs in connection with a civil claim which
involves the Trustee by virtue of his position with
the Fund.
Item 28. Business and Other Connections of Adviser.
Smith Breeden Associates, Inc. (the "Adviser") acts as
investment adviser to financial institution, insurance,
pension, charitable foundation clients and other
registered investment companies. For a description of
the officers and directors of the Adviser and their
business affiliations, see "Management of the Funds"
in the Prospectus contained within this Registration
Statement.
Item 29. Principal Underwriters
(a) FPS Broker Services, Inc., located at 3200 Horizon
Drive, P.O. Box 61503, King of Prussia, Pennsylvania
19406-0903, is the principal underwriter. FPS Broker
Services also serves as the Principal Underwriter for
the following entities:
The Govett Funds, Inc.
Bjurman Funds
Farrell ALpha Strategies
Focus Trust, Inc.
IAA Trust Growth Fund, Inc.
IAA Trust Asset Allocation Fund, Inc.
IAA Trust Tax Exempt Bond Fund, Inc.
IAA Trust Taxable Fixed Income Series
Fund, Inc.
Matthews International Funds
MCM Funds
Metropolitan West Funds
Polynous Trust
Sage/TSO Trust
Smith Breeden Series Fund
Smith Breeden Trust
The Stratton Funds, Inc.
Stratton Growth Fund, Inc.
Stratton Monthly Dividend Shares,Inc.
Trainer Wortham First Mutual Funds
(b) The table below sets forth certain information
as to the Underwriter's Directors, Officers and
Control Persons:
NAME AND PRINCIPAL POSITION AND OFFICES POSITION
BUSINESS ADDRESS WITH UNDERWRITER AND OFFICES
WITH
REGISTRANT
Kenneth J. Kempf Director None
3200 Horizon Drive and President
P.O. Box 61503
King of Prussia, PA
19406-0903
Lynne M. Cannon Vice President None
3200 Horizon Drive and Principal
P.O. Box 61503
King of Prussia, PA
19406-0903
Rocco C. Cavalieri Director None
3200 Horizon Drive and Vice President
P.O Box 61503
King of Prussia, PA
19406-0903
Gerald J. Holland Director, Senior None
3200 Horizon Drive Vice President
P.O. Box 61503 and Principal
King of Prussia, PA
19406-0903
Joseph M. O'Donnell Director None
3200 Horizon Drive and Vice President
P.O. Box 61503
King of Prussia, PA
19406-0903
Sandra L. Adams Assistant None
3200 Horizon Drive Vice President
P.O. Box 61503 and Principal
King of Prussia, PA
19406-0903
John H. Leven Treasurer None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA
19406-0903
Mary P. Efstration Secretary None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA
19406-0903
Bruno DiStefano Principal None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA
19406-0903
James W. Stratton may be considered a control person
of the Underwriter due to his direct or indirect
ownership of FPS Services, Inc., the parent of the
Underwriter.
c) Not Applicable.
Item 30. Locations of Accounts and Records.
The accounts, books or other documents required to be
maintained by Section 31(a) of the Investment Company
Act of 1940 and the Rules thereunder will be kept by
the Registrant at the following offices:
(1) FPS Services, Inc., 3200 Horizon Drive,
P. O. Box 61503, King of Prussia,
Pennsylvania 19406-0903
(2) Smith Breeden Associates, Inc., 100 Europa
Drive, Suite 200, Chapel Hill, NC 27514
Item 31. Management Services.
There are no management-related service contracts
not discussed in Part A or Part B.
Item 32. Undertakings.
(a) The Registrant previously has undertaken to
promptly call a meeting of shareholders for the purpose
of voting upon the question of removal of any trustee
or trustees when requested in writing to do so by the
record holders of not less than 10 percent of the
Registrant's outstanding shares and to assist its
shareholders in accordance with the requirements of
Section 16(c) of the Investment Company Act of 1940
relating to shareholder communications.
(b) The Registrant hereby undertakes to furnish to
each person to whom a prospectus is delivered a copy
of the Registrant's latest annual report to
shareholders upon request and without charge.
The Registrant hereby undertakes to file a post-
effective amendment within four to six months from the
effective date of this Registration Statement
under the Securities Act of 1933. The Registrant
understands that such post-effective amendment may
contain financial statements which are not certified by
independent public accountants.
SIGNATURES
Pursuant to the requirements of the Securities
Act of 1933, as amended, and the Investment Company Act
of 1940, as amended, the Registrant certifies that it meets all
of the requirements for effectiveness of this Registration
Statement pursuant to Rule 485(b) under the Securities Act of
1933 and has duly caused this Amendment to the Registration
Statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Chapel Hill,
the State of North Carolina, on the 16th day of December, 1997.
SMITH BREEDEN TRUST
By
Michael J. Giarla
President
Pursuant to the requirements of the Securities Act
of 1933, this Amendment to the Registration Statement
has been signed below by the following persons in the
capacities and on the dates indicated.
SIGNATURE TITLE DATE
Michael J. Giarla President, December 16, 1997
Trustee
Douglas T. Breeden* Trustee December 16, 1997
Stephen M. Schaefer* Trustee December 16, 1997
Myron S. Scholes* Trustee December 16, 1997
William F. Sharpe* Trustee December 16, 1997
Marianthe S. Mewkill Principal December 16, 1997
Financial
and Accounting
Officer
* By:
Marianthe S. Mewkill
*Attorney-in-Fact pursuant to power-of-attorney filed
previously.
CONSENT OF INDEPENDENT AUDITORS
Smith Breeden Trust:
We consent to the use in Post-Effective Amendment No. 13 to
Registration Statement
No. 33-44909 of our report dated May 12, 1997 relating to the
Smith Breeden Equity Plus Fund of Smith Breeden Trust appearing
in the Statement of Additional Information, which is a part of
such Registration Statement and to the references to us under the
captions "Experts" appearing in the Statement of Additional
Information and "Financial Highlights" appearing in the
Prospectus, which also is a part of such Registration Statement.
DELOITTE & TOUCHE LLP
Princeton, New Jersey
December 8, 1997
<TABLE> <S> <C>
<ARTICLE> 6
<SERIES>
<NUMBER> 1
<NAME> SMITH BREEDEN EQUITY PLUS FUND
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-END> SEP-30-1997
<INVESTMENTS-AT-COST> 42012722
<INVESTMENTS-AT-VALUE> 42271603
<RECEIVABLES> 15431556
<ASSETS-OTHER> 19184686
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 76887845
<PAYABLE-FOR-SECURITIES> 14655973
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 1145482
<TOTAL-LIABILITIES> 15801455
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 56240220
<SHARES-COMMON-STOCK> 4015310
<SHARES-COMMON-PRIOR> 1075509
<ACCUMULATED-NII-CURRENT> 217425
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 4017695
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 611050
<NET-ASSETS> 61086390
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 919615
<OTHER-INCOME> 0
<EXPENSES-NET> 139434
<NET-INVESTMENT-INCOME> 780181
<REALIZED-GAINS-CURRENT> 3582275
<APPREC-INCREASE-CURRENT> 1099360
<NET-CHANGE-FROM-OPS> 5461816
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 598989
<DISTRIBUTIONS-OF-GAINS> 429677
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 3404871
<NUMBER-OF-SHARES-REDEEMED> 528659
<SHARES-REINVESTED> 63589
<NET-CHANGE-IN-ASSETS> 47579013
<ACCUMULATED-NII-PRIOR> 36234
<ACCUMULATED-GAINS-PRIOR> 865097
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 110914
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 204119
<AVERAGE-NET-ASSETS> 31886289
<PER-SHARE-NAV-BEGIN> 12.560
<PER-SHARE-NII> 0.250
<PER-SHARE-GAIN-APPREC> 2.877
<PER-SHARE-DIVIDEND> 0.230
<PER-SHARE-DISTRIBUTIONS> 0.247
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 15.21
<EXPENSE-RATIO> 0.88
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
2
SMITH BREEDEN TRUST
(the "Trust")
Amendment No. 3
to
Agreement and Declaration of Trust
The undersigned, being at least a majority of the Trustees of the
Smith Breeden Trust, hereby amend the Agreement and Declaration
of Trust by deleting therefrom the first sentence of Section 6 of
Article III, and substituting therefore the following:
"Without limiting the authority of the Trustees set
forth in Section 5, inter alia, to establish and
designate any further series or classes or to modify
the rights and preferences of any series, the "Smith
Breeden Financial Services Fund" and the "Smith Breeden
Equity Market Plus Fund" (formerly the "Smith Breeden
Equity Plus Fund", which name change shall be effective
concurrently with the public offering and sale of
shares of the Smith Breeden Financial Services Fund)
shall be, and hereby are, established and designated."
WITNESS our hands set hereto as of this sixth day of
October, 1997.
October 6, 1997
Douglas T. Breeden
October 6, 1997
Michael J. Giarla
October 6, 1997
Stephen M. Schaefer
October 6, 1997
Myron S. Scholes
October 6, 1997
William E. Sharpe
Investment Company Services Agreement between Smith Breeden
Trust and FPS Services, Inc.
A:\AGREMNT.WPD; Dated November 24,1997 Page 12 of 12
FORM OF AGREEMENT
Investment Company Services Agreement
This Agreement, dated as of the day of
, 1997, made by and between Smith Breeden Trust, (the
"Trust"), a business trust operating as an open-end,
management investment company registered under the
Investment Company Act of 1940, as amended (the "Act"), duly
organized and existing under the laws of the Commonwealth of
Massachusetts and FPS Services, Inc. ("FPS"), a corporation
duly organized under the laws of the State of Delaware
(collectively, the "Parties").
Witnesseth That:
Whereas, the Trust is authorized by its Trust
Instrument to issue separate series of shares representing
interests in separate investment portfolios which are
identified on Schedule "C" attached hereto and which
Schedule "C" may be amended from time to time by mutual
agreement of the Trust and FPS; and
Whereas, the Parties desire to enter into an agreement
whereby FPS will provide the services to the Trust as
specified herein and set forth in particular in Schedule "A"
which is attached hereto and made a part hereof.
Now Therefore, in consideration of the premises and
mutual covenants contained herein, and in exchange of good
and valuable consideration, the sufficiency and receipt of
which are hereby acknowledged, the Parties hereto, intending
to be legally bound, do hereby agree as follows:
General Provisions
Section 1. Appointment. The Trust hereby appoints FPS
as servicing agent and FPS hereby accepts such appointment.
In order that FPS may perform its duties under the terms of
this Agreement, the Board of Trustees of the Trust shall
direct the officers, investment adviser, legal counsel,
independent accountants and custodian of the Trust to
cooperate fully with FPS and, upon request of FPS, to
provide such information, documents and advice relating to
the Trust which FPS requires to execute its responsibilities
hereunder. In connection with its duties, FPS shall be
entitled to rely, and will be held harmless by the Trust
when acting in reasonable reliance, upon any instruction,
advice or document relating to the Trust as provided to FPS
by any of the aforementioned persons on behalf of the Trust.
All fees charged by any such persons acting on behalf of the
Trust will be deemed an expense of the Trust.
Any services performed by FPS under this Agreement will
conform to the requirements of:
(a) the provisions of the Act and the Securities Act
of 1933, as amended, and any rules or regulations in force
thereunder;
(b) any other applicable provision of state and
federal law;
(c) the provisions of the Trust Instrument and the By-
Laws as amended from time to time and delivered to FPS;
(d) any policies and determinations of the Board of
Trustees of the Trust which are communicated to FPS; and
(e) the policies of the Trust as reflected in the
Trust's registration statement as filed with the U.S.
Securities and Exchange Commission.
Nothing in this Agreement will prevent FPS or any
officer thereof from providing the same or comparable
services for or with any other person, firm or corporation.
While the services supplied to the Trust may be different
than those supplied to other persons, firms or corporations,
FPS will provide the Trust equitable treatment in supplying
services. The Trust recognizes that it will not receive
preferential treatment from FPS as compared with the
treatment provided to other FPS clients.
Section 2. Duties and Obligations of FPS.
Subject to the provisions of this Agreement, FPS will
provide to the Trust the specific services as set forth in
Schedule "A" attached hereto.
Section 3. Definitions. For purposes of this
Agreement:
"Certificate" will mean any notice, instruction, or
other instrument in writing, authorized or required by this
Agreement. To be effective, such Certificate shall be given
to and received by the custodian and shall be signed on
behalf of the Trust by any two of its designated officers,
and the term Certificate shall also include instructions
communicated to the custodian by FPS.
"Custodian" will refer to that agent which provides
safekeeping of the assets of the Trust.
"Instructions" will mean communications containing
instructions transmitted by electronic or telecommunications
media including, but not limited to, Industry
Standardization for Institutional Trade Communications,
computer-to-computer interface, dedicated transmission line,
facsimile transmission (which may be signed by an officer or
unsigned) and tested telex.
"Oral Instruction" will mean an authorization,
instruction, approval, item or set of data, or information
of any kind transmitted to FPS in person or by telephone,
telegram, telecopy or other mechanical or documentary means
lacking original signature, by a person or persons
reasonably identified to FPS to be a person or persons so
authorized by a resolution of the Board of Trustees of the
Trust to give Oral Instructions to FPS on behalf of the
Trust.
"Shareholders" will mean the registered owners of the
shares of the Trust in accordance with the share registry
records maintained by FPS for the Trust.
"Shares" will mean the issued and outstanding shares of
the Trust.
"Signature Guarantee" will mean the guarantee of
signatures by an "eligible guarantor institution" as defined
in Rule 17Ad-15 under the Securities Exchange Act of 1934,
as amended (the "Exchange Act"). Eligible guarantor
institutions include banks, brokers, dealers, credit unions,
national securities exchanges, registered securities
associations, clearing agencies and savings associations.
Broker-dealers guaranteeing signatures must be members of a
clearing corporation or maintain net capital of at least
$100,000. Signature guarantees will be accepted from any
eligible guarantor institution which participates in a
signature guarantee program.
"Written Instruction" will mean an authorization,
instruction, approval, item or set of data or information of
any kind transmitted to FPS in an original writing
containing an original signature or a copy of such document
transmitted by telecopy including transmission of such
signature reasonably identified to FPS to be the signature
of a person or persons so authorized by a resolution of the
Board of Trustees of the Trust, or so identified by the
Trust to give Written Instructions to FPS on behalf of the
Trust.
Concerning Oral and Written Instructions For all
purposes under this Agreement, FPS is authorized
to act upon receipt of the first of any Written or
Oral Instruction it receives from the Trust or its
agents. In cases where the first instruction is
an Oral Instruction that is not in the form of a
document or written record, a confirmatory Written
Instruction or Oral Instruction in the form of a
document or written record shall be delivered. In
cases where FPS receives an Instruction, whether
Written or Oral, to enter a portfolio transaction
onto the Trust's records, the Trust shall cause
the broker/dealer executing such transaction to
send a written confirmation to the Custodian.
FPS shall be entitled to rely on the first
Instruction received. For any act or omission
undertaken by FPS in compliance therewith, it
shall be free of liability and fully indemnified
and held harmless by the Trust, provided however,
that in the event a Written or Oral Instruction
received by FPS is countermanded by a subsequent
Written or Oral Instruction received prior to
acting upon such countermanded Instruction, FPS
shall act upon such subsequent Written or Oral
Instruction. The sole obligation of FPS with
respect to any follow-up or confirmatory Written
Instruction or Oral Instruction in documentary or
written form shall be to make reasonable efforts
to detect any such discrepancy between the
original Instruction and such confirmation and to
report such discrepancy to the Trust. The Trust
shall be responsible and bear the expense of its
taking any action, including any reprocessing,
necessary to correct any discrepancy or error. To
the extent such action requires FPS to act, the
Trust shall give FPS specific Written Instruction
as to the action required.
The Trust will file with FPS a certified copy of each
resolution of the Trust's Board of Trustees authorizing
execution of Written Instructions or the transmittal of Oral
Instructions as provided above.
Section 4. Indemnification.
(a) FPS, its directors, officers, employees,
shareholders, and agents will be liable for any loss
suffered by the Trust resulting from the willful
misfeasance, bad faith, negligence or reckless disregard on
the part of FPS in the performance of its obligations and
duties under this Agreement. FPS agrees to indemnify and
hold the Trust harmless, together with its trustees,
officers, employees, shareholders and agents, from and
against any and all claims, demands, expenses and
liabilities (whether with or without basis in fact or law)
of any and every nature which the Trust may sustain or incur
or which may be asserted against the Trust by any person
arising directly or indirectly out of or in any way relating
to the willful misfeasance, bad faith, negligence or
reckless disregard on the part of FPS in the performance of
its obligations and duties under this Agreement.
(b) Any director, officer, employee, shareholder or
agent of FPS, who may be or become an officer, director,
employee or agent of the Trust, will be deemed, when
rendering services to the Trust, or acting on any business
of the Trust (other than services or business in connection
with FPS' duties hereunder), to be rendering such services
to or acting solely for the Trust and not as a director,
officer, employee, shareholder or agent of, or under the
control or direction of FPS even though such person may be
receiving compensation from FPS.
(c) The Trust agrees to indemnify and hold FPS
harmless, together with its directors, officers, employees,
shareholders and agents from and against any and all claims,
demands, expenses and liabilities (whether with or without
basis in fact or law) of any and every nature which FPS may
sustain or incur or which may be asserted against FPS by any
person by reason of, or as a result of:
(i) any action taken or omitted to be taken by
FPS except claims, demands, expenses and liabilities arising
from willful misfeasance, bad faith, negligence or reckless
disregard on the part of FPS in the performance of its
obligations and duties under this Agreement; or
(ii) any action taken or omitted to be taken by
FPS in reliance upon any Certificate, instrument, order or
stock certificate or other document reasonably believed by
FPS to be genuine and signed, countersigned or executed by
any duly authorized person, upon the Oral Instructions or
Written Instructions of an authorized person of the Trust,
or upon the written opinion of legal counsel for the Trust
or FPS; or
(iii) the offer or sale of shares of the Trust
to any person, natural or otherwise, which is in violation
of any state or federal law.
If a claim is made against either party as to which
such party may seek indemnity under this Section (the
"Indemnified Party"). The Indemnified Party will notify the
party required to provide such indemnity (the "Indemnifying
Party") promptly after receipt of any written assertion of
such claim threatening to institute an action or proceeding
with respect thereto and will notify the Indemnifying Party
promptly of any action commenced against the Indemnified
Party within ten (10) days after the Indemnified Party has
been served with a summons or other legal process. Failure
to notify the Indemnifying Party will not, however, relieve
the Indemnifying Party from any liability which it may have
on account of the indemnity under this Section so long as
the Indemnifying Party has not been prejudiced in any
material respect by such failure.
The Parties will cooperate in the control of the
defense of any action, suit or proceeding in which the
Indemnified Party is involved and for which indemnity is
being provided by the Indemnifying Party to the Indemnified
Party. The Indemnifying Party may negotiate the settlement
of any action, suit or proceeding subject to approval, which
will not be unreasonably withheld. The Indemnified Party
reserves the right, but not the obligation, to participate
in the defense or settlement of a claim, action or
proceeding with its own counsel. Costs or expenses incurred
by the Indemnified Party in connection with, or as a result
of such participation, will be borne solely by the
Indemnifying Party if:
(i) the Indemnified Party has received an opinion
of counsel from counsel to the Indemnifying Party stating
that the use of counsel to the Indemnifying Party by the
Indemnified Party would present an impermissible conflict of
interest;
(ii) the defendants in, or targets of, any such
action or proceeding include both the Indemnified Party and
the Indemnifying Party, and legal counsel to the Indemnified
Party has reasonably concluded that there are legal defenses
available to it which are different from or additional to
those available to the Trust or which may be adverse to or
inconsistent with defenses available to the Indemnifying
Party (in which case the Indemnifying Party will not have
the right to direct the defense of such action on behalf of
the Indemnified Party); or
(iii) the Indemnifying Party authorizes the
Indemnified Party to employ separate counsel at the expense
of the Indemnifying Party.
(d) The terms of this Section will survive the
termination of this Agreement.
Section 5. Representations and Warranties.
(a) FPS represents and warrants that:
(i) it is a corporation duly organized and
existing and in good standing under the laws of Delaware;
(ii) it is empowered under applicable laws
and by its Certificate of Incorporation and By-Laws to enter
into and perform this Agreement;
(iii) all requisite corporate proceedings
have been taken to authorize FPS to enter into and perform
this Agreement;
(iv) it has and will continue to have access to
the facilities, personnel and equipment required to fully
perform its duties and obligations hereunder;
(v) no legal or administrative proceeding have
been instituted or threatened which would impair FPS'
ability to perform its duties and obligations under this
Agreement;
(vi) its entrance into this Agreement shall not
cause a material breach or be in material conflict with any
other agreement or obligation of FPS or any law or
regulation applicable to it;
(vii) it is registered as a transfer agent
under Section 17A(c)(2) of the Exchange Act;
(viii) this Agreement has been duly authorized
by FPS and, when executed and delivered, will constitute
valid, legal and binding obligation of FPS, enforceable in
accordance with its terms.
(b) The Trust represents and warrants that:
(i) it is a business trust duly organized and
existing and in good standing under the laws of the
Commonwealth of Massachusetts;
(ii) it is empowered under applicable laws and by
its Trust Instrument and By-Laws to enter into and perform
this Agreement;
(iii) all requisite proceedings have been
taken to authorize the Trust to enter into and perform this
Agreement;
(iv) no legal or administrative proceedings have
been instituted or threatened which would impair the Trust's
ability to perform its duties and obligations under this
Agreement;
(v) the Trust's entrance into this Agreement
shall not cause a material breach or be in material conflict
with any other agreement or obligations of the Trust, or any
law or regulation applicable to either;
(vi) the Shares are properly registered or
otherwise authorized for issuance and sale;
(vii) this Agreement has been duly authorized
by the Trust and, when executed and delivered, will
constitute valid, legal and binding obligation of the Trust,
enforceable in accordance with its terms.
(c) Delivery of Documents
The Trust will furnish or cause to be furnished to
FPS the following documents;
(i) current Prospectus and Statement of
Additional Information;
(ii) most recent Annual Report;
(iii) most recent Semi-Annual Report for
registered investment companies on Form N-SAR;
(iv) certified copies of resolutions of the
Trust's Board of Trustees authorizing the execution of
Written Instructions or the transmittal of Oral Instructions
and those persons authorized to give those Instructions.
(d) Record Keeping and Other Information
FPS will create and maintain all records required of it
pursuant to its duties hereunder and as set forth in
Schedule "A" in accordance with all applicable laws, rules
and regulations, including records required by Section 31(a)
of the Act. All such records will be the property of the
Trust and will be available during regular business hours
for inspection, copying and use by the Trust. Where
applicable, such records will be maintained by FPS for the
periods and in the places required by Rule 31a-2 under the
Act. Upon termination of this Agreement, FPS will deliver
all such records to the Trust or such person as the Trust
may designate.
In case of any request or demand for the inspection of
the Share records of the Trust, FPS shall notify the Trust
and secure instructions as to permitting or refusing such
inspection. FPS may, however, exhibit such records to any
person in any case where it is advised by its counsel that
it may be held liable for failure to do so.
Section 6. Compensation. The Trust agrees to pay FPS
compensation for its services, and to reimburse it for
expenses at the rates, times, manner and amounts as set
forth in Schedule "B" attached hereto and incorporated
herein by reference and as will be set forth in any
amendments to such Schedule "B" agreed upon in writing by
the Parties. Upon receipt of an invoice therefor, FPS is
authorized to collect such fees by debiting the Trust's
custody account. In addition, the Trust agrees to reimburse
FPS for any out-of-pocket expenses paid by FPS on behalf of
the Trust within ten (10) calendar days of the Trust's
receipt of an invoice therefor.
For the purpose of determining fees payable to FPS, the
value of the Trust's net assets will be computed at the
times and in the manner specified in the Trust's Prospectus
and Statement of Additional Information then in effect.
During the term of this Agreement, should the Trust
seek services or functions in addition to those outlined
below or in Schedule "A" attached hereto, a written
amendment to this Agreement specifying the additional
services and corresponding compensation will be executed by
the Parties.
In the event that the Trust is more than sixty (60)
days delinquent in its payments of monthly billings in
connection with this Agreement (with the exception of
specific amounts which may be contested in good faith by the
Trust), this Agreement may be terminated upon thirty (30)
days' written notice to the Trust by FPS. The Trust must
notify FPS in writing of any contested amounts within thirty
(30) days of receipt of a billing for such amounts.
Disputed amounts are not due and payable while they are
being disputed.
Section 7. Days of Operation. Nothing contained in
this Agreement is intended to or will require FPS, in any
capacity hereunder, to perform any functions or duties on
any holiday, day of special observance or any other day on
which the New York Stock Exchange ("NYSE") is closed.
Functions or duties normally scheduled to be performed on
such days will be performed on and as of the next succeeding
business day on which the NYSE is open. Notwithstanding the
foregoing, FPS will compute the net asset value of the Trust
on each day required pursuant to Rule 22c-1 promulgated
under the Act.
Section 8. Acts of God, etc. FPS will not be liable
or responsible for delays or errors caused by acts of God or
by reason of circumstances beyond its control including,
acts of civil or military authority, national emergencies,
labor difficulties, mechanical breakdown, insurrection, war,
riots, or failure or unavailability of transportation,
communication or power supply, fire, flood or other
catastrophe.
In the event of equipment failures beyond FPS' control,
FPS will, at no additional expense to the Trust, take
reasonable steps to minimize service interruptions but will
have no liability with respect thereto. The foregoing
obligation will not extend to computer terminals located
outside of premises maintained by FPS. FPS has entered into
and maintains in effect agreements making reasonable
provision for emergency use of electronic data processing
equipment to the extent appropriate equipment is available.
Section 9. Inspection and Ownership of Records. In
the event of a request or demand for the inspection of the
records of the Trust, FPS will use its best efforts to
notify the Trust and to secure instructions as to permitting
or refusing such inspection. FPS may, however, make such
records available for inspection to any person in any case
where it is advised in writing by its counsel that it may be
held liable for failure to do so after notice to the Trust.
FPS recognizes that the records it maintains for the
Trust are the property of the Trust and will be surrendered
to the Trust upon written notice to FPS as outlined under
Section 10(c) below. The Trust is responsible for the
payment in advance of any fees owed to FPS. FPS agrees to
maintain the records and all other information of the Trust
in a confidential manner and will not use such information
for any purpose other than the performance of FPS' duties
under this Agreement.
Section 10. Duration and Termination.
(a) The initial term of this Agreement will be for the
period of one (1) year, commencing on the date hereinabove
first written (the "Effective Date") and will continue
thereafter subject to termination by either Party as set
forth in subsection (c) below.
(b) The fee schedules set forth in Schedule "B"
attached hereto will be fixed for the initial term
commencing on the Effective Date of this Agreement and will
continue thereafter subject to their review and any
adjustment.
(c) Either Party may give written notice to the other
(the day on which the notice is received by the Party
against which the notice is made shall be the "Notice Date")
of a date on which this Agreement shall be terminated
("Termination Date"). The Termination Date shall be set on
a day not less than ninety (90) days after the Notice Date.
The period of time between the Notice Date and the
Termination Date is hereby identified as the "Notice
Period". Any time up to, but not later than fifteen (15)
days prior to the Termination Date, the Trust will pay to
FPS such compensation as may be due as of the Termination
Date and will likewise reimburse FPS for any out-of-pocket
expenses and disbursements reasonably incurred or expected
to by incurred by FPS up to and including the Termination
Date.
