SMITH BREEDEN MUTUAL FUNDS
ANNUAL REPORTS
Smith Breeden Short Duration U.S. Government Series
Smith Breeden Intermediate Duration U.S. Government Series
Smith Breeden Equity Plus Fund
March 31, 1997
May 8, 1997
Dear Fellow Shareholder:
Enclosed please find the annual report for the Smith Breeden Mutual Funds for
the fiscal year ended March 31, 1997.
We are pleased to report that all three Smith Breeden Mutual Funds continue to
maintain either four or five star ratings from Morningstar, indicative of
strong risk-adjusted performance relative to their peers. As your funds
celebrate their five-year anniversaries during 1997 (March 31 for the Short and
Intermediate Series and June 30 for the Equity Plus Fund), you may have noticed
an increase in their visibility in the financial press. The Funds' philosophy,
management style and performance have been the subject of a number of articles,
including a recent story in the May issue of Money magazine.
In an effort to make information more easily accessible to you, we have
directed additional resources to our toll-free phone lines and introduced
a Smith Breeden website. We hope you have a chance to visit the website at
www.smithbreeden.com. The NAVs for all three funds are now listed daily in
major newspapers such as The Wall Street Journal and The New York Times.
The recent stock and bond market volatility has caused many people to reassess
their investment strategies. At the Smith Breeden Mutual Funds we endeavor to
make investing simple by offering a small number of funds --each representing
a distinct domestic asset class and risk level -- stocks, bonds, and cash.
Whatever your risk tolerance or target asset allocation, Smith Breeden Mutual
Funds offers sound investment alternatives to help achieve your goals.
The annual report begins with a discussion of each fund's performance. Please
do not hesitate to call us if you have any questions about the information
presented or if you have suggestions about how we might better serve you. We
would like to thank the many shareholders who have paid us a compliment by
either recommending Smith Breeden Mutual Funds to others or by entrusting us to
manage a greater proportion of their investment dollars.
Thank you for your continued trust in the Smith Breeden Mutual Funds.
Sincerely,
Douglas T. Breeden Michael J. Giarla
Chairman President
1<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT SERIES
ANNUAL REPORT AND PERFORMANCE REVIEW
Performance Review
The Smith Breeden Short Duration U.S. Government Series provided a total
return of 6.57% in the year ended March 31, 1997. The Series' return
exceeded its benchmark, the six-month U.S. Treasury Bill, by a significant
margin, 1.16%. Since the Series' inception, its return has exceeded that of
its benchmark by 4.48%, and on an annualized basis by 0.74%. The graph below
plots the Series' return versus both its benchmarks and the average return of
Morningstar, Inc.'s Ultrashort Bond Fund category.
THE LINE GRAPH DETAILING PERFORMANCE VERSUS THE SHORT SERIES' 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 SHORT
SERIES VERSUS THAT OF TWO BENCHMARKS, THE SIX MONTH US TREASURY BILL AND
MORNINGSTAR INC.'S ULTRASHORT BOND FUND CATEGORY. FROM INCEPTION OF MARCH 31,
1992 THROUGH MARCH 31, 1997, AN INVESTMENT OF $10,000 IN THE SHORT SERIES WOULD
HAVE GROWN TO $13,959, VERSUS $12,623 IN THE AVERAGE OF THE FUNDS IN THE
ULTRASHORT CATEGORY AND VERSUS $12,610 IN THE SIX MONTH US TREASURY BILL.
SHORT SERIES AND MORNINGSTAR RETURNS ARE NET OF FEES AND SALES CHARGES; THE
RETURN OF THE SIX MONTH US TREASURY DOES NOT REFLECT FEES OR TRANSACTION COSTS.
THE ANNUALIZED ONE YEAR RETURN FOR THE SHORT SERIES IS 6.57%, ANNUALIZED THREE
RETURN IS 6.03%, ANNUALIZED FIVE YEAR RETURN IS 5.48% AND ANNUALIZED RETURN
FROM INCEPTION IS 5.48%. THE ANNUALIZED RETURNS FOR THE AVERAGE OF THE FUNDS
IN MORNINGSTAR'S ULTRASHORT BOND FUND CATEGORY ARE AS FOLLOWS: ONE YEAR 5.62%,
THREE YEAR 5.17%, FIVE YEAR 4.77%, AND INCEPTION 4.77%. THE ANNUALIZED RETURNS
FOR THE SIX MONTH US TREASURY ARE AS FOLLOWS: ONE YEAR 5.41%, THREE YEAR 5.46%
FIVE YEAR 4.74%, AND INCEPTION 4.74%.
The Series' outstanding performance for the fiscal year owes mostly to
declines in interest rate volatility, both on a realized and an expected basis.
Most of the Series' holdings are mortgage-backed securities (MBS), which
perform better when volatility is low because investors have greater certainty
about the timing of their cashflows. MBS cashflows are inherently uncertain,
because homeowners change their refinancing behavior in response to changes
in interest rates. When rates fall, refinancing activity rises; when rates
rise, refinancing activity falls. Investors in MBS require a substantial yield
premium over US Treasury securities, most of which is to compensate them for
the uncertainty of MBS cashflows (in contrast, Treasury cashflows are fixed).
When interest rate volatility is low, investors require less of a yield premium
and MBS perform well relative to Treasury securities, as they have over the
past year.
2<PAGE>
The excellent return of the Series reflects more than just the good
overall performance of the MBS market, however. We were able to add value
in other ways as well, using three general techniques:
(1) we raised and lowered the overall mortgage weight in response
to short-term changes in the relative attractiveness of the MBS market;
(2) we changed portfolio sector weights frequently as relative value
changed, for example selling fixed-rate MBS to purchase adjustable-rate MBS;
and
(3) we took advantage of opportunities to move within MBS
sectors, for example selling low-coupon fixed-rate MBS to purchase middle-
coupon MBS. Smith Breeden's extensive coverage of the MBS market and
our proprietary valuation models enabled us to make these portfolio
adjustments in a timely and profitable fashion.
Since the Series' holdings are very liquid, we are able to reposition
the portfolio frequently to produce excess return. The transaction costs are
small in relation to the advantage gained through the repositioning. This high-
liquidity, actively-managed style does result in relatively high portfolio
turnover, which totaled 556% for the year. Much of the turnover resulted
from transactions among very similar securities, however. Selling a GNMA
7% passthrough to purchase a GNMA 8% passthrough creates "turnover," but
the change in the portfolio's characteristics is much smaller than, for example,
if a stock fund were to sell Ford stock to purchase Intel.
The Series' strong risk management discipline stood it in good stead during the
fiscal year and will continue to do so in the months to come, which many
expect to be fairly unpredictable, in both the fixed income and stock markets.
As the Series' performance demonstrated not only over the past year but over
its five-year history, our attention to risk management, combined with our
skills in mortgage investing, have enabled the Series to provide steady,
superior returns in rising and falling interest rate environments.
3<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT SERIES
SCHEDULE OF INVESTMENTS 31-Mar-97
Market
Face Amount Security Value
U.S. GOVERNMENT & AGENCY OBLIGATIONS - 123.30 %
FEDERAL HOME LOAN MORTGAGE CORP. - 34.22% *
FHLMC GOLD:
$23,728,869 7.50%, due 7/01/24 to 6/01/27 ...............$ 23,273,767
944,252 8.00%, due 9/01/24 to 5/01/25........... 952,924
16,057,726 8.50%, due 11/01/24 to 8/01/26 ........... 16,493,947
TOTAL FEDERAL HOME LOAN MORTGAGE CORP.
(Cost $40,870,754 ) 40,720,638
FEDERAL NATIONAL MORTGAGE ASSOCIATION - 0.46% *
FNMA INTEREST ONLY **:
1,649,849 9.00%, due 7/25/21 ............................... 543,088
TOTAL FEDERAL NATIONAL MORTGAGE ASSOCIATION
(Cost $227,375) 543,088
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION - 88.11% *
GNMA ARM:
19,286,497 5.00%, due 1/20/27 to 2/20/27 .......... .......18,658,334
20,600,000 5.50%, due (a) .......................... .....20,128,625
2,985,894 5.50%, 12/20/26........................... 2,948,412
12,901,392 6.00%, due 2/20/27***...................... 12,850,847
4,500,000 6.00%, due (a) ..................................4,462,031
3,652,376 6.50%, due 3/20/21 to 9/20/26 ............. 3,705,068
3,779,910 7.125%, due 7/20/17 to 4/01/24 .............. 3,869,279
GNMA:
36,563,907 8.00%, due 6/1/26 to 1/1/27................. 36,769,416
1,349,922 9.50%, due 7/15/09 to 4/15/25......... ..... 1,450,502
TOTAL GOVERNMENT NATIONAL MORTGAGE ASSOCIATION
(Cost $105,238,843) 104,842,514
U.S. GOVERNMENT OBLIGATIONS - 0.51%
U.S. TREASURY BILL ****
610,000 5.39% and 5.02%, due 5/29/97 ................. ... 604,890
TOTAL U.S. GOVERNMENT OBLIGATIONS
(Cost $604,767)........... 604,890
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(Cost $146,941,739) . 146,711,130
Notional Amount INTEREST RATE SWAP CONTRACTS - 1.81%
$20,000,000 Contract dated 6/22/93 with Prudential Global Funding,
Expires 6/22/98, pay rate 5.458% .. .............. 212,603
20,000,000 Contract dated 8/31/93 with Salomon Swapco,
Expires 8/30/00, pay rate 5.34% .. ............... 884,505
20,000,000 Contract dated 12/2/93 with Morgan Guaranty Trust Company,
Expires 12/2/00, pay rate 5.69% ................. 677,160
40,000,000 Contract dated 5/15/95 with Salomon Swapco,
Expires 5/15/05, pay rate 6.951% ................ 381,282
TOTAL INTEREST RATE SWAP CONTRACTS .............. 2,155,550
Notional Market
Amount Security Value
THREE MONTH LIBOR INTEREST RATE CAP CONTRACTS - 1.17%
$50,000,000 Contract with Salomon Swapco, expires 4/23/03,
Strike rate 7.50%................................ $1,393,000
TOTAL THREE-MO. LIBOR INTEREST RATE CAP CONTRACTS
(Cost $1,585,644) .. 1,393,000
Contracts OPTION CONTRACTS - 0.27%
130 Call on 10 Year US Treasury Note futures, expires 5/97,
strike price $109 .. 8,125
50 Call on 10 Year US Treasury Note futures, expires 5/97,
strike price $111 781
100 Call on 10 Year US Treasury Note futures, expires 5/97,
strike price $112 1,563
130 Put on 10 Year US Treasury Note futures, expires 5/97,
strike price $105 . 95,469
100 Put on 10 Year US Treasury Note futures, expires 5/97,
strike price $106 . 120,313
50 Put on 10 Year US Treasury Note futures, expires 5/97,
strike price $107 . 92,187
TOTAL OPTION CONTRACTS (Cost $243,144) ............... 318,438
TOTAL INVESTMENTS- 126.55% (Cost $148,770,527) .....150,578,118
Face Amount REPURCHASE AGREEMENTS - 18.49%:
$22,000,000 Morgan Stanley, 5.55% and 5.63%, due 4/01/97 and 4/3/97
dated 3/25/97 and 3/27/97 $22,000,000
TOTAL REPURCHASE AGREEMENTS (Cost $22,000,000)... 22,000,000
REVERSE REPURCHASE AGREEMENTS - (10.08%):
12,000,000 FHLMC, 6.60%, due 4/01/97 dated 3/31/97......... (12,000,000)
TOTAL REVERSE REPURCHASE AGREEMENTS ......... (12,000,000)
SHORT SALES - (17.06%)
21,106,250 GNMA 6.5% due (a)................................ (20,301,875)
TOTAL SHORT SALES (Proceeds $20,350,000)........... (20,301,875)
OTHER LIABILITIES LESS CASH AND OTHER
ASSETS - (17.90%). (21,287,634)
NET ASSETS - 100.00% $118,988,609
* Mortgage-backed obligations are subject to principal paydowns as a
result of prepayments or refinancings of the underlying mortgage
instruments. As a result, the average life may be substantially less
than the original maturity. The interest rate shown is the rate in
effect at March 31, 1997. ARMs have coupon rates which adjust
periodically. The adjusted rate is determined by adding a spread to a
specified index.
** Represents an interest only stripped mortgage-backed security.
*** This security is held as collateral under a reverse repurchase agreement.
**** 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.
5<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT SERIES
STATEMENT OF ASSETS AND LIABILITIES
31-Mar-97
ASSETS:
Investments at market value (identified cost $148,770,527)
(Note 1).. $150,578,118
Cash.............................................................. 676,200
Repurchase agreement (cost $22,000,000) (Note 1)............ 22,000,000
Receivables:
Subscriptions............................................ 1,152,765
Interest................................................. 762,909
Securities sold......................................... 80,444,418
TOTAL ASSETS.......................................... 255,614,410
LIABILITIES:
Reverse repurchase agreement (Note 1)....................... 12,000,000
Short sales at market value (Proceeds $20,350,000)......... 20,301,875
Payables:
Variation margin on futures contracts (Note 2)............ 9,191
Redemptions................................. .................. 20,470
Distribution................................. ................. 676,913
Securities purchased.................................... 103,345,618
Swap interest............................... ................ 72,393
Due to adviser (Note 3)..................... .......... 80,755
Accrued expenses....................................... 118,586
TOTAL LIABILITIES....................................... 136,625,801
NET ASSETS:
(Applicable to outstanding shares of 12,106,419
unlimited number of shares of beneficial
interest authorized; no stated par)..................... $118,988,609
Net asset value, offering price and redemption
price per share ($118,988,609/12,106,419).. ................. $9.83
SOURCE OF NET ASSETS:
Paid in capital...............................................$124,434,880
Overdistributed net investment income........................... (676,914)
Accumulated net realized loss on investments................. (5,589,259)
Net unrealized appreciation of investments, interest rate swaps,
short sales and futures contracts............. ............... 819,902
NET ASSETS............................................. $118,988,609
The accompanying notes are an integral part of these financial statements.
6<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT SERIES
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1997
INVESTMENT INCOME:
Interest and discount earned, net of premium
amortization and interest
expense (Note 1) ................................. $11,805,901
EXPENSES:
Advisory fees (Note 3).............................. 1,417,921
Accounting and pricing services fees....................69,655
Custodian fees..........................................74,731
Audit and tax preparation fees..........................57,500
Legal fees..............................................65,580
Amortization of organization expenses (Note 1).......... 9,548
Transfer agent fees.....................................32,778
Registration fees.......................................18,228
Trustees fees and expenses.............................102,499
Insurance...............................................22,309
Other...................................................11,220
TOTAL EXPENSES BEFORE REIMBURSEMENT..............1,881,969
Expenses reimbursed by Adviser (Note 3)...........(301,998)
NET EXPENSES.....................................1,579,971
NET INVESTMENT INCOME ......................... 10,225,930
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized gain on investments........................846,686
Change in unrealized appreciation (depreciation)
of investments, interest rate swaps,
caps, and futures contracts............................1,887,652
Net realized and unrealized gain on investments........2,734,338
Net increase in net assets resulting from operations.$12,960,268
The accompanying notes are an integral part of these financial statements.
7<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT SERIES
STATEMENTS OF CHANGES IN NET ASSETS
Year Ended Year Ended
31-Mar-97 31-Mar-96
OPERATIONS:
Net investment income.............................$10,225,930 $15,412,781
Net realized gain on investments.................... 846,686 4,639,312
Change in unrealized appreciation
(depreciation) of investments,
interest rate swaps, caps and futures contracts......1,887,652 (8,342,309)
Net increase in net assets resulting from
operations..........................................12,960,268 11,709,784
DISTRIBUTIONS TO SHAREHOLDERS:
Dividends from net investment income...............(10,225,930) (15,412,781)
Dividends in excess of net investment income..........(929,596) (269,331)
Total distributions......................... ......(11,155,526) (15,682,112)
CAPITAL SHARE TRANSACTIONS:
Shares sold........................................ 59,328,830 93,214,276
Shares issued on reinvestment of distributions.......2,816,807 3,773,450
Shares redeemed...................................(166,786,906) (89,621,927)
(Decrease) increase in net assets
resulting from capital
share transactions (a)..........................(104,641,269) 7,365,799
TOTAL INCREASE (DECREASE) IN NET ASSETS......(102,836,527) 3,393,471
NET ASSETS:
Beginning of year.................................221,825,136 218,431,665
End of year......................................$118,988,609 $221,825,136
(a) Transactions in capital shares were as follows:
Shares sold.....................................6,065,723 9,500,348
Shares issued on reinvestment of distributions....289,222 386,101
Shares redeemed...............................(17,017,982) (9,167,732)
Net (decrease) increase ......................(10,663,037) 718,717
Beginning balance .............................22,769,456 22,050,739
Ending balance.................................12,106,419 22,769,456
The accompanying notes are an integral part of these financial statements.
8<PAGE>
SMITH BREEDEN SHORT DURATION US GOVERNMENT SERIES
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED MARCH 31, 1997
Year Ended
31-Mar-97
Cash flows from operating activities:
Net increase in net assets resulting from operations.......$12,960,268
Net realized and unrealized gain on investments......... (2,734,338)
Net investment income.....................................10,225,930
Adjustments to reconcile net investment income
to net cash provided by operating activities:
Interest rate cap and interest-only strip amortization...... 225,006
Net paydown gains and losses................................... 34,366
Decrease in interest receivable. ............... 793,222
Increase in other assets............. ...................... (9,643)
Decrease in other liabilities......... ........... (72,793)
Net cash provided by operating activities................ 11,196,088
Cash flows from investing activities:
Payments for futures variations.... ............. (265,747)
Proceeds from sales of long-term investments.. .......... 462,741,835
Proceeds from sales of short-term investments.. ......... 508,493
Proceeds from sales of options..................... 833,807
Proceeds from maturities of short-term investments..... 2,076,065,225
Proceeds from paydowns of long-term investments......... 12,247,008
Purchases of long-term investments........................(352,732,116)
Purchases of short-term investments.....................(2,099,153,718)
Purchases of options...................................... (2,768,588)
Net cash provided by investing activities................(97,476,199)
Cash flows from financing activities:
Increase in collateralized borrowings......................11,000,000
Proceeds from shares tendered........... ........... 55,359,258
Payments for shares redeemed........................... (166,766,436)
Dividends from net investment income..... ......... (7,661,806)
Net cash used in financing activities............... (108,068,984)
Net increase in cash................... ....... (603,303)
Cash at beginning of year..... .......................... 72,897
Cash at end of year.................. ................. $676,200
Noncash financing activities:
Market value of shares issued to stockholders
through reinvestment of dividends....................... $2,816,807
Supplemental disclosure:
Interest paid.................................................$61,491
The accompanying notes are an integral part of these financial statements.
9<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT SERIES
<TABLE>
FINANCIAL HIGHLIGHTS
The following average per share data, ratios and supplemental information
have been derived from information provided in the financial statements.
<CAPTION>
Year Year Year Year Year
Ended Ended Ended Ended 3/31/92 <F1>
3/31/97 3/31/96 3/31/95 3/31/94 to 3/31/93
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $9.74 $9.90 $9.90 $10.00 $10.00
Income From Investment Operations
Net investment income.............. 0.476 0.621 0.628 0.432 0.552
Net realized and unrealized
gain (loss) on investments......... 0.146 (0.148) - (0.07) 0.002
Total from investment operations. 0.622 0.473 0.628 0.362 0.554
Less Distributions
Dividends from net
investment income................... (0.476) (0.621) (0.628) (0.462) (0.554)
Dividends in excess of
investment income.................... (0.056) (0.012) - - -
Total distributions............ (0.532) (0.633) (0.628) (0.462) (0.554)
Net Asset Value, End of Period....... $9.83 $9.74 $9.90 $9.90 $10.00
Total Return .......................... 6.57% 4.95% 6.58% 3.67% 5.67%
Ratios/Supplemental Data
Net assets, end of period....... $118,988,609 $221,825,136 $218,431,665 $218,167,491 $48,531,206
Ratio of expenses to average net assets <F2> 0.78% 0.78% 0.78% 0.78% 0.78%
Ratio of net investment income to
average net assets <F3>... 5.04% 6.29% 6.33% 4.17% 4.53%
<FN>
<F1>
Commencement of operations.
</FN>
<FN>
<F2>
The annualized operating expense ratios prior to reimbursement of expenses by the Adviser were 0.93%, 0.93%, 0.92%, 1.00%, and
2.58% for the Short Duration U.S. Government Series for the years ended March 31, 1997, March 31, 1996, March 31, 1995, March 31,
1994, and the period ended 1993, respectively. Through March 31, 1995, expense ratios include both the direct expenses of the Short
Duration U.S. Government Series, and the indirect expenses incurred through the Series' investment in the Short Duration U.S.
Government Fund (Note 1).
</FN>
<FN>
<F3>
The annualized net investment income ratios prior to reimbursement of both direct and indirect expenses by the Adviser were 4.90%,
6.13%, 6.18%, 3.95% and 2.73% for the Short Duration U.S. Government Series 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>
The accompanying notes are an integral part of these financial statements.
10<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT SERIES
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Breeden Series Fund (the "Fund") is an open-end, diversified
management investment company registered under the Investment Company
Act of 1940, as amended. The Fund offers shares in two series: the Smith
Breeden Short Duration U.S. Government Series (the "Short Series" or
"Series") and the Smith Breeden Intermediate Duration U.S. Government
Series ("Intermediate Duration Series"). Prior to April 1, 1995, the Short
Series sought to achieve its investment objective by investing all of its
assets in the Smith Breeden Short Duration U.S. Government Fund (the "Short
Fund"), an open-end, diversified management investment company having
the same investment objective as the Series. However, at the close of
business on March 31, 1995, pursuant to a plan of liquidation adopted
March 1, 1995 by the Board of Trustees of the Short Fund,
and approved by the Board of Trustees of the Short Series, the Short Series
redeemed in-kind its shares of the Short Fund. The assets of the Short Fund
were transferred in proportion to the Short Series' ownership of the Short
Fund in cancellation of its shares.
A. Security Valuation: 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 the
procedures approved by the Board of Trustees.
B. Repurchase Agreements: Repurchase agreements may be entered
into 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 Funds' Board of Trustees. In a
repurchase agreement, securities are acquired 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 custodian maintains control or custody of securities
collateralizing repurchase agreements until maturity of the repurchase
agreements. The value of the collateral will be monitored daily, and if
necessary, additional collateral is received to ensure that the
market value of the underlying assets remains sufficient to protect the Series
in the event of the seller's default. However, in the event of default or
bankruptcy of the seller, the right to the collateral may be subject to legal
proceedings.
C. Reverse Repurchase Agreements: A reverse repurchase agreement
involves the sale of portfolio assets concurrently with an agreement to
repurchase the same assets at a later date at a fixed price. Assets will be
maintained in a segregated account with the 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 the obligations under the
reverse repurchase agreements. In the event the buyer of securities under a
reverse repurchase agreement files for bankruptcy or becomes insolvent, the
use of the proceeds under the agreement may be restricted pending a
determination by the other party, or its trustee or receiver, whether to
enforce the obligation to repurchase the securities.
11<PAGE>
NOTES TO FINANCIAL STATEMENTS (cont.)
D. Dollar Roll Agreements: A dollar roll is an agreement to sell
securities for delivery in the current month and simultaneously contract to
repurchase substantially similar (same type and coupon) securities on a
specified future date. During the roll period, principal and interest paid on
these securities are not received. Compensation under the dollar roll
agreement is represented 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.
E. Distributions and Taxes: Dividends to shareholders are recorded on
the ex-dividend date. The Short Series 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
Series of Federal income taxes. To so qualify, the Series 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 Series had a net capital loss carryforward of
$3,170,133 with $589 expiring on March 31, 2001, $75,461
expiring on March 31, 2002, $905,312 expiring on March 31, 2003,
$1,359,214 expiring on March 31, 2004, and $829,557 expiring on March
31, 2005.
F. 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.
G. Deferred Organization Expenses: Deferred organization expenses are
being amortized on a straight-line basis over five years.
H. 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
Derivative Financial Instruments Held or Issued for Purposes other than
Trading: Interest rate futures, swap, cap and option contracts are used for
risk management purposes in order to reduce fluctuations in net asset value
relative to the Series' targeted option-adjusted duration.
A. Futures Contracts: Upon entering into a futures contract, either cash
or securities in an amount (initial margin) equal to a certain percentage of
the contract value is required to be deposited in a segregated account.
Subsequent payments (variation margin) are made or received each day.
The variation margin payments are equal to the daily changes in the contract
value and are recorded as unrealized gains or losses. A realized gain or loss
is recognized 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.
12<PAGE>
NOTES TO FINANCIAL STATEMENTS (cont.)
The Short Series had the following open futures contracts as of March 31,
1997:
Type Notional Expiration Unrealized
Amount Position Month Gain/(Loss)
5 Year Treasury $ 22,400,000 Long June, 1997 $(432,132)
10 Year Treasury 16,700,000 Long June, 1997 (405,658)
3 Month Eurodollar 98,000,000 Long September, 1997 ( 41,779)
3 Month Eurodollar 150,000,000 Long June, 1997 (133,425)
3 Month Eurodollar 154,000,000 Long March, 1998 (25,443)
3 Month Eurodollar 40,000,000 Short March, 1999 820
3 Month Eurodollar 38,000,000 Short March, 2000 779
3 Month Eurodollar 30,000,000 Short March, 2001 615
3 Month Eurodollar 20,000,000 Short March, 2002 410
Total $(1,035,813)
Futures transactions involve costs and may result in losses. The effective use
of strategies using futures depends on the Series' ability to terminate
futures positions at times when the Series' 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 Series, of the futures contract itself,
and of the securities which are the subject of a hedge.
The aggregate market value of investments to cover margin requirements for
the open positions was $604,890.
B. Interest Rate Swap Contracts: The Fund may enter into over-the-
counter transactions swapping interest rates. Interest rate swaps represent an
agreement between counterparties to exchange cash flows based on the
difference between two interest rates, applied to a notional principal amount
for a specified period. The most common type of interest rate swap involves
the exchange of fixed-rate cash flows for variable-rate cash flows. Interest
rate swaps do not involve the exchange of principal between the parties.
The Series' interest rate swap contracts have been entered into on a net
basis, i.e., the two payment streams are netted out, with the Short Series
receiving or paying, as the case may be, only the net amount of the two
payments. As of March 31, 1997, the Short Series had four open interest
rate swap contracts. In each of the contracts, the Short Series has agreed to
pay a fixed rate and receive a floating rate. The floating rate on the
contracts resets quarterly and is the three month London Interbank Offered
Rate ("LIBOR"). Interest rate swap contracts will not be entered into unless
the unsecured commercial paper, unsecured senior debt or the claims-paying
ability of the other party thereto is rated either AA or A-1 or better by
Standard & Poor's Corporation or Aa or P-1 or better by Moody's Investors
Service, Inc. (or is otherwise acceptable to either agency) at the time of
entering into such transaction. If there is a default by the other party to the
swap transaction, the Short Series will be limited to contractual remedies
pursuant to the agreements related to the transaction. There is no assurance
that interest rate swap contract counterparties will be able to meet their
obligations pursuant to the swap contracts or that, in the event of default,
the Short Series will succeed in pursuing contractual remedies. The Short
Series thus assumes the risk that it may be delayed in, or prevented from,
obtaining payments owed to it pursuant to the swap contracts.
13<PAGE>
NOTES TO FINANCIAL STATEMENTS (cont.)
The Short Series' interest payable on the interest rate swap contracts as of
March 31, 1997 was $72,393, and swap contract interest receivable was
$2,935. No collateral is required to be maintained on these contracts.
C. Interest Rate Cap Contracts: 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 caps. The Short
Series had one interest rate cap contract open at March 31, 1997.
3. TRANSACTIONS WITH AFFILIATES
Smith Breeden Associates, Inc. (the "Adviser"), a registered investment
adviser, provides the Short Series with investment management services.
The Adviser has voluntarily agreed to reimburse normal business expenses of
the Short Series through March 31, 1998 so that total direct and indirect
operating expenses do not exceed 0.78% of its average net assets. This
voluntary agreement may be terminated at any time by the Adviser in its sole
discretion after March 31, 1998. The Adviser has also agreed to reduce its
fees payable (to the extent of such fees) by the amount the Series' direct and
indirect expenses would, absent the fee reduction, exceed the applicable
expense limitations imposed by state securities administrators. For the year
ended March 31, 1997, the Adviser received $1,417,921 in fees and
reimbursed the Short Series $301,998.
Certain officers and trustees of the Fund are also officers and directors of the
Adviser.
Pursuant to Rule 12b-1 under the Investment Company Act of 1940 ("1940
Act"), the Series adopted, effective August 1, 1994, a Distribution and
Services Plan (the "Plan"). 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 Short Series, 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 the advisory fee paid to it by the Short Series, to dealers and
other persons at the annual rate of up to 0.25% of the Short Series' average
net assets, subject to the authority of the Trustees of the Short Series, 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.
14<PAGE>
4. INVESTMENT TRANSACTIONS
During the year ended March 31, 1997, purchases and proceeds from sales of
securities, other than short-term investments, aggregated $1,226,155,709 and
$1,357,342,232 respectively for the Series. The cost of the Short Series'
securities for federal income tax purposes at March 31, 1997, is
$148,770,527. Net unrealized appreciation of investments, short sales and
futures contracts consists of:
Gross unrealized appreciation $ 3,190,281
Gross unrealized depreciation (2,370,379)
Net unrealized appreciation $ 819,902
15<PAGE>
INDEPENDENT AUDITORS REPORT
The Board of Trustees and Shareholders,
Smith Breeden Short Duration U.S. Government Series of the Smith
Breeden Series Fund:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of the Smith Breeden Short
Duration U.S. Government Series of the Smith Breeden Series Fund 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 March 31, 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 Short Duration U.S. Government Series of the Smith
Breeden Series Fund 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
16<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT SERIES
ANNUAL REPORT AND PERFORMANCE REVIEW
Performance Review
The Smith Breeden Intermediate Duration U.S. Government Series
provided a total return of 5.92% in the year ending March 31, 1997. The
Series' return exceeded that of its benchmark, the Salomon Brothers
Mortgage Index by 0.03%. Since the Series' inception, its return has
exceeded that of its benchmark by 2.60%, and on an annualized basis by
0.39%. The graph below plots the Series' return versus its benchmark,
which as noted in the graph, changed effective January 1, 1994. The graph
also shows the Series' return versus the average return of the Morningstar,
Inc.'s Government Bond Mortgage fund category, of which the
Intermediate Series was the number one performing fund over the five-year
period ended March 31, 1997.
THE LINE GRAPH DETAILING PERFORMANCE VERSUS THE INTERMEDIATE SERIES' 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 INTERMEDIATE SERIES VERSUS ITS STATED BENCHMARK AND VERSUS THE AVERAGE OF
THE FUNDS IN MORNINGSTAR'S GOVERNMENT BOND MORTGAGE CATEGORY. FOR THE PERIOD
FROM THE SERIES' INCEPTION MARCH 31, 1992 THROUGH DECEMBER 31, 1993, THE SERIES
STATED BENCHMARK WAS THE FIVE YEAR US TREASURY AS TRACKED BY SALOMON BROTHERS,
INC. AFTER DECEMBER 31, 1993, UPON APPROVAL OF A MAJORITY OF THE SHAREHOLDERS,
THE SERIES' BENCHMARK WAS CHANGED TO THE SALOMON BROTHERS MORTGAGE INDEX.
THE SERIES' AVERAGE ANNUAL RETURN WAS 5.92% FOR THE ONE YEAR PERIOD, 7.21% FOR
THE THREE YEAR PERIOD, 8.08% FOR THE FIVE YEAR PERIOD, AND 8.08% FOR THE PERIOD
SINCE INCEPTION. THE AVERAGE ANNUAL RETURN OF THE STATED BENCHMARK WAS 5.89%
FOR THE ONE YEAR PERIOD, 7.45% FOR THE THREE YEAR PERIOD, 7.69% FOR THE FIVE
YEAR PERIOD, AND 7.69% FOR THE PERIOD FROM INCEPTION. THE AVERAGE ANNUAL
RETURN OF THE AVERAGE OF THE FUNDS IN MORNINGSTAR'S GOVERNMENT BOND MORTGAGE
CATEGORY WAS 4.78% FOR THE ONE YEAR PERIOD, 5.99% FOR THE THREE YEAR PERIOD,
AND 6.01% FOR THE FIVE YEAR AND SINCE INCEPTION RETURNS.
FROM INCEPTION THROUGH MARCH 31, 1997, AN INVESTMENT
OF $10,000 IN THE INTERMEDIATE SERIES WOULD HAVE GROWN TO $14,748, VERSUS
$14,486 IN ITS BENCHMARK, AND $13,389 IN THE AVERAGE OF THE FUNDS IN
MORNINGSTAR'S GOVERNMENT BOND MORTGAGE CATEGORY.
The Salomon Brothers Mortgage Index, and the Intermediate
Series, performed outstandingly well over the last twelve months. For the
year, the Series' performance exceeded that of the five-year U.S. Treasury
Note by 2.77% and the three-year Note by 1.22%. Compared to the Lehman
Intermediate Aggregate Bond Index, the Series' performance was 0.69%
ahead.
17<PAGE>
The reason for the outstanding performance of mortgages relates
mostly to declines in interest rate volatility, both on a realized and an
expected basis. Mortgage-backed securities (MBS) perform better when
volatility is low because investors have greater certainty about the timing of
their cashflows. MBS cashflows are inherently uncertain, because
homeowners change their refinancing behavior in response to changes in
interest rates. When rates fall, refinancing activity rises; when rates rise,
refinancing activity falls. Investors in MBS require a substantial yield
premium over US Treasury securities, most of which is to compensate for
the uncertainty of MBS cashflows (in contrast, Treasury cashflows are
fixed). When interest rate volatility is low, investors require less of a yield
premium and MBS perform well relative to Treasury securities, as they
have over the past year.
While the benchmark of the Intermediate Series is the Salomon
Brothers Mortgage Index ("SBMI"), the Series will invest in mortgages
not included in the SBMI. In so doing, the Series seeks to generate excess
returns, on a risk-adjusted basis, which after fund expenses, will contribute
to the fund's incremental performance. As the Intermediate Series' moves
in and out of different mortgage sectors, this can drive up the fund's
portfolio turnover rate. The portfolio turnover rate for the fiscal year 1996
was 409%. However, since the Intermediate Series limits its investment in
these sectors to those that are the most liquid and of AAA credit quality,
transaction costs related to this portfolio turnover are relatively small.
18<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT SERIES
SCHEDULE OF INVESTMENTS 31-Mar-97
Market
Face Amount Security Value
U.S. GOVERNMENT & AGENCY OBLIGATIONS - 113.17%
FEDERAL HOME LOAN MORTGAGE CORP. - 43.24 % *
FHLMC GOLD:
$14,500,000 7.50%, due (a) ................... $14,198,906
2,089,955 8.00%, due 9/01/24 to 10/19/24 .......2,116,804
TOTAL FEDERAL HOME LOAN MORTGAGE CORP.
(Cost $16,381,165) 16,315,710
FEDERAL NATIONAL MORTGAGE ASSOC. - 11.82% *
FNMA:
3,199,150 7.00%, due 8/1/23 to 6/01/24 ......... 3,078,697
1,282,714 9.50%, due 7/01/16 to 5/01/22........ 1,381,554
TOTAL FEDERAL NATIONAL MORTGAGE ASSOC.
(Cost $4,282,274) 4,460,251
GOVERNMENT NATIONAL MORTGAGE ASSOC. - 57.69% *
GNMA:
59,603 7.00%, due 3/15/26 ..................... 56,926
9,241,972 8.00%, due 11/15/06 to 12/15/26 .... 9,320,120
GNMA ARM:
990,000 5.00%, due 3/20/27 ............. ....... 957,230
3,942,410 5.50%, due 11/20/26 ........... 3,889,964
2,858,832 6.00%, due 11/20/26 to 1/20/27... 2,848,303
293,950 6.88%, due 11/20/17 ....................300,234
1,823,924 6.50%, due 2/20/23 ................... 1,857,098
2,479,666 7.125%, due 8/20/17 to 4/20/22.........2,540,041
TOTAL GOVERNMENT NATIONAL MORTGAGE ASSOC.
(Cost $21,663,823) 21,769,916
UNITED STATES TREASURY BILLS - 0.42% **
160,000 5.39%, due 5/29/97 ***................ 158,660
TOTAL UNITED STATES TREASURY BILLS
(Cost $158,612) 158,660
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(Cost $42,485,874) 42,704,537
Contracts OPTION CONTRACTS - 0.02%
10 Call on 10 Year US Treasury Note futures, expires 5/97,
strike price $109 625
10 Call on 10 Year US Treasury Note futures, expires 5/97,
strike price $105 7,343
TOTAL OPTION CONTRACTS (Cost $9,778) .... 7,968
TOTAL INVESTMENTS
(Cost $42,495,652) - 113.19% .. 42,712,505
Face Amount REPURCHASE AGREEMENTS - 18.55%:
$7,000,000 Morgan Stanley, 5.63%, due 4/3/97
dated 3/27/97 . .... 7,000,000
TOTAL REPURCHASE AGREEMENTS
(Cost $7,000,000). .. 7,000,000
SHORT SALES - (7.36%)
3,000,000 GNMA 6.50%, due (a)....................(2,777,813)
TOTAL SHORT SALES
(Proceeds $2,836,992).. ....... (2,777,813)
CASH AND OTHER ASSETS LESS LIABILITIES - (24.38%) (9,199,167)
NET ASSETS - 100.00% ............................ $37,735,525
19<PAGE>
* Mortgage-backed obligations are subject to principal paydowns as a result
of prepayments or refinancings of the underlying mortgage instruments.
As a result, the average life may be substantially less than the original
maturity. The interest rate shown is the rate in effect at March 31, 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.
20<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT SERIES
STATEMENT OF ASSETS AND LIABILITIES
31-Mar-97
ASSETS:
Investments at market value (identified cost $42,495,652)
(Note 1) $42,712,505
Repurchase agreement (cost $7,000,000) (Note 1)............. 7,000,000
Cash.......... ............................................... 2,270,462
Receivables:
Subscriptions. . ........................................... 8,800
Interest......... ........................................ 206,189
Securities sold......... .......................... 12,215,707
Deferred organization expenses (Note 1). .................. 757
TOTAL ASSETS............................................ 64,414,420
LIABILITIES:
Short sales at market value (Proceeds $2,836,992)........... 2,777,813
Payables:
Variation margin on futures contracts (Note 2). ............... 2,469
Securities purchased........................................ 23,738,701
Distributions..................................... ......... 124,309
Due to advisor (Note 3)................................. ...... 14,992
Accrued expenses.............................................. 20,611
TOTAL LIABILITIES........................................ 26,678,895
NET ASSETS:
(Applicable to outstanding shares of 3,878,010;
unlimited number of shares of beneficial
interest authorized; no stated par)........................ $37,735,525
Net asset value, offering price and redemption
price per share ($37,735,525/3,878,010) $9.73
SOURCE OF NET ASSETS:
Paid in capital.............................................. $38,554,091
Overdistributed net investment income........................ (124,309)
Accumulated net realized loss on investments...................... (830,703)
Net unrealized appreciation of investments... ................... 136,446
NET ASSETS............................................. $37,735,525
The accompanying notes are an integral part of these financial statements.
21<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT SERIES
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1997
INVESTMENT INCOME:
Interest and discount earned, net of premium amortization and interest
expense (Note 1) ............................................. $2,632,266
EXPENSES:
Advisory fees (Note 3) ...................... .................. 259,767
Accounting and pricing services fees ........................... 39,224
Custodian fees ................................................. 21,512
Audit & tax preparation fees ................. ......... 14,500
Legal fees ..................................................... 10,251
Amortization of organization expenses (Note 1) ................. 9,402
Transfer agent fees ................................ .......... 29,735
Registration fees .............................................. 20,200
Trustees fees and expenses ......................... ........... 13,324
Insurance ...................................................... 10,541
Other .......................................................... 1,888
TOTAL EXPENSES BEFORE REIMBURSEMENT ................ 430,344
Expenses reimbursed by Adviser (Note 3) .................. (101,379)
NET EXPENSES ............................. ................. 328,965
NET INVESTMENT INCOME .............................. 2,303,301
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized loss on investments . ............... ........... (82,705)
Change in unrealized appreciation of investments................ (93,993)
Net realized and unrealized loss on investments ............... (176,698)
Net increase in net assets resulting from operations ........ $2,126,603
The accompanying notes are an integral part of these financial statements.
22<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT SERIES
STATEMENTS OF CHANGES IN NET ASSETS
Year Ended Year Ended
March 31, 1997 March 31, 1996
OPERATIONS:
Net investment income......................... $2,303,301 $2,369,671
Net realized (loss) gain on investments....... (82,705) 1,227,064
Change in unrealized appreciation (depreciation)
of investments............. (93,993) (257,447)
Net increase in net assets resulting from
operations............ 2,126,603 3,339,288
DISTRIBUTIONS TO SHAREHOLDERS:
Dividends from net investment income........ (2,260,030) (2,358,436)
Distributions from net realized gains on
investments... ... (943,662) (367,107)
Total distributions...................... (3,203,692) (2,725,543)
CAPITAL SHARE TRANSACTIONS:
Shares sold.... ............................ 1,730,791 1,030,079
Shares issued on reinvestment of distributions 935,335 702,855
Shares redeemed. ........................... (300,452) (697,235)
Increase in net assets resulting from capital
share transactions(a). .... 2,365,674 1,035,699
TOTAL INCREASE IN NET ASSETS........... 1,288,585 1,649,444
NET ASSETS:
Beginning of year... ...................... 36,446,940 34,797,496
End of year........... .................... $37,735,525 $36,446,940
(a) Transactions in capital shares were as follows:
Shares sold........ ................... 174,344 100,992
Shares issued on reinvestment of
distributions.............. ... 94,439 69,235
Shares redeemed..................... . (30,101) (69,182)
Net increase......................... . 238,682 101,045
Beginning balance ................... . 3,639,328 3,538,283
Ending balance ........................ 3,878,010 3,639,328
The accompanying notes are an integral part of these financial statements.
23<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION US GOVERNMENT SERIES
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED MARCH 31, 1997
Year Ended
31-Mar-97
Cash flows from operating activities:
Net increase in net assets resulting from operations....... $2,126,603
Net realized and unrealized loss on investments............ 176,698
Net investment income.................................... 2,303,301
Adjustments to reconcile net investment income
to net cash provided by operating activities:
Net paydown gains and losses........................................(37,392)
Decrease in interest receivable.................................... 53,993
Decrease in other assets........................................... 18,904
Decrease in other liabilities...................................... (14,677)
Net cash provided by operating activities... ............ 2,324,129
Cash flows from investing activities:
Payments for futures variations. .......................... (60,974)
Proceeds from sales of long-term investments....... 56,055,128
Proceeds from sales of short-term investments..................... 159,527
Proceeds from sales of options................ .................... 5,223
Proceeds from maturities of short-term investments..............232,680,862
Proceeds from paydowns of long-term investments............... 3,435,588
Purchases of long-term investments........................ (51,848,780)
Purchases of short-term investments........................ (239,832,318)
Purchases of options....................................... (102,279)
Net cash provided by investing activities................ 491,977
Cash flows from financing activities:
Proceeds from shares tendered.....................................1,721,991
Payments for shares redeemed.......................................(300,452)
Dividends from net investment income and
realized gains on investments.....................................(2,279,430)
Net cash used in financing activities...........................(857,891)
Net increase in cash.................................... 1,958,215
Cash at beginning of year............................................. 312,247
Cash at end of year.............................................. $2,270,462
Noncash financing activities:
Market value of shares issued to stockholders
through reinvestment of dividends............................... $935,335
Supplemental disclosure:
Interest paid.................................................. $ 3,079
The accompanying notes are an integral part of these financial statements.
24<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT SERIES
FINANCIAL HIGHLIGHTS
<TABLE>
The following average per share data, ratios and supplemental information have
been derived from information provided in the financial statements.
<CAPTION>
Year Year Year Year Period
Ended Ended Ended Ended 3/31/92 <F3>
3/31/97 3/31/96 3/31/95 3/31/94 to 3/31/93
<S> <C> <C> <C> <C> <C>
Net Asset Value,
Beginning of Period $10.01 $9.83 $10.01 $10.62 $10.00
Income From Investment Operations
Net investment income............................................0.599 0.66 0.664 1.05 0.826
Net realized and unrealized (loss) gain on investments..........(0.024) 0.277 (0.049) (0.601) 0.621
Total from investment operations.............................0.575 0.937 0.615 0.449 1.447
Less Distributions
Dividends from net investment income............................(0.604) (0.656) (0.664) (1.044) (0.826)
Dividends in excess of net investment income......................- - (0.108) - -
Distributions from net realized gains on investments............(0.251) (0.101) - (0.015) -
Distributions in excess of net realized gains on investments......- - (0.022) - -
Total distributions........................................ (0.855) (0.757) (0.794) (1.059) (0.826)
Net Asset Value, End of Period....................................$9.73 $10.01 $9.83 $10.01 $10.62
Total Return.......................................................5.92% 9.69% 6.10% 4.11% 14.93%
Ratios/Supplemental Data
Net assets, end of period......................................$37,735,525 $36,446,940 $34,797,496 $6,779,666 $2,923,913
Ratio of expenses to average net assets <F1>.......................0.88% 0.90% 0.90% 0.90% 0.82%
Ratio of net investment income to average net assets <F2>..........6.19% 6.49% 6.20% 7.74% 8.18%
Portfolio turnover rate.......................................... 409% 193% 557% 84% 42%
<FN>
<F1>
(1)The annualized ratio of expenses to average net assets prior to reimbursement of expenses by the Adviser was 1.16%, 1.14%,
2.33%, 2.34%, and 17.52% for the years ended March 31, 1997, March 31, 1996, March 31, 1995 and March 31, 1994 and for the
period ended March 31, 1993, respectively. Through August 1, 1994, expense ratios include both
the direct expenses of the Intermediate Duration U.S. Government Series, and the indirect expenses
incurred through the Series' investment in the Institutional Intermediate Duration U.S. Government Fund (Note 5).
</FN>
<FN>
<F2>
(2) The annualized ratio of net investment income to average net assets prior to reimbursement of both direct and indirect expenses
by the Advisor was 6.26%, 4.77%, 6.30% and (8.52)% for the years ended March 31, 1997, March 31, 1996, March 31, 1995 and March 31,
1994, and for the period March 31, 1993, respectively.
</FN>
<FN>
<F3>
(3) Commencement of operations.
</FN>
</TABLE>
The accompanying notes are an integral part of these financial statements.
25<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S.
GOVERNMENT SERIES
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Breeden Series Fund (the "Fund") is an open-end, diversified
management investment company registered under the Investment Company
Act of 1940, as amended. The Fund offers shares in two series: the Smith
Breeden Short Duration U.S. Government Series and the Smith Breeden
Intermediate Duration U.S. Government Series ("Intermediate Series" or
"Series"). The following is a summary of significant accounting policies
consistently followed by the Intermediate Series.
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 Intermediate Series 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 Series
of Federal income taxes. To so qualify, the Series 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 Series had no capital loss carryforward.
C. Repurchase Agreements: The Intermediate Series 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 Series' Board of
Trustees. In a repurchase agreement, the Series 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 Intermediate Series' custodian maintains
control or custody of these securities collateralizing 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
Series in the event of the seller's default. However, in the event of default
or bankruptcy of the seller, the Series' right to the collateral may be subject
to legal proceedings.
D. Reverse Repurchase Agreements: A reverse repurchase agreement
involves the sale by the Intermediate Series of portfolio assets concurrently
with an agreement by the Series to repurchase the same assets at a later date at
a fixed price. The Series 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 Series' use of the proceeds of
26<PAGE>
NOTES TO FINANCIAL STATEMENTS (cont.)
the agreement may be restricted pending a determination by the other party, or
its trustee or receiver, whether to enforce the Series' obligation to repurchase
the securities.
E. Dollar Roll Agreements: The Intermediate Series may enter into
dollar rolls in which the Series 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 Series foregoes principal and interest paid on these securities.
The Series 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.
F. 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.
G. Deferred Organizational Expenses: Deferred organizational
expenses are being amortized on a straight-line basis over five periods.
H. 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 Intermediate Series uses interest rate futures contracts for risk
management purposes in order to reduce fluctuation of the Series' net asset
value relative to its targeted option-adjusted duration. Upon entering into a
futures contract, the Series 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 Series
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 Series
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.
27<PAGE>
NOTES TO FINANCIAL STATEMENTS (cont.)
The Intermediate Series had the following open futures contracts as of
March31, 1997:
Type Notionanal Position Expiration Unrealized
Amount Month Gain/ (Loss)
5 Year Treasury $1,500,000 Long June, 1997 $ 32,817
10 Year Treasury 3,200,000 Long June, 1997 (106,769)
Total $ (139,586)
Futures transactions involve costs and may result in losses. The effective use
of futures strategies depends on the Series' ability to terminate futures
positions at times when the Series' 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 Series, of the futures contract itself, and of the securities
which are the subject of a hedge.
The aggregate market value of investments pledged to cover margin
requirements for the open positions at March 31, 1997 was $158,660.
3. INVESTMENT ADVISORY FEES AND OTHER
TRANSACTIONS WITH AFFILIATES
Smith Breeden Associates, Inc. (the "Adviser"), a registered investment
adviser, provides the Series with investment management services. As
compensation for these services, the Intermediate Series pays the Adviser a fee
computed daily and payable monthly, at an annual rate equal to 0.70% of the
Series' average daily net asset value.
The Adviser has voluntarily agreed to reduce or otherwise limit other expenses
of the Intermediate Series (excluding advisory fees and litigation,
indemnification and other extraordinary expenses) to 0.88% of the Series'
average daily net assets. This voluntary agreement may be terminated or
modified at any time by the Adviser in its sole discretion. The Adviser has
agreed to reduce the fees payable (to the extent of such fees) by the amount
the Series' expenses would, absent the fee reduction, exceed the applicable
expense limitations imposed by state securities administrators. For the year
ended March 31, 1997, the Adviser received fees of $259,767 and reimbursed
the Series $101,379.
28<PAGE>
NOTES TO FINANCIAL STATEMENTS (cont.)
Effective August 1, 1994, the Series adopted a Distribution and Services Plan
(the "Plan") pursuant to Rule 12b-1 under the 1940 Act. The purpose of the
Plan is to permit the Adviser to compensate investment dealers and other
persons involved in servicing shareholder accounts for services provided and
expenses incurred in promoting the sale of shares of the Series, reducing
redemptions, or otherwise maintaining or improving services provided to
shareholders by such dealers or other persons.
The Plan provides for payments by the Adviser, out of its advisory fee, to
dealers and other persons at the annual rate of up to 0.25% of the Intermediate
Series' average net assets subject to the authority of the Trustees of the
Series 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 Series 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 $174,835,826 and
$180,397,654, respectively. The purchases and proceeds shown above do not
include dollar roll agreements which are considered borrowings by the
Intermediate Series. The cost of securities for federal income tax purposes is
$42,495,652. Net unrealized appreciation of investments, short sales and
futures contracts consists of:
Gross unrealized appreciation $ 431,474
Gross unrealized depreciation (295,028)
Net unrealized appreciation $ 136,446
29<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders,
Smith Breeden Intermediate Duration U.S. Government Series of the
Smith Breeden Series Fund:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of the Smith Breeden Intermediate
Duration U.S. Government Series of the Smith Breeden Series Fund 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 March
31, 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 Intermediate Duration U.S. Government Series of the
Smith Breeden Series Fund 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
30<PAGE>
Smith Breeden Equity Plus Fund Annual Report and Performance
Review
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.
31<PAGE>
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.
32<PAGE>
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
33<PAGE>
* 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.
34<PAGE>
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.
35<PAGE>
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.
36<PAGE>
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.
37<PAGE>
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.
38<PAGE>
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.
39<PAGE>
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.
40<PAGE>
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
41<PAGE>
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)
42<PAGE>
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
43<PAGE>
BOARD OF TRUSTEES
Douglas T. Breeden
Michael J. Giarla
Stephen M. Schaefer
Myron S. Scholes
William E. Sharpe
OFFICERS
PRESIDENT
Michael J. Giarla
VICE PRESIDENTS
Daniel C. Dektar (Smith Breeden Series Fund)
John B. Sprow (Smith Breeden Trust)
TREASURER AND SECRETARY
Marianthe S. Mewkill
<PAGE>
INVESTMENT ADVISER
Smith Breeden Associates, Inc.
100 Europa Drive
Suite 200
Chapel Hill NC
27514
TRANSFER AGENT AND DIVIDEND PAYING AGENT
FPS Services, Inc.
3200 Horizon Drive
PO Box 61503
King of Prussia PA 19406-0903
DISTRIBUTOR
FPS Broker Services, INc.
3200 Horizon Drive
PO Box 61503
King of Prussia, PA
19406-0903
CUSTODIAN
Bank of New York
48 Wall Street
New York, New York
10286
INDEPENDENT AUDITORS
Deloitte and Touche LLP
117 Campus Drive
Princeton, New Jersey
08540
For information about:
Establishing an account
Account Procedures
Exchanges
Call 1-800-221-3137
For all other information about the Funds:
Call 1-800-221-3138
