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PROSPECTUS/DECEMBER 22, 1997
[SMITH BREEDEN LOGO]
SMITH BREEDEN
-----------------------
M U T U A L F U N D S
- Equity Market Plus Fund
- Financial Services Fund
- Short Duration U.S. Government Fund
- Intermediate Duration U.S. Government Fund
"We are pleased to announce the introduction of our newest fund -- the Smith
Breeden Financial Services Fund. This fund, like our others, aims to deliver
professional investment strategies that focus on performance and risk
control."
<TABLE>
<S> <C>
/s/ DOUGLAS T. BREEDEN /s/ MICHAEL J. GIARLA
Douglas T. Breeden Michael J. Giarla
Chairman President
<PAGE>
[INTENTIONAL LEFT BLANK PAGE]
<PAGE>
[SMITH BREEDEN LOGO]
NOT PART OF THE PROSPECTUS
Dear Investor,
Thank you for selecting Smith Breeden No-Load Mutual Funds. Enclosed
is the information you requested.
How Your Fund is Managed -- Please read the enclosed prospectus
booklet carefully to learn about the potential rewards and risks of
each fund before you invest or send money. Please call us at
800-221-3138 if you have questions.
How To Invest -- To invest, simply complete the separate account
application. Please return the application with a check payable to
Smith Breeden Mutual Funds ($1000 initial minimum for each fund,
$250 minimum for Uniform Gifts to Minors and Retirement accounts,
$50 subsequent minimum purchase) using the enclosed postage paid
envelope. Shares may also be purchased by bank wire transfer or
through leading computerized fund trading systems.
We Will Keep You Informed -- You will receive an account statement
each time you buy or sell shares, and whenever your fund pays or
reinvests a dividend. The share prices of most Smith Breeden funds
are published daily in the mutual fund section of major newspapers
or simply call us at 800-221-3138 for prices and dividend
information.
Again, thank you for selecting Smith Breeden Mutual Funds.
Sincerely,
/s/ DOUGLAS T. BREEDEN /s/ MICHAEL J. GIARLA
Douglas T. Breeden Michael J. Giarla
Chairman President
<PAGE>
[SMITH BREEDEN LOGO]
NOT PART OF THE PROSPECTUS
Fund Spotlight:
Short Duration US Govt Fund
Intermediate Duration US Govt Fund
Fund Managers:
[PHOTO OF DANIEL C. DEKTAR] [PHOTO OF TIMOTHY D. ROWE]
Daniel C. Dektar Timothy D. Rowe
Smith Breeden's goal is to design funds that target the risk profile of
specific asset classes and not deviate from those risk targets. Our focus is on
risk target stability, as well as delivering returns that exceed relevant
benchmarks.
The Short Duration Fund is positioned to be a step up from money market
funds. Our goal is to maintain a very low risk profile -- about the same as a
6-month Treasury Bill.
Our Intermediate Duration Fund also has a specific risk target: the Salomon
Brothers Mortgage Index, whose risk should be similar to a 3-5 year maturity
Treasury Note. Of course while Treasury Bills and Notes are U.S. Government
insured and offer a fixed rate of return, the U.S. Government does not
guarantee mutual fund performance. All bond funds experience some fluctuation
in principal and yield.
Smith Breeden's expertise is in finding undervalued securities in the
mortgage-backed securities market. We've been successful in creating total
returns in the mortgage market that are above what you'd expect for the risks
we have taken. We call these "excess returns."
Mortgage-backed securities can be prepaid by homeowners. That possibility
generally results in higher yields but a different risk profile than, say,
non-callable corporate bonds. Our expertise in protecting against mortgage
prepayment risk is a key feature in each of these bond funds.
We are willing to spend part of the higher yield that mortgage securities
provide to pay for the cost of hedging (protecting) our investments from
homeowner prepayment risk. With both of our bond funds, our goal is to mimic
the risk profile of our benchmarks but deliver higher total returns.
Fund Spotlight:
Equity Market Plus Fund
Fund Manager:
[PHOTO OF JOHN B. SPROW]
John B. Sprow
I am often asked about the unique strategy used by the Equity Market Plus
Fund. So I would like to discuss how the Fund works.
The Equity Market Plus Fund, like our bond funds, is designed to match the risk
profile of a specific benchmark. In this case it's the S&P 500 stock index. But
unlike a purely passive index fund, we use a strategy designed to outperform
the S&P 500 without adding additional equity market risk.
The Equity Market Plus Fund can be viewed as comprising income and equity
segments. The income segment invests in a combination of U.S. Government Agency
mortgage securities, hedged to a low level of interest rate risk, a strategy
similar to that of our Short Duration bond fund. The Equity segment invests in
S&P 500 index futures contracts. (S&P 500 index futures contracts only require
the posting of 5% margin, so 95% of the cash in the Fund is available to invest
in the income segment.) When the "excess" returns we generate in the income
segment (using our expertise in the mortgage markets) exceed the funding cost
of the S&P 500 futures contracts plus the operating expenses incurred by the
Fund, the Fund is able to outperform the S&P 500 Index.
While S&P 500 futures contracts are designed to track the S&P 500 index, they
are not stocks and their performance can differ from the actual S&P index.
Smith Breeden was one of the first firms to implement this institutional
strategy in a no-load mutual fund and we've been very pleased with the results.
DFU 7/97
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Past performance is not indicative of future results. Share prices and returns
will fluctuate and when redeemed, shares may be worth more or less than their
original investment. There are special risks associated with investing in
futures and option contracts which may or may not be suitable for all
investors.
<PAGE>
[SMITH BREEDEN LOGO]
NOT PART OF THE PROSPECTUS
Fund Spotlight:
Financial Services Fund
Fund Managers:
[PHOTO OF [PHOTO OF [PHOTO OF
DOUGLAS T. BREEDEN] MICHAEL J. GIARIA] ROBERT B. PERRY]
DOUGLAS T. BREEDEN] Michael J. Giaria Robert B. Perry
Smith Breeden Associates began life in 1982 as a business consultant to
financial services firms. These past 15 years, the firm has had extensive
consulting relationships with over 50 financial firms. Additionally, Smith
Breeden's principals have made substantial investments in financial services
firms. With such depth of specialized experience, managing a financial services
mutual fund is a natural extension of our expertise.
Successful analysis of investments in the financial services sector depends on
understanding the internal workings of the companies themselves, the industry
in which they operate, how that industry is regulated, and how it is impacted
by economic events. Here we are uniquely qualified.
My work teaching graduate level courses in banking as well as serving as Editor
for the Journal of Fixed Income helps enormously in keeping our investment
research techniques at the leading edge of this rapidly changing
industry. Assisting me in managing this portfolio will be Michael J. Giarla,
President of Smith Breeden and Robert B. Perry, a Principal of Smith Breeden,
both of whom have extensive experience in consulting for financial
institutions. Our goal is to invest in firms where the values seem reasonable
in relation to the growth prospects and risks of the firms. Banks, thrifts,
financial and leasing companies, brokerage, investment banking and advisory
firms, these are the primary types of firms we analyze.
Knowing that the fortunes of these firms can be related to changes in the
market and in interest rates, we may also seek to protect investments in this
area through the use of interest rate and equity futures and options,
securities in which we have extensive experience. Although all investments
involve a degree of risk, and we can't guarantee future results, we are
confident that our skills and unique qualifications will provide investors with
the potential to reap the rewards from the dynamic financial services sector.
DFU 12/97
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Past performance is not indicative of future results. Share prices and returns
will fluctuate and when redeemed, shares may be worth more or less than their
original investment. There are special risks associated with investing in
futures and option contracts which may or may not be suitable for all
investors.
<PAGE>
[SMITH BREEDEN LOGO]
NOT PART OF THE PROSPECTUS
Tips for Successful Investing
1. Invest Regularly. Most mutual fund share prices fluctuate, and we
do not believe that anyone can predict future share prices. By
investing at regular intervals you don't have to worry about buying
at the "right" time. With regular periodic investing you are more
likely to buy shares at a variety of prices and achieve an average
purchase price that is satisfactory. Smith Breeden has an automatic
investment plan that makes regular investing easy.1
2. Invest For The Long Term. You should expect daily fluctuations in
the performance of most mutual funds. Short-term fluctuations may
result in gains or losses. But mutual fund performance over longer
(monthly, annual or multi-year) periods tend to be less volatile. By
focusing on the long-term, you are less likely to sell your shares
prematurely due to daily news events.
3. Defer Taxes When Possible. If you can invest through an IRA
(Individual Retirement Account) or other tax-deferred account, you
will benefit from compounded returns on a portion of investment
gains you might otherwise pay in federal or state income taxes. Such
compounded returns can increase your overall investment success.
Please call us at 800-221-3138 if you wish to set up a Smith Breeden
IRA account or have other questions.
1Dollar cost averaging does not guarantee a profit or loss against a
declining market and an investor should consider his or her ability
to continue investing through periods of low price levels.
DFU 7/97
<PAGE>
[SMITH BREEDEN LOGO]
Dear Shareholder:
We are delighted to share with you the addition of The Financial Services Fund
to the Smith Breeden group of mutual funds. The Financial Services Fund seeks
capital appreciation through investment of its assets in U.S. and foreign
financial services companies. The investments include banks, thrifts, finance
and leasing companies, brokerage, investment banking and advisory firms, real
estate related firms and insurance companies.
Since its inception in 1982, Smith Breeden Associates, Inc. has had extensive
consulting relationships with over 50 financial services companies. The
principals of Smith Breeden have made and continue to retain substantial
investments in financial services firms. From this unique depth of specialized
experience and "Hands On" knowledge of the industry, the Smith Breeden
Financial Services Fund has been created and launched. The Fund is comanaged by
three principals of Smith Breeden with combined experience in the financial
services industry of over 30 years. Highlights of their experience and
background are detailed below.
Fund Manager Douglas T. Breeden: Dr. Breeden, the Chairman of the Board of
Smith Breeden Associates, co-founded the firm in 1982. He has served on
business school facilities at Duke University, Stanford University and the
University of Chicago, and as a visiting professor at Yale University and at
the Massachusetts Institute of Technology. Dr. Breeden is the Editor of the
Journal of Fixed Income. He has served as Associate Editor for five journals in
financial economics, and was elected to the Board of Directors of the American
Finance Association. He holds a Ph.D. in Finance from the Stanford University
Graduate School of Business, and a B.S. in Management Science from the
Massachusetts Institute of Technology. He serves as Chairman of Harrington
Financial Group, the holding company for Harrington Bank, F.S.B., of Richmond,
Indiana.
Fund Manager Michael J. Giarla: Mr. Giarla is Chief Operating Officer,
President and Director of Smith Breeden Associates and has been with the firm
since 1985. He also serves as a Director of Harrington Financial Group, the
holding company for Harrington Bank, F.S.B., of Richmond, Indiana. Formerly
Smith Breeden's Director of Research, he was involved in research and
programming, particularly in the development and implementation of models to
evaluate and hedge mortgage securities. He also consults with institutional
clients and conducts special projects. Mr. Giarla holds a Master of Business
Administration with Concentration in Finance from the Stanford University
Graduate School of Business, where he was an Arjay Miller Scholar. He earned a
Bachelor of Arts in Statistics, summa cum laude, from Harvard University, where
he was elected to Phi Beta Kappa and was a Harvard Club of Boston Scholar. Mr
Giarla is a Trustee of the Roxbury Latin School, West Roxbury, Massachusetts.
Fund Manager Robert F. Perry: Mr. Perry is a Principal at Smith Breeden
Associates, providing hedging and investment advice to Smith Breeden's
financial services clients. He is also responsible for calculating
market-to-market values and projected income of institutions, and assesses the
affects of interest rate and economic changes. Prior to joining Smith Breeden,
Mr. Perry served as an interest rate risk analyst for Centura Bank, and
secretary to the ALCO committee. He has also served as a Director for Community
First Financial Group, a multi-bank holding company located in Indianapolis,
Indiana. Mr. Perry earned his Bachelor of Arts in Business Administration from
North Carolina State University.
Please read the enclosed prospectus for more detailed and complete information
on the new Financial Services Fund. It also includes complete and updated
information of the Smith Breeden Mutual Funds in which you are already
invested.
Thank you for your continued trust in the Smith Breeden Mutual Funds. Please
visit our website @ www.smithbreeden.com for daily performance and portfolio
manager updates.
Sincerely,
/s/ Marianthe S. Mewkill
Marianthe S. Mewkill
Chief Financial Officer, Smith Breeden Mutual Funds
enclosures
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Past performance is no guarantee of future results. Please read enclosed
prospectus for more complete information including management fees and
expenses. Read it carefully before you invest or send money. Share prices and
returns will fluctuate and when redeemed, shares may be worth more or less than
their original investment. There are special risks associated with investing in
futures and option contracts which may or may not be suitable for all
investors. DISTRIBUTOR; FPS BROKER SERVICES, INC. 800/221-3137 12/97
<PAGE>
[SMITH BREEDEN LOGO]
DECEMBER 22, 1997
SMITH BREEDEN MUTUAL FUNDS
PROSPECTUS
The Smith Breeden Mutual Funds consist of four no-load, diversified Series (the
"Funds") of two management investment companies -- Smith Breeden Trust and
Smith Breeden Series Fund. The investment adviser for the Funds is Smith
Breeden Associates, Inc. (the "Adviser").
Smith Breeden Equity Market Plus Fund (the "Equity Market Plus Fund", a series
of the Smith Breeden Trust) seeks to provide a total return exceeding the
Standard & Poor's 500 Composite Stock Index without additional equity market
risk. The Fund does not invest principally in the common stocks that make up
the S&P 500 Index (the "Index") or any other index. Instead, the Fund uses S&P
500 futures and swaps in an effort to maintain an equity market exposure
similar to that which would be achieved if all of the Fund's assets were
invested in the stocks comprising the Index. Since the Equity Market Plus Fund
utilizes index futures contracts and equity swap contracts to track the S&P 500
Index, it can invest substantially all of its cash in fixed-income securities
and related hedging instruments. Whether the Fund's total return equals or
exceeds the performance of the S&P 500 Index depends largely on whether the
total return on the Equity Market Plus Fund's fixed-income investments equals
or exceeds the Fund's total operating expenses, as well as other factors.
Smith Breeden Financial Services Fund (the "Financial Services Fund", a series
of the Smith Breeden Trust) seeks capital appreciation. To pursue this goal,
the Fund invests in U.S. and foreign financial services companies. These
include banks, thrift, finance and leasing companies, brokerage, investment
banking and advisory firms, real estate related firms and insurance companies.
Smith Breeden Short Duration U.S. Government Fund (the "Short Fund", a series
of the Smith Breeden Series Fund) seeks a high level of current income
consistent with low volatility of net asset value. The Short Fund seeks to
match the duration, or interest-rate risk, of a portfolio that invests
exclusively in six month U.S. Treasury securities on a constant maturity
basis. The dollar weighted average maturity of the Fund's securities may at
times significantly exceed six months.
Smith Breeden Intermediate Duration U.S. Government Fund (the "Intermediate
Fund", a series of the Smith Breeden Series Fund) seeks a total return in
excess of the total return of the major market indices for mortgage-backed
securities. The major market indices for mortgage-backed securities currently
include, but are not limited to, the Salomon Brothers Mortgage Index and the
Lehman Brothers Mortgage Index. These indices include all outstanding
government sponsored fixed-rate mortgage-backed securities, weighted in
proportion to their current market capitalization. The duration, or
interest-rate risk, of these indices is similar to that of intermediate-term
U.S. Treasury Notes, and typically will range between three and five years. The
Intermediate Fund consistently seeks to achieve a volatility of net asset value
similar to that of a portfolio that invests exclusively in mortgage-backed
securities, as weighted in the major mortgage market indices.
An investment in any of the Funds is neither insured nor guaranteed by the
U.S. Government. There can be no assurance that any of the Funds will meet
their investment objectives. This Prospectus sets forth concisely the
information about the Funds that you should know before investing. Please read
this Prospectus carefully and keep it for future reference. Statements of
Additional Information dated December 22, 1997, have been filed with the
Securities and Exchange Commission with respect to each Trust and are legally
part of this prospectus. The Statements of Additional Information can be
obtained without charge by writing to the Funds at 100 Europa Drive, Chapel
Hill, North Carolina 27514 or by calling 1-800-221-3138.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
1
<PAGE>
[SMITH BREEDEN LOGO]
TABLE OF CONTENTS
Expense Table...............................................................3
Financial Highlights -- Equity Market Plus Fund.............................5
Financial Highlights -- Short Fund..........................................6
Financial Highlights -- Intermediate Fund...................................7
Smith Breeden Mutual Funds..................................................8
Investment Objectives, Policies and Risk Considerations.....................8
Other Investment Practices and Risk Considerations.........................14
Management of the Funds....................................................18
Pricing of Fund Shares.....................................................22
How to Purchase Shares.....................................................23
How to Exchange Shares.....................................................25
How to Redeem Shares.......................................................25
Dividends and Distributions................................................27
Shareholder Reports and Information........................................28
Retirement Plans...........................................................29
Service and Distribution Plans.............................................28
Taxes......................................................................28
Capital Structure..........................................................30
Transfer, Dividend Disbursing Agent, Custodian and
Independent Accountants...................................................30
Fund Performance...........................................................30
No person has been authorized to give any information or to make any
representations not contained in this Prospectus and, if given or made, such
information or representations must not be relied upon as having been
authorized by the Funds. The Prospectus does not constitute an offering by the
Funds in any jurisdiction in which such offering may not be lawfully made.
2
<PAGE>
[SMITH BREEDEN LOGO]
EXPENSE TABLE
The following table is designed to assist you in understanding the expenses you
will bear as a shareholder of a Fund. Shareholder Transaction Expenses are
charges that you pay when buying or selling shares of a Fund. Annual Fund
Operating Expenses are paid out of a Fund's assets and include fees for
portfolio management, maintenance of shareholder accounts, shareholder
servicing, accounting and other services. The annual fund operating expenses
shown below reflect expense limitations agreed to by the Adviser, and are based
on each Fund's expenses for the past fiscal year, if applicable, or on good
faith estimates provided by the Advisor.
</TABLE>
<TABLE>
<CAPTION>
Equity
Market Financial
Plus [ZW]
Services Short Intermediate
Fund [ZW]
Fund Fund Fund
<S> <C> [ZW]
<C> <C> <C>
Shareholder Transaction Expenses
Maximum Sales Load Imposed on Purchases None [ZW]
None None None
Maximum Sales Load Imposed on Reinvested Dividends None [ZW]
None None None
Deferred Sales Load Imposed on Redemptions None [ZW]
None None None
Redemption Fees1 None [ZW]
None None None
Exchange Fees None [ZW]
None None None
Annual Fund Operating Expenses
(as a percentage of average net assets)
Management Fees2 0.70% [ZW]
1.50% 0.70% 0.70%
Other Expenses (net of reimbursement)3 0.18% [ZW]
0.00% 0.08% 0.18%
Total Fund Operating Expenses (net of reimbursement)3 0.88% [ZW]
1.50% 0.78% 0.88%
</TABLE>
- -------------------------
1 A transaction charge of $9 may be imposed on redemptions by wire transfer.
2 Pursuant to a distribution and services plan in respect of each Fund, the
Adviser may pay annual distribution and servicing fees of up to 0.25% of
each of the Fund's net assets out of its management fee. See "Service and
Distribution Plans."
3 The Other Expenses and Total Fund Operating Expenses in the table reflect
undertakings by the Adviser to bear expenses of each of the Funds and/or
waive its fees to the extent necessary to limit Total Fund Operating
Expenses to 0.78% for the Short Fund and 0.88% for each of the Equity Market
Plus Fund and Intermediate Fund and to 1.50% for the Financial Services Fund
through August 1, 1998. Absent the expense limitation, Other expenses and
Total Fund Operating Expenses for the past fiscal year would have been 0.23%
and 0.93% for the Short Fund, 0.46% and 1.16% for the Intermediate Fund, and
1.90% and 2.60% for the Equity Market Plus Fund, and are estimated to be
about 4.30% and 5.00% for the Financial Services Fund.
3
<PAGE>
[SMITH BREEDEN LOGO]
The following examples illustrate the expenses that apply to a $1,000
investment in each Fund over various time periods assuming: (1) a 5% annual
rate of return, and (2) redemption or no redemption at the end of each time
period. Except as noted in the table above, the Funds charge no redemption
fees.
Short Duration Fund
<TABLE>
<CAPTION>
1 Year 3 Years 5 Years 10 Years
------------ --------- --------- ---------
<S> <C> <C> <C>
$ 8 $ 26 $ 45 $ 99
</TABLE>
Intermediate Duration Fund and Equity Market Plus Fund
<TABLE>
<CAPTION>
1 Year 3 Years 5 Years 10 Years
------- --------- --------- ---------
<S> <C> <C> <C>
$ 9 $ 29 $ 50 $ 111
</TABLE>
Financial Services Fund
<TABLE>
<CAPTION>
1 Ye ar 3 Years 5 Years 10 Years
------------ --------- --------- ---------
<S> <C> <C> <C>
$ 16 $ 49 $ 84 $ 184
</TABLE>
These examples are based on the annual operating expenses shown above and
should not be considered a representation of past or future expenses or
performance. Actual expenses may be greater or less than those shown. The
annual rate of return may be more or less than 5%.
The Funds may be recommended to investors by registered investment
advisors. Such advisors customarily impose fees that would be in addition to
any fees and expenses presented in the above table. Certain broker- dealers may
also charge a fee for purchase or redemption of shares through their
network. Neither the Funds, nor the Adviser, exercise any control over such
advisory or broker-dealer fees and may not be informed of the level of such
fees.
4
<PAGE>
[SMITH BREEDEN LOGO]
EQUITY MARKET PLUS FUND
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
The following selected per share data and ratios cover the fiscal periods from
June 30, 1992, the date the Fund commenced operations, through September 30,
1997, and except for the six months ended September 30, 1997, are part of the
Fund's financial statements, which have been audited by Deloitte & Touche
LLP, independent auditors. This data should be read in conjunction with the
Fund's most recent annual audited financial statements and the report of
Deloitte & Touche LLP thereon, and unaudited semi-annual financial statements,
which appear in the Statement of Additional Information for the Smith Breeden
Trust.
<TABLE>
<CAPTION>
Six Months
Ended Year Ended Year [ZW]
Ended Year Ended Year Ended Period Ended
September 30, March 31, March [ZW]
31, March 31, March 31, March 31,
1997 1997 [ZW]
1996 1995 1994 1993
--------------- ------------- [ZW]
- ------------ ------------ ------------ -------------
<S> <C> <C> [ZW]
<C> <C> <C> <C>
Net Asset Value, Beginning of
Period .............................. $12.56 $12.27 [ZW]
$10.84 $ 9.88 $10.85 $10.00
----------- ----------- [ZW]
- ---------- ---------- ---------- --------
Income From Investment Operations
- ---------------------------------------
Net investment income .................. 0.250 0.592 [ZW]
0.615 0.568 0.476 0.355
Net realized and unrealized gain (loss)
on Investments ........................ 2.877 1.813 [ZW]
2.768 1.081 ( 0.216) 1.281
----------- ----------- [ZW]
- ---------- ---------- ---------- --------
Total from investment operations ...... 3.127 2.405 [ZW]
3.383 1.649 0.260 1.636
----------- ----------- [ZW]
- ---------- ---------- ---------- --------
Less Distributions
- -----------------------------------------
Dividends from net investment
income .............................. ( 0.230) ( 0.590) ( [ZW]
0.583) ( 0.568) ( 0.472) ( 0.311)
Dividends in excess of net investment
income .............................. -- -- [ZW]
- -- ( 0.001) -- --
Distributions from net realized gains
on Investments ........................ ( 0.247) ( 1.525) ( [ZW]
1.370) ( 0.047) ( 0.701) ( 0.420)
Distributions in excess of net realized
gains on Investments .................. -- -- [ZW]
- -- ( 0.073) ( 0.057) ( 0.055)
----------- ----------- [ZW]
- ---------- ---------- ---------- --------
Total distributions .................. ( 0.477) ( 2.115) ( [ZW]
1.953) ( 0.689) ( 1.230) ( 0.786)
----------- ----------- [ZW]
- ---------- ---------- ---------- --------
Net Asset Value, End of Period ......... $15.21 $12.56 [ZW]
$12.27 $10.84 $ 9.88 $10.85
=========== =========== [ZW]
========== ========== ========== ========
Total Return ........................... 25.08 % 21.41 % 32.30 [ZW]
% 17.18 % 2.19 % 22.59 %*
Ratios/Supplemental Data
- -----------------------------------------
Net assets, end of period ............ $61,086,390 $13,507,377 [ZW]
$4,766,534 $2,107,346 $1,760,519 $903,846
Ratio of expenses to average net assets
Before expense limitation ............ 1.28 %* 2.60 % 4.58 [ZW]
% 7.75 % 7.08 % 28.48 %*
After expense limitation ............ 0.88 %* 0.88 % 0.90 [ZW]
% 0.90 % 0.90 % 0.57 %*
Ratio of net income to average net
assets ..............................
Before expense limitation ............ 4.54 %* 3.58 % 1.85 [ZW]
% 0.59 % 1.84 % (22.63 %)*
After expense limitation ............ 4.95 %* 5.30 % 5.53 [ZW]
% 7.44 % 8.02 % 5.28 %*
Portfolio turnover rate ............... 196% 182% [ZW]
107% 120% 119% 271%
</TABLE>
* Annualized
Additional performance information is presented in the Fund's Annual Report,
which is available without charge upon request.
5
<PAGE>
[SMITH BREEDEN LOGO]
SHORT DURATION FUND
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
The following selected per share data and ratios cover the fiscal periods from
March 31, 1992, the date the Fund commenced operations, through September 30,
1997 and except for the six months ended September 30, 1997, are part of the
Short Fund's financial statements which have been audited by Deloitte & Touche
LLP, independent auditors. This data should be read in conjunction with the
Short Fund's most recent annual audited financial statements and the report of
Deloitte & Touche LLP thereon, and unaudited semi-annual financial statements,
which appear in the Statement of Additional Information for the Smith Breeden
Series Fund.
<TABLE>
<CAPTION>
Six Months
Ended Year Ended
September 30, March 31,
1997 1997
--------------- --------------
<S> <C> <C>
Net Asset Value, Beginning of Period..... $9.83 $9.74
------------ ------------
Income From Investment Operations
- -----------------------------------------
Net investment income .................. 0.261 0.476
Net gain (loss) on securities (both
realized and unrealized) ............... 0.059 0.146
------------ ------------
Total from investment operations ......... 0.320 0.622
------------ ------------
Less Distributions
- -------------------------------------------
Dividends from net investment income ... (0.260) (0.476)
Dividends in excess of net investment
income ................................. -- (0.056)
------------ ------------
Total distributions ..................... (0.260) (0.532)
------------ ------------
Net Asset Value, End of Period ......... $9.89 $9.83
============ ============
Total Return ........................... 3.30 % 6.57 %
Ratios/Supplemental Data
- -------------------------------------------
Net assets, end of period ............... $103,238,834 $118,988,609
Ratio of expenses to average net assets
Before expense limitation ............... 1.01 %* 0.93 %
After expense limitation ............... 0.78 %* 0.78 %
Ratio of net income to average net assets
Before expense limitation ............... 5.39 %* 4.90 %
After expense limitation ............... 5.62 %* 5.04 %
Portfolio turnover rate .................. 306% 556%
<CAPTION>
Year Ended Year Ended Year [ZW]
Ended Period Ended
March 31, March 31, [ZW]
March 31, March 31,
1996 1995 [ZW]
1994 1993
-------------- -------------- [ZW]
- -------------- -------------
<S> <C> <C> [ZW]
<C> <C>
Net Asset Value, Beginning of Period...... $9.90 $9.90 [ZW]
$10.00 $10.00
------------ ------------ [ZW]
- ------------ -----------
Income From Investment Operations
- -----------------------------------------
Net investment income .................. 0.621 0.628 [ZW]
0.432 0.552
Net gain (loss) on securities (both
realized and unrealized) ............... (0.148) -- [ZW]
(0.070) 0.002
------------ ------------ [ZW]
- ------------ -----------
Total from investment operations ......... 0.473 0.628 [ZW]
0.362 0.554
------------ ------------ [ZW]
- ------------ -----------
Less Distributions
- -------------------------------------------
Dividends from net investment income ... (0.621) (0.628) [ZW]
(0.462) ( 0.554)
Dividends in excess of net investment
income ................................. (0.012) -- [ZW]
- -- --
------------ ------------ [ZW]
- ------------ -----------
Total distributions ..................... (0.633) (0.628) [ZW]
(0.462) ( 0.554)
------------ ------------ [ZW]
- ------------ -----------
Net Asset Value, End of Period ......... $9.74 $9.90 $ [ZW]
9.90 $10.00
============ ============ [ZW]
============ ===========
Total Return ........................... 4.95 % 6.58 % [ZW]
3.67 % 5.67 %
Ratios/Supplemental Data
- -------------------------------------------
Net assets, end of period ............... $221,825,136 $218,431,665 [ZW]
$218,167,491 $48,531,206
Ratio of expenses to average net assets
Before expense limitation ............... 0.93 % 0.92 % [ZW]
1.00 % 2.58 %
After expense limitation ............... 0.78 % 0.78 % [ZW]
0.78 % 0.78 %
Ratio of net income to average net assets
Before expense limitation ............... 6.13 % 6.18 % [ZW]
3.95 % 2.73 %
After expense limitation ............... 6.29 % 6.33 % [ZW]
4.17 % 4.53 %
Portfolio turnover rate .................. 225 % 47 % [ZW]
112 % 3%
</TABLE>
* Annualized
Additional performance information is presented in the Short Fund's Annual
Report, which is available without charge upon request.
6
<PAGE>
[SMITH BREEDEN LOGO]
INTERMEDIATE DURATION FUND
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
The following selected per share data and ratios cover the fiscal periods from
March 31, 1992, the date the Fund commenced operations, through September 30,
1997, and except for the six months ended September 30, 1997, are part of the
Intermediate Fund's financial statements which have been audited by Deloitte &
Touche LLP, independent auditors. This data should be read in conjunction with
the Intermediate Fund's most recent annual audited financial statements and the
report of Deloitte & Touche LLP thereon, and unaudited semi-financial
statements, which appear in the Statement of Additional Information for the
Smith Breeden Series Fund.
<TABLE>
<CAPTION>
Six Months
Ended Year Ended Year [ZW]
Ended Year Ended Year Ended Period Ended
September 30, March 31, March [ZW]
31, March 31, March 31, March 31,
1997 1997 [ZW]
1996 1995 1994 1993
--------------- ------------- [ZW]
- ------------- ------------- ------------ -------------
<S> <C> <C> [ZW]
<C> <C> <C> <C>
Net Asset Value, Beginning of
Period .............................. $9.73 $10.01 $ [ZW]
9.83 $10.01 $10.62 $10.00
----------- ----------- [ZW]
- ----------- ----------- ---------- ----------
Income From Investment Operations
- ----------------------------------------
Net investment income .................. 0.284 0.599 [ZW]
0.660 0.664 1.05 0.826
Net gain (loss) on securities (both
realized and unrealized) ............ 0.328 (0.024) [ZW]
2.77 (0.049) (0.601) 0.621
----------- ----------- [ZW]
- ----------- ----------- ---------- ----------
Total from investment operations ...... 0.612 0.575 [ZW]
0.937 0.615 0.449 1.447
----------- ----------- [ZW]
- ----------- ----------- ---------- ----------
Less Distributions
- -----------------------------------------
Dividends from net investment
income .............................. (0.280) (0.604) [ZW]
(0.656) (0664) (1.044) (0826)
Dividends in excess of net investment
income .............................. -- -- [ZW]
- -- (0108) -- --
Distributions from net realized gains
on Investments ........................ -- (0.251) [ZW]
(0.101) -- (0015) --
Distributions in excess of net realized
gains on Investments .................. -- -- [ZW]
- -- (0.022) -- --
----------- ----------- [ZW]
- ----------- ----------- ---------- ----------
Total distributions .................. (0.280) (0.855) [ZW]
(0.757) (0.794) (1.059) (0826)
----------- ----------- [ZW]
- ----------- ----------- ---------- ----------
Net Asset Value, End of Period ......... 10.06 $ 9.73 [ZW]
$10.01 $ 9.83 $10.01 $10.62
=========== =========== [ZW]
=========== =========== ========== ==========
Total Return ........................... 6.33 % 5.92 % [ZW]
9.69 % 6.10 % 4.11 % 14.93 %
Ratios/Supplemental Data
- -----------------------------------------
Net assets, end of period ............ $46,914,014 $37,735,525 [ZW]
$36,446,940 $34,797,496 $6,779,666 $2,923,913
Ratio of expenses to average net
assets ..............................
Before expense limitation ............ 1.04 %* 1.16 % [ZW]
1.14 % 2.33 % 2.34 % 17.52 %
After expense limitation ............ 0.88 %* 0.88 % [ZW]
0.90 % 0.90 % 0.90 % 0.82 %
Ratio of net income to average net
assets ..............................
Before expense limitation ............ 5.53 %* 5.92 % [ZW]
6.26 % 4.77 % 6.30 % ( 8.52 %)
After expense limitation ............ 5.69 %* 6.19 % [ZW]
6.49 % 6.20 % 7.74 % 8.18 %
Portfolio turnover rate ............... 162 % 409 % [ZW]
193 % 557 % 84 % 42%
</TABLE>
*Annualized
Additional performance information is presented in the Intermediate Fund's
Annual Report, which is available without charge upon request.
7
<PAGE>
[SMITH BREEDEN LOGO]
SMITH BREEDEN MUTUAL FUNDS
The Short and Intermediate Funds are funds of the Smith Breeden Series Fund
(the "Series Fund"), an open-end diversified management investment company. The
Equity Market Plus and Financial Services Funds are series of the Smith Breeden
Trust (the "Trust"), an open-end diversified management investment company.
Smith Breeden Associates, Inc. ("Smith Breeden" or the "Adviser") acts as
investment adviser to the Funds. Smith Breeden is a money management and
consulting firm founded in 1982 whose clients include pension funds, financial
institutions, corporations, government entities, and charitable foundations.
INVESTMENT OBJECTIVES, POLICIES, AND RISK CONSIDERATIONS
Each of the Funds has a different investment objective and different investment
policies, and is designed to meet different investment needs.
The investment objectives and certain investment policies of the Short and
Intermediate Funds are fundamental and may not be changed without a vote of
shareholders of the relevant Fund. The investment objectives of the Equity
Market Plus and Financial Services Funds are not fundamental. In order to
comply with certain state securities laws, the Smith Breeden Equity Market Plus
Fund had originally agreed to give its shareholders written notification at
least thirty days prior to any change in the Fund's objective. As a result of
the changes made by the National Securities Market Improvement Act of 1996,
however, the Fund is no longer subject to such state securities law
requirements. Accordingly, while there is no current intention to change the
investment objective, this prospectus constitutes notice that on or after
January 21, 1998 the Equity Market Plus Fund may make changes to its investment
objective without giving shareholders written notification.
Since shares of each Fund represent an investment in securities with
fluctuating market prices, the net asset value per share of each Fund will vary
as the aggregate value of a Fund's portfolio securities increases or
decreases. Due to the risks inherent in all investments, there can be no
assurance that the objectives of the Funds will be met. The descriptions that
follow are designed to help you choose the Fund or combination of Funds that
best fits your investment objectives.
Short Fund
The Short Fund's investment objective is to provide investors with a high level
of current income, consistent with a volatility of net asset value similar to
that of a portfolio which invests exclusively in six-month U.S. Treasury
securities on a constant maturity basis. There is no assurance that the Short
Fund will be able to maintain a low volatility of net asset value.
The Short Fund will seek its investment objective by investing, under normal
circumstances, at least 70% of its total assets in U.S. Government Securities
(see "Investment Objectives, Policies and Risk Considerations --
Characteristics and Risks of the Securities in which the Short and Intermediate
Funds and Fixed Income Segment of the Equity Market Plus Fund Invest"). It is
anticipated that the Short Fund will invest primarily in mortgage-backed
securities issued by the U.S. Government, its agencies and
instrumentalities. The Fund will also invest in fixed-rate and adjustable-rate
mortgage-backed securities issued by non-governmental issuers. The Fund may
hold a portion of its assets in money market instruments and in time and
savings deposits (including fixed-rate or adjustable certificates of deposit)
in commercial banks or institutions whose accounts are insured by the FDIC, BIF
or SAIF.
Under normal circumstances the Short Fund will seek to achieve an interest-rate
risk or option-adjusted duration (See "Other Investment Practices and Risk
Considerations -- Adjusting Investment and Interest Rate Risk Exposure")
similar to that of a six-month U.S. Treasury security on a constant maturity
basis. However, the Short Fund expects that, under normal circumstances, the
dollar-weighted average life (or period until the next reset date) of its
portfolio securities will be longer than six months, sometimes significantly
longer.
The Adviser believes that by investing in mortgage securities from a variety of
market sectors on a selective basis and adjusting the overall option-adjusted
duration of the portfolio to approximate that of a six-month
8
<PAGE>
[SMITH BREEDEN LOGO]
U.S. Treasury security, the Short Fund will achieve a more consistent and less
volatile net asset value than is characteristic of mutual funds that invest
primarily in mortgage securities paying a fixed rate of interest or those that
invest exclusively in adjustable-rate mortgage securities. The securities in
which the Short Fund may invest may not yield as high a level of income as
other securities in which other funds may invest. However, such higher yielding
securities may be more volatile and may be issued by less creditworthy
entities.
Intermediate Fund
The Intermediate Fund's investment objective is to provide investors with a
total return in excess of the total return of the major market indices for
mortgage-backed securities. The Intermediate Fund will seek its investment
objective by investing, under normal circumstances, at least 70% of its total
assets in U.S. Government Securities. It is anticipated that the Intermediate
Fund will invest primarily in mortgage-backed securities issued by the
U.S. Government, its agencies or instrumentalities. The Fund will also invest
in fixed-rate and adjustable rate mortgage-backed securities issued by
non-governmental issuers. The Fund may hold a portion of its assets in money
market instruments and in time and savings deposits (including fixed-rate or
adjustable-rate certificates of deposit) in commercial banks or institutions
whose accounts are insured by the FDIC, BIF, or SAIF.
The major market indices for mortgage-backed securities currently include, but
are not limited to, the Salomon Brothers Mortgage Index and the Lehman Brothers
Mortgage Index. These indices include all outstanding government sponsored
fixed-rate mortgage-backed securities, weighted in proportion to their current
market capitalization. Total return is the change in value of the investment,
assuming reinvestment of all distributions. Under normal circumstances, the
Intermediate Fund will seek to achieve an interest-rate risk or option-adjusted
duration (see "Other Investments and Risk Considerations") similar to that of a
portfolio that invests exclusively in mortgage-backed securities, as weighted
in the major market indices. The duration, or interest-rate risk, of these
indices is believed by the Adviser to be similar to the that of intermediate-
term U.S. Treasury Notes, and typically will range between three and five
years. When market interest rates decline, the value of a portfolio invested in
intermediate-term fixed-rate obligations can be expected to rise. Conversely,
when market interest rates rise, the value of a portfolio invested in
intermediate-term fixed-rate obligations can be expected to fall.
There is no assurance that the Intermediate Fund will be able to maintain a
total return in excess of the total return of major market indices for
mortgage-backed securities, or that it will match the interest rate risk of a
portfolio investing exclusively in these securities.
Fundamental Policies. As a matter of fundamental policy, the Short and
Intermediate Funds will limit purchases to securities from the following
classes of assets:
1. Securities issued directly or guaranteed by the U.S. Government or its
agencies or instrumentalities;
2. Mortgage-Backed Securities rated AAA by S&P or Aaa by Moody's or unrated but
deemed of equivalent quality by the Adviser;
3. Securities fully collateralized by assets in either of the above classes;
4. Assets which would qualify as liquidity items under federal regulations if
held by a commercial bank or savings institution; and
5. Hedge instruments, which may only be used for risk management purposes. Any
securities described in the "Hedging" section and any stripped Mortgage-Backed
Securities may only be used for risk management purposes.
9
<PAGE>
[SMITH BREEDEN LOGO]
Equity Market Plus Fund
The Equity Market Plus Fund seeks to provide a total return exceeding the
Standard & Poor's 500 Composite Stock Price Index (the "Index") without
additional equity market risk. The Fund does not invest principally in the
common stocks that make up the Index or any other stock index. Instead, the
Fund uses S&P 500 futures and swaps in an effort to maintain an equity market
exposure similar to that which would be achieved if all of the Fund's assets
were invested in the stocks comprising the Index. Since the Equity Market Plus
Fund utilizes index futures contracts and equity swap contracts to track the
S&P 500 Index, it can invest substantially all of its cash in fixed-income
securities and related hedging instruments. Whether the Fund's total return
equals or exceeds the performance of the S&P 500 Index depends largely on
whether the total return on the Equity Market Plus Fund's fixed-income
investments equals or exceeds the Fund's total operating expenses, as well as
other factors.
The S&P 500 Index is an unmanaged index composed of 500 common stocks, most of
which are listed on the New York Stock Exchange. Standard & Poor's, which is
not a sponsor of or in any other way affiliated with the Fund, chooses the 500
stocks included in the S&P 500 Index on the basis of market value and industry
diversification. The S&P 500 Index assigns relative values to the stocks
included in the index, weighted according to each stock's total market value
relative to the total market value of the other stocks included in the index.
The Equity Market Plus Fund seeks its objective by dividing its portfolio into
two segments: an "S&P 500 Index Segment" and a "Fixed Income Segment." Through
the S&P 500 Index Segment, the Fund invests in a combination of equity swap
contracts, futures contracts on the S&P 500 Index and on other stock indices,
including, but not limited to, the New York Stock Exchange Composite Index, and
common stocks whose return (before deducting allocated costs) is expected to
track movements in the S&P 500 Index. By employing this strategy, the Equity
Market Plus Fund seeks to achieve the same investment opportunity and risk
profile for the S&P 500 Index Segment as that of a hypothetical portfolio,
equal in size to the Fund, invested in the common stocks comprising the S&P 500
Index in proportion to their respective weightings in the S&P 500 Index.
When index futures contracts and/or equity swap contracts are, in the judgment
of the Adviser, overpriced relative to the common stocks underlying the S&P 500
Index, the Fund may invest directly in the common stocks represented by the S&P
500 Index. The Fund will not own all 500 issues, but will attempt to purchase a
basket of common stocks which the Adviser expects will, on average, match
movements in the S&P 500 Index. Subject to limits on the Fund's investments in
other investment companies, the Fund may also invest in these stocks indirectly
by purchasing interests in asset pools investing in such stocks. To the extent
that the Fund purchases interests in other investment companies, shareholders
of the Fund may be subject to a layering of expenses because they may
indirectly bear a proportionate share of the expenses of such investment
companies (including advisory fees) in addition to bearing the direct expenses
of the Fund.
Through the Fixed Income Segment, the Fund invests in fixed-income securities
and uses related hedging techniques such as futures, options, floors, caps and
swaps. The Fixed-Income Segment will invest substantially all of its assets in
U.S. Government Securities, and may also invest in bank certificates of
deposit, corporate debt obligations, and mortgage-backed and other asset-backed
securities of non-governmental issuers. The Fund may also engage in loans of
portfolio securities, dollar rolls, and reverse repurchase agreements to
enhance income and total return. With these investments, the Fund seeks to
generate income (consisting primarily of interest income) and gains which
exceed the total costs of operating the Fund (including the costs associated
with the S&P 500 Index Segment). Thus, whether the Fund's total return equals
or exceeds the performance of the S&P 500 Index depends largely on whether the
total return on the Fund's Fixed-Income Segment equals or exceeds the Fund's
total operating expenses, as well as other factors described below.
The S&P 500 Index Segment's actual opportunities for gain or loss may be
greater than a hypothetical portfolio invested in the stocks comprising the S&P
500 Index depending upon the Fund's exposure to the S&P 500 Index, which could
at times be higher or lower than the Fund's total assets. For example, the
total net notional amount of the Fund's equity swap contracts, S&P 500 or other
stock index futures plus the market
10
<PAGE>
[SMITH BREEDEN LOGO]
value of common stocks owned by the Fund may exceed the Fund's total net assets
as a result of purchases and redemptions of Fund shares. In addition, since S&P
500 Index futures can only be purchased for specific amounts, the Fund might
not be able to match accurately a notional amount of futures contracts to the
Fund's total net assets. Under normal market conditions, the Fund expects that
such variations in S&P 500 Index exposure will generally be up to 5% greater or
less than the Fund's total net assets. Also, the ability of the S&P 500 Index
Segment of the Fund's portfolio to replicate the investment opportunity and
risk profile of a hypothetical stock portfolio may be diminished by imperfect
correlations between price movements of the S&P 500 Index with price movements
of S&P 500 and other stock index futures and/or the common stocks purchased by
the Fund. In addition, the purchase and sale of common stocks and S&P 500 and
other stock index futures involve transaction costs. Equity swap contracts
require the Fund to pay interest on the notional amount of the
contract. Therefore, assuming the Fund has successfully tracked the movement of
the S&P 500 Index, the Fund will outperform the S&P 500 Index only if the total
net return on the Fixed Income Segment of the Fund's portfolio exceeds the sum
of (to the extent applicable) (1) the Fund's transaction costs on S&P 500 and
other stock index futures and common stock transactions, (2) the interest
payments under the Fund's equity swap contracts and (3) the Fund's operating
expenses as described more fully under "Management of the Fund."
Example. Set forth below is an example of how the Equity Market Plus Fund might
invest a $100 million portfolio:
1. Enter into an equity swap contract with a notional amount of $50 million;
2. Purchase S&P 500 index futures contracts with a total contract value of $45
million; and
3. Purchase $5 million worth of common stocks comprising the S&P 500 Index in
proportion to their respective weightings in the S&P 500 Index.
Because equity swap contracts and futures contracts may generally be initially
entered into without making cash payments, the Fixed Income Segment would have
$95 million to invest in various fixed income securities with appropriate
hedging strategies. If, during the course of the year, the stocks comprising
the S&P 500 Index appreciate 10% on average and pay a 4% dividend, and if the
interest on the equity swap contract's notional amount is 6%, at the end of the
year the following would occur:
1. The counterparty to the equity swap contract would be required to pay the
Fund $4 million ($7 million appreciation and dividends minus $3 million
interest);
2. The S&P 500 index futures contract would be closed out at a gain of $3.6
million ($6.3 million S&P 500 Index appreciation less $2.7 million for the S&P
500 Futures implicit cost of carry);
3. Dividend income and gain on the common stocks would total $0.7 million and
in sum;
4. The S&P 500 Index Segment's return, before related operating expenses, would
total $8.3 million dollars or 8.3%.
The Fund's total operating expenses (other than brokerage expenses and the
interest on the notional amount of the equity swap contract as described above)
are 0.88% of total net assets, or $0.88 million dollars. After consideration of
these expenses, the S&P 500 Index Segment's return would total
7.42%. Therefore, the Fund would achieve a total return equal to the S&P 500
Index only if the Fixed Income Segment has a total return equal to 6.93% per
annum. If the Fixed Income Segment achieves this result, then the Fund's total
net assets would be $114 million -- an increase of 14% and a total return equal
to the S&P 500 Index. If the Fixed Income Segment's total return were greater
or less than 6.93% per annum, the Fund's total return would, in turn, be
greater or less than the S&P 500 Index.
Smith Breeden Financial Services Fund
The Financial Services Fund seeks capital appreciation. To pursue this goal,
the fund will invest at least 65% of its assets in U.S. and foreign financial
services companies. These include banks, thrift, finance and leasing
11
<PAGE>
[SMITH BREEDEN LOGO]
companies, brokerage, investment banking and advisory firms, real estate
related firms and insurance companies. The Fund will generally invest in common
stock and in other equity securities such as preferred stock and warrants. The
Fund may also engage in other investment practices. See "Other Investment
Practices and Risk Considerations."
Because the Financial Services Fund invests in single sector, its performance
is largely dependent on the sector's performance, which may differ from that of
the overall stock market. Changing interest rates or deteriorating economic
conditions can adversely affect the performance of financial services
companies' stocks. The Fund may buy or sell interest rate futures and options
to attempt to mitigate the affect of changing interest rates upon the
portfolio. However, the use of interest rate futures in such a strategy
involves the risk that the price movements of the hedging instrument will not
accurately reflect price movements in the security due to changing interest
rates, so that the hedge will not be fully effective or may result in losses.
The Fund may also buy or sell stock index futures or options on such indices to
adjust the risk and return characteristics of the Fund's stock portfolio. If
the Adviser judges market conditions incorrectly or employs a strategy that
does not correlate well with the Fund's investments, the use of stock index
futures could result in a loss, regardless of whether the intent was to reduce
risk or increase return. These techniques may also increase the volatility of
the Fund relative to the Financial Services sector of the stock market. See
also "Other Investment Practices and Risk Considerations" and the Statement of
Additional Information for a discussion of the use of financial futures and
options and their risks.
Financial services companies are subject to extensive government regulation
which may limit both the amounts and types of loans and other financial
commitments they can make, and the interest rates and fees they
charge. Profitability is largely dependent upon on the availability and cost of
capital funds, and can fluctuate significantly when interest rates
change. Credit losses resulting from the financial difficulties of borrowers
can negatively impact the industry. Insurance companies may be subject to
severe price competition. Legislation is currently being considered which would
reduce the separation between commercial and investment banking businesses. If
enacted this could significantly impact the financial services sector and the
Fund.
The Fund may purchase securities of foreign financial services companies, which
are subject to additional risks. Currency fluctuations can adversely affect the
returns on investments held in foreign corporations. Other risks relate to the
fact that differences exist in accounting, auditing and financial reporting
standards. Political developments may also have an adverse impact. There is
also the possibility of changes in investment or exchange control regulations,
restrictions on the flow of international capital, and difficulties in pursuing
legal remedies against issuers. The Fund will primarily invest in foreign
financial securities through ADRs, which represent shares of a foreign
corporation held by an U.S. bank that entitles the holder to all dividends and
capital gains. ADRs are denominated in U.S. dollars and trade in the
U.S. securities markets. ADRs are still subject to the risks associated with
foreign investment generally described above. The Financial Services Fund may
hedge against fluctuations in foreign exchange rates by entering into foreign
currency forward and futures contracts. For more discussion of these contracts
and their risks, see "Other Investment Practices and Risk Considerations" and
the Statement of Additional Information.
Under regulations imposed by the Investment Company Act of 1940 and its rules
(the "1940 Act"), the Fund may not purchase more than 10% of the securities of
any domestic or foreign insurance company. The Fund may also not invest more
than 5% of its total assets in the equity securities of any company that
derives more than 15% of its revenues from brokerage or investment management
activities, unless such investment is limited to not more than 5% of the equity
securities or 10% of the debt securities of such company, and such investment
represents not more than 5% of the net assets of the Fund.
The Financial Services Fund intends to be a diversified fund, as defined under
the 1940 Act, and as such, with respect to 75% of its assets, will not invest
more than 5% of its assets in any single issuer, and such 5% holding cannot
represent more than a 10% voting interest in the acquired company.
12
<PAGE>
[SMITH BREEDEN LOGO]
Characteristics and Risks of the Securities in which the Short and Intermediate
Funds and Fixed Income Segment of the Equity Market Plus Fund Invest
U.S. Government Securities. The U.S. Government Securities in which the Funds
may invest include U.S. Treasury Bills, Notes, Bonds, discount notes and other
debt securities issued by the U.S. Treasury, and obligations issued or
guaranteed by the U.S. Government, its agencies and instrumentalities
including, but not limited to, the Government National Mortgage Association
("GNMA"), Federal National Mortgage Association ("FNMA") and Federal Home Loan
Mortgage Corporation ("FHLMC"). (Other U.S. Government agencies or
instrumentalities include Federal Home Loan Banks, Bank for Cooperatives, Farm
Credit Banks, Tennessee Valley Authority, Federal Financing Bank, Small
Business Administration, and Federal Agricultural Mortgage
Corporation.) Mortgage-backed securities are explained more fully below.
Credit Risks. While certain U.S. Government securities such as U.S. Treasury
obligations and GNMAs are backed by the full faith and credit of the
U.S. Government, other securities in which the Funds may invest are subject to
varying degrees of risk of default. These risk factors include the
creditworthiness of the issuer and, in the case of mortgage-backed and
asset-backed securities, the ability of the mortgagor or other borrower to meet
its obligations. The Short and Intermediate Funds will seek to minimize this
credit risk by investing in securities of the highest credit quality
instruments, while the Equity Market Plus Fund will seek to minimize this risk
of default by investing in securities of at least investment grade, except that
the Equity Market Plus Fund's investment in mortgage backed securities will be
rated at least A by Standard & Poors ("S&P"). The individual securities
continue to be subject to the risk that their prices can fluctuate, in some
cases significantly, due to changes in prevailing interest rates.
Mortgage-Backed and Other Asset-Backed Securities. Mortgage-backed securities
are securities that directly or indirectly represent a participation in, or are
collateralized by and payable from, mortgage loans secured by real
property. The term "mortgage-backed securities," as used herein, includes
adjustable-rate mortgage securities, fixed-rate mortgage securities, and
derivative mortgage products such as collateralized mortgage obligations,
stripped mortgage-backed securities and other instruments described below.
There are currently three basic types of mortgage-backed securities: (i) those
issued or guaranteed by the U.S. Government or one of its agencies or
instrumentalities, such as GNMA, FNMA and FHLMC; (ii) those issued by private
issuers that represent an interest in or are collateralized by mortgage-backed
securities issued or guaranteed by the U.S. Government or one of its agencies
or instrumentalities; and (iii) those issued by private issuers that represent
an interest in or are collateralized by whole mortgage loans or mortgage-backed
securities without a government guarantee but usually having some form of
private credit enhancement.
The Short and Intermediate Funds may only invest in mortgage-backed securities
issued by private originators of, or investors in, mortgage loans issued by
private entities that are rated AAA by S&P or Aaa by Moody's Investors Service
("Moody's"), or, if unrated, determined by the Adviser to be of comparable
quality. The Short and Intermediate Funds will not pay any additional fees for
credit support and will not invest in private mortgage pass-through securities
unless they are rated AAA by S&P or Aaa by Moody's, or are unrated but deemed
to be of comparable credit quality by the Adviser. In addition, the Short and
Intermediate Funds will only purchase mortgage-backed securities which
constitute "Mortgage Related Securities" for purposes of the Secondary Mortgage
Market Enhancement Act of 1984.
The Equity Market Plus Fund may invest in other mortgage-backed and
asset-backed securities. Its investment in mortgage-backed and other
asset-backed securities will be rated at least A by Moody's or S&P. Asset-backed
securities are structured like mortgage-backed securities, but instead of
mortgage loans or interests in mortgage loans, the underlying assets may
include, but are not limited to, pools of automobile loans, educational loans
and credit card receivables.
Mortgage-backed and asset-backed securities have yield and maturity
characteristics corresponding to their underlying assets. Unlike traditional
debt securities, which may pay a fixed rate of interest until maturity
13
<PAGE>
[SMITH BREEDEN LOGO]
when the entire principal amount comes due, payments on certain mortgage-backed
and asset-backed securities include both interest and a partial payment of
principal. This partial payment of principal may be comprised of a scheduled
principal payment as well as an unscheduled payment from the voluntary
prepayment, refinancing, or foreclosure of the underlying loans. As a result of
these unscheduled payments of principal, or prepayments on the underlying
securities, the price and yield of mortgage-backed securities can be adversely
affected. For example, during periods of declining interest rates, prepayments
can be expected to accelerate, and the Funds would be required to reinvest the
proceeds at the lower interest rates then available. Prepayments of mortgages
which underlie securities purchased at a premium could result in capital losses
because the premium may not have been fully amortized at the time the
obligation is prepaid. In addition, like other interest-bearing securities, the
values of mortgage-backed securities generally fall when interest rates rise,
but when interest rates fall, their potential for capital appreciation is
limited due to the existence of the prepayment feature. In order to hedge
against possible prepayment, the Funds may purchase certain options and options
on futures contracts as described more fully in "Other Investment Practices and
Risk Considerations" and the Statement of Additional Information.
Adjustable-Rate Securities. Adjustable-rate securities have interest rates that
are reset at periodic intervals, usually by reference to some interest rate
index or market interest rate. Some adjustable-rate securities are backed by
pools of mortgage loans. The Short and Intermediate Funds will only invest in
adjustable-rate securities backed by pools of mortgage loans ("ARMs"). The
Fixed Income Segment of the Equity Market Plus Fund may also invest in
adjustable-rate securities backed by assets other than mortgage pools.
Although the rate adjustment feature may act as a buffer to reduce large
changes in the value of adjustable-rate securities, these securities are still
subject to changes in value based on changes in market interest rates or
changes in the issuer's creditworthiness. Because the interest rate is reset
only periodically, changes in the interest rate on adjustable-rate securities
may lag changes in prevailing market interest rates. Also, some adjustable-rate
securities (or the underlying mortgages or other underlying loans or
receivables) are subject to caps or floors that limit the maximum change in
interest rate during a specified period or over the life of the
security. Because of the resetting of interest rates, adjustable-rate
securities are less likely than non-adjustable-rate securities of comparable
quality and maturity to increase significantly in value when market interest
rates fall. Adjustable-rate securities are also subject to the prepayment risks
associated generally with mortgage- backed securities.
Other Mortgage Backed Securities and Fixed Income Investments. The Short and
Intermediate Funds and Fixed Income Segment of the Equity Market Plus Fund may
also invest in other types of mortgage-backed and fixed income securities
including Collateralized Mortgage Obligations, Stripped Securities, and zero
coupon bonds. These types of securities, including their risks, are described
in detail in the Statement of Additional Information. New instruments and
variations of existing mortgage-backed securities continue to be developed. The
Funds may invest in any such instruments or variations to the extent consistent
with their investment objectives and policies and applicable regulatory
requirements.
OTHER INVESTMENT PRACTICES AND RISK CONSIDERATIONS
The Statement of Additional Information for each Fund contains more detailed
information about the following practices, including limitations designed to
reduce their risks.
Adjusting Investment and Interest Rate Risk Exposure. A Fund can use various
techniques to increase or decrease its exposure to changing security prices and
indices, currency exchange rates, interest rates or other factors that affect
security value, or to employ temporary substitutes for anticipated future
transactions. These techniques include buying or selling financial futures
contracts, purchasing call or put options, or selling covered call options on
such futures or entering into currency exchange contracts or swap
agreements. Any or all of these techniques may be used at one time, except that
only the Financial Services Fund may enter into currency exchange futures,
forward or swap contracts. Use of any particular transaction is a function of
market conditions. There is no overall limitation on the percentage of a Fund's
assets which may be subject to a hedge position.
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Swap agreements are two-party contracts entered into primarily by institutional
investors for periods ranging from a few weeks to more than one year. In a
standard swap transaction, two parties agree to exchange the returns (or
differentials in rates of return) earned or realized on particular
predetermined investments or instruments, which may be adjusted for an interest
factor. The gross returns to be exchanged or "swapped" between the two parties
are generally calculated with respect to a "notional amount", i.e., the return
on or increase in value of a particular dollar amount invested at a particular
interest rate, in a particular foreign currency, or in a "basket" of securities
representing a particular index. Whether a Fund's use of swap agreements will
be successful in furthering its investment objective will depend on the
Advisor's ability to predict correctly whether certain types of investments are
likely to produce greater returns than other investments. Because they are
two-party contracts and because they may have terms of greater than seven days,
swap agreements are currently considered illiquid investments. Moreover, a Fund
bears the risk of loss of the amount expected to be received under a swap
agreement in the event of the default or bankruptcy of a swap agreement
counterparty. The Funds will enter into swap agreements only with
counterparties that meet certain standards for creditworthiness (generally such
counterparties would have to be eligible counterparties under the terms of the
Funds' repurchase agreement guidelines). Certain restrictions imposed on the
Funds by the Internal Revenue Code may limit the Funds' ability to use swap
agreements. The swaps market is a relatively new market and is largely
unregulated. It is possible that developments in the swaps market, including
potential government regulation, could adversely affect a Fund's ability to
terminate existing swap agreements or to realized amounts to be received under
such agreements.
Options and futures transactions involve costs and may result in losses. The
losses from investing in futures transactions are potentially unlimited. In
addition, the effective use of options and futures strategies depends on a
Fund's ability to terminate options and futures positions at times when the
Adviser deems it desirable to do so. This ability to terminate positions when
the Adviser deems it desirable to do so may be hindered by the lack of a liquid
secondary market. Although a Fund will take an options or futures contract
position only if the Adviser believes there is a liquid secondary market for
the option or futures contract, there is no assurance that a Fund will be able
to effect closing transactions at any particular time or at an acceptable
price.
The use of options and futures strategies also involves the risk of imperfect
correlation between movements in the values of the securities underlying the
futures and options purchased and sold by a Fund, of the option and futures
contract itself, and of the securities which are the subject of a hedge. For
example, a Fund bears the risk that prices of hedged securities will not move
to the same degree as the hedging instrument, or that price movements in the
hedging instrument will not accurately reflect price movements in the security
underlying the hedging instrument. It is also possible for a Fund to incur a
loss on both the hedged securities and the hedging instrument. In the case of
the Short and Intermediate Funds, and the Fixed Income segment of the Equity
Market Plus Fund, this means that they may not achieve, and may at times
exceed, their targeted option-adjusted durations.
Option-adjusted duration is a measure of the price sensitivity of a portfolio
to changes in interest rates. The maturity of a security, another commonly used
measure of price sensitivity, measures only the time until final payment is
due, whereas option-adjusted duration takes into account the pattern of all
payments of interest and principal on a security over time, including how these
payments are affected by prepayments and by changes in interest rates. In
computing the duration of a Fund's portfolio, the Adviser will estimate the
duration of obligations that are subject to prepayment or redemption by the
issuer, taking into account the influence of changes in interest rates on
prepayments and coupon flows.
At times, a Fund may sell interest rate futures in a different dollar amount
than the dollar amount of securities being hedged, depending on the expected
relationship between the volatility of the prices of such securities and the
volatility of the futures contracts, based on duration calculations by the
Adviser. If the actual price movements of the securities and futures are
inconsistent with the Adviser's estimates of their durations, the hedge may not
be effective.
The Short, Intermediate and Equity Market Plus Fund will not maintain open
short positions in interest rate futures contracts if, in the aggregate, the
value of the open positions (marked to market) exceeds the current market value
of its fixed income securities portfolio plus or minus the unrealized gain or
loss on these open
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positions, adjusted for the expected volatility relationship between the
portfolio and the futures contracts based on duration calculations. If this
limitation should be exceeded at any time, a Fund will take prompt action to
close out the appropriate number of open contracts to bring its open futures
position into compliance with this limitation.
The Short and Intermediate Funds will not purchase a put or call option on
U.S. Government securities or mortgage-backed securities if, as a result of
such purchase, more than 10% of its total assets would be invested in such
options. The Short and Intermediate Funds will engage in OTC option
transactions only with primary United States government securities dealers
recognized by the Federal Reserve Bank of New York. The Short and Intermediate
Funds will also not sell options which are not covered.
The Equity Market Plus Fund will not purchase or sell S&P 500 or other stock
index futures, except for bona fide hedging purposes, if as a result the Fund's
aggregate initial margin deposits and premiums would be greater than 5% of the
Fund's total assets. In addition to margin deposits, when the Fund purchases an
S&P 500 or other stock index futures contract, it is required to maintain at
all times liquid securities in a segregated account with its Custodian, in an
amount which, together with the initial margin deposit on the futures contract,
is equal to the current delivery or cash settlement value of the futures
contract. The Statement of Additional Information provides additional
information regarding equity swap contracts, S&P 500 and other stock index
futures contracts and their related risks.
In accordance with regulations established by the Commodity Futures Trading
Commission, each Funds' aggregate initial margin and premiums on all futures
and options contract positions not held for bona fide hedging purposes, will
not exceed 5% of a Fund's net assets, after taking into account unrealized
profits and losses on such contracts.
The Funds' ability to engage in options and futures transactions and to sell
related securities might also be limited by tax considerations and by certain
regulatory requirements. See "Taxes" in the relevant Statement of Additional
Information.
Securities Lending, Repurchase Agreements and Forward Commitments. The Funds
may lend portfolio securities to broker-dealers and may enter into repurchase
agreements. These transactions must be fully collateralized at all times but
involve some risk to the Funds if the other party should default on its
obligations and a Fund is delayed in or prevented from recovering the
collateral. None of the Funds will lend portfolio securities if, as a result,
the aggregate of such loans exceeds 33 1/3% of the total asset value (including
such loans). The Funds will only enter into repurchase agreements with or lend
securities to (i) member banks of the Federal Reserve System having total
assets in excess of $500 million and (ii) securities dealers, provided such
banks or dealers meet the creditworthiness standards established by the Board
of Trustees ("Qualified Institutions"). The Adviser will monitor the continued
creditworthiness of Qualified Institutions, subject to the oversight of the
Board of Trustees.
The Funds may also purchase securities for future delivery, which may increase
overall investment exposure and involves a risk of loss if the value of the
securities declines prior to the settlement date. At the time a Fund enters
into a transaction on a when-issued or forward commitment basis, a segregated
account consisting of liquid securities equal to at least 100% of the value of
the when-issued or forward commitment securities will be established and
maintained with the Funds' custodian. Subject to this requirement, the Funds
may purchase securities on such basis without limit. Settlements in the
ordinary course, which may be substantially more than three business days for
mortgage-backed securities, are not treated as when-issued or forward
commitment transactions, and are not subject to the foregoing limitations,
although some of the risks described above may exist.
Reverse Repurchase Agreements, Dollar Roll Agreements and Borrowing. The Funds
may enter into reverse repurchase agreements or dollar roll agreements with
commercial banks and registered broker-dealers in amounts up to 33 1/3% of
their assets. The Short and Intermediate Funds may only enter into these
transactions with commercial banks and registered broker-dealers which are also
Qualified Institutions. The Statement of Additional Information for each Trust
contains a more detailed explanation of these practices.
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Reverse repurchase agreements and dollar rolls are considered borrowings by a
Fund and require segregation of assets with a Fund's custodian in an amount
equal to the Fund's obligations pending completion of such transactions. Each
Fund may also borrow money from banks in an amount up to 33 1/3% of a Fund's
total assets to realize investment opportunities, for extraordinary or
emergency purposes, or for the clearance of transactions. Borrowing from banks
usually involves certain transaction and ongoing costs and may require a Fund
to maintain minimum bank account balances. Use of these borrowing techniques to
purchase securities is a speculative practice known as "leverage." Depending on
whether the performance of the investments purchased with borrowed funds is
sufficient to meet the costs of borrowing, a Fund's net asset value per share
will increase or decrease, as the case may be, more rapidly than if the Fund
did not employ leverage.
Short Sales. The Funds may make short sales of securities. A short sale is a
transaction in which the Fund sells a security it does not own in anticipation
that the market price of that security will decline. The Short, Intermediate,
and Equity Market Plus Funds expect to engage in short sales as a form of
hedging in order to shorten the overall duration of the portfolio and maintain
portfolio flexibility. The Financial Services Fund may make short sales of
securities to reduce the risk of the portfolio to the market or to increase
return. While a short sale may act as effective hedge to reduce the market or
interest rate risk of a portfolio, it may also result in losses which can
reduce the portfolio's total return.
When a Fund makes a short sale, it must borrow the security sold short and
deliver it to the broker-dealer through which it made the short sale as
collateral for its obligation to deliver the security upon completion of the
transaction. A Fund may have to pay a fee to borrow particular securities, and
is often obligated to relinquish any payments received on such borrowed
securities.
Until a Fund replaces a borrowed security, it will maintain daily a segregated
account with its custodian into which it will deposit liquid securities such
that the amount deposited in the account plus any amount deposited with the
broker as collateral will equal the current value of the security sold
short. Depending on arrangements made with the broker, a Fund may not receive
any payments (including interest) on collateral deposited with the broker. If
the price of the security sold short increases between the time of the short
sale and the time a Fund replaces the borrowed security, the Fund will incur a
loss; conversely, if the price declines, the Fund will realize a gain. Although
a Fund's gain is limited to the amount at which it sold the security short, its
potential loss is limited only by the maximum attainable price of the security
less the price at which the security was sold.
A Fund will not make a short sale if, after giving effect to such sale, the
market value of all securities sold exceeds 25% of the value of the Fund's
total net assets. A Fund may also effect short sales where the Fund owns, or
has the right to acquire at no additional cost, the identical security (a
technique known as a short sale "against the box"). Such transactions might
accelerate the recognition of gain. See "Taxes" in the relevant Statement of
Additional Information.
Illiquid Securities. A Fund may invest up to 15% of its net assets in illiquid
securities. The term illiquid securities for this purpose means securities that
cannot be disposed of within seven days in the ordinary course of business. The
SEC staff takes the position that this includes non-terminable repurchase
agreements having maturities of more than seven days.
The Financial Services Fund may invest in restricted securities, which
represent securities that can be sold in privately negotiated transactions,
pursuant to an exemption from registration under the Securities Act of 1933, or
in registered public offering. Restricted securities deemed to be liquid under
procedures established by the Board are not subject to the limitations on
illiquid securities.
The determination of whether certain IO/PO Strips issued by the U.S. Government
and backed by fixed-rate mortgages or any other securities in which a Fund
desires to invest are liquid shall be made by the Adviser under guidelines
established by the Trustees in accordance with applicable pronouncements of the
SEC. At present, all other IO/PO Strips, other residual interests of CMOs and
OTC options are treated as illiquid
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securities. The SEC staff also currently takes the position that the interest
rate swaps, caps and floors discussed in the Statement of Additional
Information, as well as equity swap contracts and reverse equity swap
contracts, are illiquid.
Portfolio Turnover. The Adviser buys and sells securities for a Fund whenever
it believes it is appropriate to do so. Portfolio turnover generally involves
some expense to a Fund, including brokerage commissions or dealer mark-ups and
other transaction costs on the sale of securities and reinvestment in other
securities. Such transactions may result in realization of taxable capital
gains. The portfolio turnover rate for each Fund's previous fiscal periods is
shown in the table under the heading "Financial Highlights". The Adviser
expects that for the Financial Services Fund, the portfolio turnover rate will
not exceed 400%.
The portfolio turnover rates reported in the "Financial Highlights" for the
Short and Intermediate Funds for the fiscal year ended March 31, 1997 were
relatively high. Since the Short and Intermediate Funds' portfolio holdings are
very liquid, the Funds may reposition its holdings between different mortgage
sectors relatively frequently, but without generating substantial transaction
costs. The mortgage securities in which the Short, Intermediate and Equity
Market Plus Funds invest are generally traded on a "net" basis with dealers
acting as principals for their own account without a stated commission.
The Funds will pay commissions in connection with options and future
transactions and, for the Equity Market Plus Fund and Financial Services Fund,
in relation to any purchase of common stocks or other equity securities.
Until March 31, 1998, for the Short, Intermediate, and Equity Market Plus Funds
only, another potential consequence of high portfolio turnover is that if 30%
or more of a Fund's gross income for a taxable year is derived from gains from
the sale of securities held for less than three months, the Fund will not
qualify as a regulated investment company and, therefore, would be subject to
corporate income tax during that taxable year. The Adviser endeavors to manage
the investment composition of these Funds and to adjust the portfolio turnover,
if necessary, to ensure that each Fund will be eligible for treatment as a
regulated investment company.
MANAGEMENT OF THE FUNDS
Its Board of Trustees manages the business affairs of the Funds. Each of the
Funds has entered into an investment advisory agreement with Smith Breeden
Associates, Inc., 100 Europa Drive, Chapel Hill, North Carolina, 27514 (the
"Investment Advisory Agreements"). Pursuant to such investment advisory
agreements, the Adviser furnishes continuous investment advisory services to
each of the Funds.
Trustees and Officers
The following is a listing of the Trustees and officers of the Series Fund and
Trust, the legal entities that have issued shares in the Funds. Unless
otherwise indicated, all of the named individuals serve in their capacities for
both the Series Fund and Trust.
Douglas T. Breeden* Trustee and Chairman
Portfolio Manager, Financial Services Fund
Dr. Breeden, the Chairman of the Board of Smith Breeden Associates, co-founded
the firm in 1982. In conjunction with Michael J. Giarla and Robert B. Perry, he
is responsible for the day-to-day operations of the Financial Services
Fund. Dr. Breeden has served on business school faculties at Duke University,
Stanford University and the University of Chicago, and as a visiting professor
at Yale University and at the Massachusetts Institute of Technology. He is the
Editor of The Journal of Fixed Income. Dr. Breeden served as Associate Editor
for five journals in financial economics, and was elected to the Board of
Directors of the American Finance Association. He has published several
well-cited articles in finance and economics journals. He holds
* Interested Person
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a Ph.D. in Finance from the Stanford University Graduate School of Business,
and a B.S. in Management Science from the Massachusetts Institute of
Technology. He serves as Chairman of Harrington Financial Group, the holding
company for Harrington Bank, F.S.B., of Richmond, Indiana.
Michael J. Giarla* Trustee and President
Portfolio Manager, Financial Services Fund
Mr. Giarla is Chief Operating Officer, President and Director of Smith Breeden
Associates. In conjunction with Douglas T. Breeden and Robert B. Perry, he is
responsible for the day-to-day operations of the Financial Services Fund. He
also serves as a Director of Harrington Financial Group, the holding company
for Harrington Bank, F.S.B., of Richmond, Indiana. Formerly Smith Breeden's
Director of Research, he was involved in research and programming, particularly
in the development and implementation of models to evaluate and hedge mortgage
securities. He also consults with institutional clients and conducts special
projects. Before joining Smith Breeden Associates, Mr. Giarla was a Summer
Associate in Goldman Sachs & Company's Equity Strategy Group in New York. Mr.
Giarla has published a number of articles and book chapters regarding MBS
investment, risk management and hedging. He served as an Associate Editor of
The Journal of Fixed Income from 1991-1993. Mr. Giarla holds a Master of
Business Administration with Concentration in Finance from the Stanford
University Graduate School of Business, where he was an Arjay Miller
Scholar. He earned a Bachelor of Arts in Statistics, summa cum laude, from
Harvard University, where he was elected to Phi Beta Kappa and was a Harvard
Club of Boston Scholar. Mr. Giarla is a Trustee of the Roxbury Latin School,
West Roxbury, Massachusetts.
Stephen M. Schaefer Trustee
Stephen M. Schaefer is Esmee Fairbairn Professor of Finance at the London
Business School. Previously on the Faculty of the Graduate School of Business
of Stanford University, he has also taught at the Universities of California
(Berkeley), Chicago, British Columbia and Venice. His research interests focus
on capital markets and financial regulation. He served on the editorial board
of a number of professional journals including, currently, the Journal of Fixed
Income, the Review of Derivative Research, and Ricerche Economiche. He consults
for a number of leading financial institutions and is a former Independent
Board Member of the Securities and Futures Authority of Great Britain.
Myron S. Scholes Trustee
Myron S. Scholes is a Principal in the money management firm Long-Term Capital
Management Co. (since 1993). He is the Frank E. Buck Professor of Finance
Emeritus at the Graduate School of Business at Stanford University (since
1983). He is a member of the Econometric Society. Professor Scholes was also a
Managing Director and co-head of the fixed income derivatives group at Salomon
Brothers between 1991-1993. Prior to coming to Stanford University in 1983,
Professor Scholes was the Edward Eagle Brown Professor of Finance at the
Graduate School of Business, University of Chicago (1974-1983). He served as
the Director of the University of Chicago's Center for Research in Security
Prices from 1974-1980. Prior to coming to the University of Chicago, Professor
Scholes was first an Assistant Professor then an Associate Professor at the
Sloan School of Management at M.I.T. from 1968 to 1973. He received his
Ph.D. in 1969 from the Graduate School of Business, University of Chicago. He
has honorary Doctor of Law degrees from the University of Paris and McMaster
University. He is a past president of the American Finance Association (1990).
Dr. Scholes has published numerous articles in academic journals and in
professional volumes. He is most noted as the co-originator of the
Black-Scholes Options Pricing Model as described in the paper, "The Pricing of
Options and Corporate Liabilities," published in the Journal of Political
Economy (with Fischer Black, May 1973), for which he was awarded the Nobel
Prize in Economic Sciences in 1997. His other papers include such topics as
risk-return relationships, the effects of dividend policy on stock prices, and
the effects of taxes and tax policy on corporate decision making. His book with
Mark Wolfson (Stanford University) Taxes and Business Strategy: A Planning
Approach was published by Prentice Hall in 1991.
* Interested Person
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William F. Sharpe Trustee
William F. Sharpe is the STANCO 25 Professor of Finance at Stanford
University's Graduate School of Business. He is best known as one of the
developers of the Capital Asset Pricing Model, including the beta and alpha
concepts used in risk analysis and performance measurement. He developed the
widely used binomial method for the valuation of options and other contingent
claims. He also developed the computer algorithm used in many asset allocation
procedures, a procedure for estimating the style of an investment manager from
its historic returns, and the Sharpe ratio for measuring investment
performance. Dr. Sharpe has published articles in a number of professional
journals. He has also written six books, including Portfolio Theory and Capital
Markets, (McGraw-Hill, 1970), Asset Allocation Tools, (Scientific Press, 1987),
Fundamentals of Investments (with Gordon J. Alexander and Jeffery Bailey,
Prentice-Hall, 1993) and Investments (with Gordon J. Alexander and Jeffrey
Bailey, Prentice-Hall, 1990). Dr. Sharpe is a past President of the American
Finance Association. He also served as consultant to a number of corporations
and investment organizations. He is Trustee of the Barr Rosenberg mutual funds,
a director of Stanford Management Company and the Chairman of the Board of
Financial Engines, a company providing electronic portfolio advice. He received
the Nobel Prize in Economic Sciences in 1990.
Daniel C. Dektar Vice President, Smith Breeden Series Fund
Portfolio Manager, Short and Intermediate
Funds
Daniel C. Dektar is a Principal, Executive Vice President, Director of
Portfolio Management, and Director of Smith Breeden Associates. Mr. Dektar has
been primarily responsible for the day-to-day management of the Short and
Intermediate Funds since their commencement of operations in 1992. In December
1997, Timothy D. Rowe joined Mr. Dektar as co-Portfolio Manager of the
Intermediate Fund, and shares responsibility for the day-to-day management of
that Fund. As head of Smith Breeden Associates' portfolio management group,
Mr. Dektar is constantly in touch with developments on Wall Street. He serves
as a liaison among the portfolio management, client service, and research
groups to ensure accurate analysis and timely execution of portfolio management
opportunities. Mr. Dektar consults with institutional clients in the areas of
investments and risk management. He made several presentations on mortgage
investments and risk management at seminars for institutional
investors. Mr. Dektar was an Associate in the Mergers and Acquisitions Group of
Montgomery Securities in San Francisco, California and a Financial Analyst in
the Investment Banking Division of Morgan Stanley & Co., Incorporated, New York
before joining Smith Breeden Associates. He holds a Master of Business
Administration with Concentration in Finance from Stanford University Graduate
School of Business, where he was an Arjay Miller Scholar. Mr. Dektar received a
Bachelor of Science in Business Administration, summa cum laude, from the
University of California at Berkeley, where he was University of California
Regent's Scholar, was elected to Phi Beta Kappa and Phi Eta Sigma, and won the
White Award as the top student in finance.
Timothy D. Rowe Portfolio Manager, Intermediate Fund
Timothy D. Rowe is a Principal, Director, and Vice President of Smith Breeden
Associates. Mr. Rowe, in conjunction with Daniel C. Dektar, is responsible for
the day-to-day management of the Intermediate Fund. Mr. Rowe is a senior
portfolio manager working primarily with discretionary separate account
clients. He implements investment strategies designed to generate portfolio
returns superior to the broad investment grade and mortgage market indices. Mr.
Rowe joined Smith Breeden in 1988. His prior experience includes three years as
Assistant Economist at the Federal Reserve Bank of Richmond, Virginia. While at
the Bank, he co-edited the sixth edition of Instruments of the Money Market,
and produced research papers for publication in the Bank's Economic Review
magazine. He holds a Master of Business Administration with specialization in
Finance from the University of Chicago Graduate School of Business, and a
Bachelor of Arts in Economics and History from Duke University. He graduated
from Duke magna cum laude, earned Class Honors and was a National Merit
Scholar.
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John B. Sprow Vice President, Smith Breeden Trust
Portfolio Manager, Equity Market Plus Fund
John B. Sprow is a Principal, Director and Executive Vice President of Smith
Breeden Associates. Mr. Sprow has been primarily responsible for the day-to-day
management of the Equity Market Plus Fund from the commencement of its
operations in 1992. Mr. Sprow is a senior portfolio manager who works primarily
with discretionary pension accounts. In addition to traditional mortgage
accounts, he also manages S&P 500 indexed accounts. Prior to directly managing
discretionary accounts, Mr. Sprow assisted in the development of the Adviser's
models for pricing and hedging mortgage-related securities, risky commercial
debt, and forecasting mortgage prepayment behavior. Mr. Sprow came to Smith
Breeden Associates from the Fuqua School of Business, Duke University, where he
was Research Assistant. Previously, Mr. Sprow was a Research Assistant to the
Department Head of the Materials Science Department, Cornell University. He
received a Master of Business Administration with Emphasis in Finance from the
Fuqua School of Business, Duke University. Mr. Sprow holds a Bachelor of
Science in Materials Science and Engineering from Cornell University, where he
was awarded the Carpenter Technology Scholarship three successive years.
Robert B. Perry Vice President, Smith Breeden Trust
Portfolio Manager, Financial Services Fund
Robert B. Perry is a Principal at Smith Breeden Associates, providing hedging
and investment advice to Smith Breeden's financial services clients. He is also
responsible for calculating market-to-market values and projected income of
institutions, and assesses the effects of interest rate and economic
changes. In conjunction with Douglas T. Breeden and Michael J. Giarla, Mr.
Perry is responsible for the day-to-day operations of the Financial Services
Fund. Prior to joining Smith Breeden, Mr. Perry served as an interest rate risk
analyst for Centura Bank, and secretary to the ALCO committee. He has also
served as a Director for Community First Financial Group, a multi-bank holding
company located in Indianapolis, Indiana. Mr. Perry earned his Bachelor of Arts
in Business Administration from North Carolina State University.
Marianthe S. Mewkill Vice President, Secretary, Treasurer, and
Chief Accounting Officer
Marianthe S. Mewkill is a Principal, Vice President and Chief Financial Officer
of Smith Breeden Associates. Ms. Mewkill handles financial reporting,
budgeting, tax research and planning for the Smith Breeden Mutual Funds and for
Smith Breeden Associates, Inc. She ensures compliance with agency regulations
and administers the Adviser's internal trading and other policies. She was
previously employed as a Controller for the Hunt Alternatives Fund, as an
Associate at Goldman Sachs & Co., and as a Senior Auditor at Arthur Andersen &
Co. She earned a Master of Business Administration with Concentrations in
Finance and Accounting from New York University and graduated from Wellesley
College, magna cum laude with a Bachelor of Arts degree in History and French
and a Minor in Economics.
Investment Adviser
Smith Breeden Associates, Inc., a registered investment adviser, acts as
investment adviser to the Funds. Approximately 66% of the Adviser's voting
stock is owned by Douglas T. Breeden, its Chairman. Under its Investment
Advisory Agreement with each Fund, the Adviser, subject to the general
supervision of the Board of Trustees, manages the Funds' portfolios and
provides for the administration of all of the Funds' other affairs. For these
services, the Adviser receives a fee, computed daily and payable monthly, at
the annual rate of 0.70% of the Short, Intermediate and Equity Market Plus
Funds' average daily net assets. The Adviser receives a fee at the rate of
1.50% for its management of the Financial Services Fund. Until the renewal date
of its contracts with the Funds, August 1, 1998, the Adviser has voluntarily
agreed to reduce its compensation, and to the extent necessary absorb other
expenses of the Funds, such that the total expenses (exclusive of ordinary
brokerage commissions, investment transaction taxes and extraordinary expenses)
do not exceed 0.88% of the average net assets for each of the Equity Market
Plus Fund and the Intermediate Fund, 0.78% of the average net assets of the
Short Fund and 1.50% of the Financial Services Fund.
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The Adviser places all orders for purchases and sales of the Funds'
securities. Subject to seeking the most favorable price and execution
available, the Adviser may consider sales of shares of the Funds as a factor in
the selection of broker-dealers.
Distribution
FPS Broker Services, Inc. (the "Principal Underwriter") acts as distributor for
the Funds for which the Adviser pays the Principal Underwriter an annual fee of
$30,000. Shares may also be sold by authorized dealers who have entered into
dealer agreements with the Principal Underwriter or the Adviser.
Expenses
The Funds pay all of their own expenses, including, without limitation, the
cost of preparing and printing their registration statements required under the
Securities Act of 1933 and the 1940 Act and any amendments thereto, the expense
of registering their shares with the Securities and Exchange Commission and the
various states, the printing and distribution costs of prospectuses mailed to
existing investors, reports to investors, reports to government authorities and
proxy statements, fees paid to directors who are not interested persons of the
Adviser, interest charges, taxes, legal expenses, association membership dues,
auditing services, insurance premiums, brokerage commissions and expenses in
connection with portfolio transactions, fees and expenses of the custodian of
their assets, printing and mailing expenses and charges and expenses of
dividend disbursing agents, accounting services agents, registrars and stock
transfer agents.
PRICING OF FUND SHARES
The price you pay when buying a Fund's shares, and the price you receive when
selling (redeeming) a Fund's shares, is the net asset value of the shares next
determined after receipt of a purchase or redemption request in proper form. No
front-end sales charge or commission of any kind is added by the Fund upon a
purchase, and no charge is deducted upon redemption. These charges may apply if
you purchase or sell shares through certain broker-dealers. The Funds currently
charge a $9 fee for each redemption made by wire. See "How to Redeem Shares."
The per share net asset value of a Fund is determined by dividing the total
value of its assets, less its liabilities, by the total number of its shares
outstanding at that time. The net asset value is determined as of the close of
regular trading (usually at 4:00 p.m. Eastern time) each day that the Adviser
and Transfer Agent are open for business and on which there is a sufficient
degree of trading in a Fund's securities such that the net asset value of a
Fund's shares might be affected. Accordingly, Purchase Applications accepted or
redemption requests received in proper form by the Transfer Agent, or other
agent designated by the Funds, prior to the close of regular trading each day
that the Adviser and Transfer Agent are open for business, will be confirmed at
that day's net asset value. Purchase Applications accepted or redemption
requests received in proper form after the close of regular trading by the
Transfer Agent, or other agent designated by the Funds, will be confirmed at
the net asset value of the following business day.
Current holiday schedules indicate that the Funds' net asset values will not be
calculated on New Year's Day, Martin Luther King Day, President's Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, the day
following Thanksgiving, Christmas Eve and Christmas Day. The Short and
Intermediate Funds will also not be priced on Columbus Day and Veterans' Day.
Under procedures approved by the Board of Trustees, a Fund's securities for
which market quotations are readily available are valued at current market
value provided by a pricing service, bank or broker-dealer experienced in such
matters. Short-term investments that will mature in 60 days or less are
generally valued at amortized cost, which approximates market value. All other
securities and assets are valued at fair market value as determined by
following procedures approved by the Board of Trustees.
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HOW TO PURCHASE SHARES
All of the Funds are no-load, so you may purchase, redeem or exchange shares
directly at net asset value without paying a sales charge. Because the Funds'
net asset value changes daily, your purchase price will be the next net asset
value determined after the Funds' Transfer Agent, or other agent designated by
the Funds, receives and accepts your purchase order. See "Pricing of Fund
Shares."
<TABLE>
<CAPTION>
Initial Minimum Additional Minimum
Type of Account Investment Investment
<S> <C> <C>
Regular $1000 $50
Automatic Investment Plan None $50
Individual Retirement Account $250 $50
Gift to Minors $250 $50
</TABLE>
Each Fund reserves the right to reject any orders for the purchase of its
shares or to limit or suspend, without prior notice, the offering of its
shares. The required minimum investments may be waived in the case of qualified
retirement plans.
How to Open Your Account by Mail. Please complete the Purchase Application. You
can obtain additional copies of the Purchase Application and a copy of the IRA
Purchase Application from the Funds by calling 1-800-221-3138.
Your completed Purchase Application should be mailed directly to:
Smith Breeden Mutual Funds
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA 19406-0903
All applications must be accompanied by payment in the form of a check or money
order made payable to "Smith Breeden Mutual Funds." All purchases must be made
in U.S. dollars, and checks must be drawn on U.S. banks. No cash, credit cards
or third party checks will be accepted. When a purchase is made by check and a
redemption is made shortly thereafter, the Funds will delay the mailing of a
redemption check until the purchase check has cleared your bank, which may take
up to 15 calendar days from the purchase date. If you contemplate needing
access to your investment shortly after purchase, you should purchase the
shares by wire as discussed below.
How to Open Your Account by Wire. You may make purchases by direct wire
transfers. To ensure proper credit to your account, please call the Funds at
1-800-221-3137 for instructions prior to wiring funds. Funds should be wired
through the Federal Reserve System as follows:
United Missouri Bank
A.B.A. Number 10-10-00695
For the account of FPS Services, Inc.
Account Number 98-7037-071-9
For credit to (identify which Fund to purchase)
For further credit to: (investor account number)
(name or account registration)
(Social Security or Tax Identification Number)
Following such wire transfer, you must promptly complete a Purchase Application
and mail it to the Funds at the following address: Smith Breeden Mutual Funds,
3200 Horizon Drive, P.O. Box 61503, King of Prussia, PA 19406-0903. Shares will
be redeemed with Federal tax withheld if the Funds do not receive a properly
completed and executed Purchase Application.
Telephone Transactions. The privilege to initiate redemption or exchange
transactions by telephone is made automatically available to shareholders when
opening an account, unless they indicate otherwise by
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checking the appropriate boxes on the Purchase Application. Each Fund will
employ reasonable procedures to ensure that instructions communicated by
telephone are genuine. If reasonable procedures are not implemented, the Funds
may be liable for any loss due to unauthorized or fraudulent transactions. In
all other cases, you are liable for any loss due to unauthorized
transactions. The Funds reserve the right to refuse a telephone transaction if
they believe it is advisable to do so.
If you have any questions, please call the Funds at 1-800-221-3138.
How to Add to Your Account. You may make additional investments by mail or by
wire in an amount equal to or greater than $50. When adding to an account by
mail, you should send the Funds your check, together with the additional
investment form from a recent statement. If this form is unavailable, you
should send a signed note giving the full name of the account and the account
number. For additional investments made by wire transfer, you should use the
wiring instructions listed above. Be sure to include your account number.
Automatic Investment Plan. You may make purchases of shares of each Fund
automatically on a regular basis ($50 minimum per transaction). You have two
options under the Plan to make investments. One is by automatic payroll
deduction. Under this method, you authorize your employer to direct a portion
of each paycheck to be invested in the Fund of your choice. Your employer must
be using direct deposit to process its payroll in order for you to elect this
method. Under the other method, your bank debits a pre-authorized amount from
your checking or savings account each month and applies the amount to your
investment in Fund shares. In order to have your bank account debited
automatically for investment into the Funds, your financial institution must be
a member of the Automated Clearing House. No service fee is currently charged
by the Funds for participation in either method under the Plan. A $20 fee will
be imposed by the Funds if sufficient funds are not available in your bank
account, or if your bank account has been closed at the time of the automatic
transaction. You may adopt either method under the Plan at the time an account
is opened by completing the appropriate section of the Purchase
Application. Enclosed with the application are the necessary forms to deliver
to your employer to set up the payroll deduction. You may obtain an application
to establish the Automatic Investment Plan after an account is opened by
calling the Funds at 1-800-221-3138. In the event you discontinue participation
in the Plan, the Funds reserve the right to redeem your Fund account
involuntarily, upon sixty days' written notice, if the account's net asset
value is $1000 or less.
Purchasing Shares Through Other Institutions. The Funds have authorized dealers
besides the Principal Underwriter to accept on its behalf purchase and
redemption orders. If you purchase shares through a program of services offered
or administered by one of these broker-dealers, financial institutions, or
other service provider, you should read the program materials, including
information relating to fees, in addition to this Prospectus. Certain services
of a Fund may not be available or may be modified in connection with the
program of services provided, and service providers may establish higher
minimum investment amounts. The Funds may only accept requests to purchase
additional shares into a broker-dealer street name account from the broker-
dealer.
Certain broker-dealers, financial institutions, or other service providers that
have entered into an agreement with the Adviser or Principal Underwriter may
enter purchase and redemption orders on behalf of their customers by phone,
with payment to follow within several days as specified in the agreement. These
broker-dealers and service providers may designate other intermediaries to
accept purchase and redemption orders on the Funds' behalf. The Funds will be
deemed to have effected such purchase or redemption orders at the net asset
value next determined after acceptance of the telephone purchase order by the
authorized broker or the authorized broker's designee. It is the responsibility
of the broker-dealer, financial institution, or other service provider to place
the order with the Funds on a timely basis. If payment is not received within
the time specified in the agreement, the broker-dealer, financial institution,
or other service provider could be held liable for any resulting fees or
losses.
Miscellaneous. The Funds will charge a $20 service fee against your account for
any check or electronic funds transfer that is returned unpaid. You will also
be responsible for any losses suffered by the Funds as a result. In order to
relieve you of responsibility for the safekeeping and delivery of stock
certificates, the Funds do not currently issue certificates.
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HOW TO EXCHANGE SHARES
Shares of any Fund may be exchanged for shares of another Fund at any
time. This exchange offer is available only in states where shares of such
other Fund may be legally sold. You may open a new account, or purchase
additional shares in an existing account, by making an exchange from an
identically registered Smith Breeden Fund account. A new account will have the
same registration as the existing account from which the exchange was made, and
is subject to the same initial investment minimums.
Exchanges may be made either in writing or by telephone. Written instructions
should be mailed to 3200 Horizon Drive, King of Prussia, PA 19406 and must be
signed by all account owners, and accompanied by any properly endorsed
outstanding share certificates, if applicable. The telephone exchange is
automatically accepted unless checked otherwise. The telephone exchange
privilege is available only for uncertificated shares. During periods of
drastic economic or market changes, it is possible that exchanges by telephone
may be difficult to implement. In this event, shareholders should follow the
written exchange procedures. The telephone exchange privilege may be modified
or discontinued by the Funds at any time upon a 60-day notice to the
shareholders. To exchange by telephone, you must follow the instructions below
under "How to Redeem by Telephone."
The Funds will accept exchange orders by telephone or other means of electronic
transmission from broker- dealers, financial institutions or other service
providers who execute an agreement with the Adviser or Principal
Underwriter. It is the responsibility of the broker-dealer, financial
institution or other service provider to place the exchange order on a timely
basis.
Exchanges are made on the basis of the Funds' relative net asset
values. Because the exchange is considered a redemption and purchase of shares,
the shareholder may recognize a gain or loss for federal income tax
purposes. Backup withholding and information reporting may also
apply. Additional information regarding the possible tax consequences of such
an exchange is included under the caption "Taxes" in the Funds' Statements of
Additional Information.
There are differences among the Funds. When exchanging shares, shareholders
should be aware that the Funds might have different dividend payment dates. The
dividend payment schedules should be checked before exchanging shares. The
amount of any accumulated, but unpaid, dividend is included in the net asset
value per share.
If you buy shares by check, you may not exchange those shares for up to 15
calendar days to ensure your check has cleared. If you intend to exchange
shares soon after their purchase, you should purchase the shares by wire or
contact the Funds at 1-800-221-3137 for further information.
The Funds reserve the right to temporarily or permanently terminate, with or
without advance notice, the exchange privilege of any investor who makes
excessive use of the exchange privilege (e.g., more than four exchanges per
calendar year).
Additional documentation may be required for exchange requests if shares are
registered in the name of a corporation, partnership or fiduciary. Please
contact the Funds for additional information concerning the exchange privilege.
HOW TO REDEEM SHARES
You may redeem shares of the Funds at any time. The price at which the shares
will be redeemed is the net asset value per share next determined after proper
redemption instructions are received by the Transfer Agent or other agent
designated by the Funds. See "Pricing of Fund Shares." There are no charges for
the redemption of shares, except that a fee of $9 is charged for each wire
redemption. Depending upon the redemption price you receive, you may realize a
capital gain or loss for federal income tax purposes.
How to Redeem by Mail to Receive Proceeds by Check. To redeem shares by mail,
simply send an unconditional written request to the Funds specifying the number
of shares or dollar amount to be redeemed, the name of the Fund, the name(s) on
the account registration and the account number. A request
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for redemption must be signed exactly as the shares are registered. If the
amount requested is greater than $25,000, or the proceeds are to be sent to a
person other than the recordholder or to a location other than the address of
record, each signature must be guaranteed by a commercial bank or trust company
in the United States, a member firm of the National Association of Securities
Dealers, Inc. or other eligible guarantor institution. A notary public is not
an acceptable guarantor. Guarantees must be signed by an authorized signatory
of the bank, trust company, or member firm, and "Signature Guaranteed" must
appear with the signature. Additional documentation may be required for the
redemption of shares held in corporate, partnership or fiduciary accounts. In
case of any questions, please contact the Funds in advance.
A Fund will mail payment for redemption within seven days after receiving
proper instructions for redemption. However, the Funds will delay payment for
15 calendar days on redemptions of recent purchases made by check. This allows
the Funds to verify that the check used to purchase Fund shares will not be
returned due to insufficient funds and is intended to protect the remaining
investors from loss.
How to Redeem by Telephone. The redemption of shares by telephone is available
automatically unless you elected to refuse this redemption privilege on your
Purchase Application. Shares may be redeemed by calling the Funds at
1-800-221-3137. Proceeds redeemed by telephone will be mailed to your address,
or wired or credited to your pre-authorized bank account. To establish wire
redemption privileges, you must select the appropriate box on the Purchase
Application and enclose a voided check.
In order to arrange for telephone redemptions after your account has been
opened, or to change the bank account or address designated to receive
redemption proceeds, you must send a written request to your Fund. The request
must be signed by each registered holder of the account with the signatures
guaranteed by a commercial bank or trust company in the United States, a member
firm of the National Association of Securities Dealers, Inc. or other eligible
guarantor institution. A notary public is not an acceptable guarantor. Further
documentation as provided above may be requested from corporations, executors,
administrators, trustees and guardians.
Payment of the redemption proceeds for Fund shares redeemed by telephone where
you request wire payment will normally be made in federal funds on the next
business day. The Funds reserve the right to delay payment for a period of up
to seven days after receipt of the redemption request. There is currently a $9
fee for each wire redemption, which will be deducted from your account.
The Funds reserve the right to refuse a telephone redemption or exchange
transaction if they believe it is advisable to do so. Procedures for redeeming
or exchanging shares of the Funds by telephone may be modified or terminated by
the Funds at any time. In an effort to prevent unauthorized or fraudulent
redemption or exchange requests by telephone, the Funds have implemented
procedures designed to reasonably assure that telephone instructions are
genuine. These procedures include: requesting verification of certain personal
information; recording telephone transactions; confirming transactions in
writing; and restricting transmittal of redemption proceeds only to
pre-authorized designations. Other procedures may be implemented from time to
time. If reasonable procedures are not implemented, the Funds may be liable for
any loss due to unauthorized or fraudulent transactions. In all other cases,
you are liable for any loss for unauthorized transactions.
You should be aware that during periods of substantial economic or market
change, telephone or wire redemptions may be difficult to implement. If you are
unable to contact the Funds by telephone, you may also redeem shares by
delivering or mailing the redemption request to: Smith Breeden Mutual Funds,
3200 Horizon Drive, P.O. Box 61503, King of Prussia, PA 19406-0903.
The Funds reserve the right to suspend or postpone redemptions during any
period when trading on the New York Stock Exchange ("Exchange") is restricted
as determined by the Securities and Exchange Commission ("SEC"), or the
Exchange is closed for other than customary weekend and holiday closing; the
SEC has by order permitted such suspension; or an emergency, as determined by
the SEC, exists, making disposal of portfolio securities or valuation of net
assets of a Fund not reasonably practicable.
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Due to the relatively high cost of maintaining small accounts, if your account
balance falls below $1000 as a result of a redemption or exchange, or if you
discontinue the Automatic Investment Plan before your account balance reaches
$1000, you may be given a 60-day notice to bring your balance to $1000 or
reactivate an Automatic Investment Plan. If this requirement is not met, your
account may be closed and the proceeds sent to you.
Check Writing. In addition to telephone and written redemption requests, the
Short Fund offers redemption through check writing. Shareholders electing this
option will receive checks that may be used like personal or business
checks. Checks are not ordered to be mailed to the shareholder until 15 days
after the account is opened, if the account is opened by check by the
shareholder. This allows the Fund to verify that the check used to open the
account will not be returned due to insufficient funds. There is no limit on
the number of checks you may write. Checks must be written for at least
$100. There is a $30 fee for returned checks. Because dividends declared on
shares held in a shareholder's account, prior redemptions, and possible changes
in net asset value may cause the value of the account to change, shareholders
should not write a check for the entire value of the account or close the
account by writing a check.
In using the check writing privilege, shareholders bear the responsibility of
ensuring that the check amount does not exceed the value of their account on
the day the check is presented to the Transfer Agent for payment. The day the
check is presented for payment is the day the redemption of Fund shares takes
place. If insufficient shares are in the account, the check will be returned
and no shares will be redeemed. The clearing agent for the check writing
facility is United Missouri Bank. Shareholders utilizing check writing are
subject to United Missouri Bank's rules governing checking accounts. However,
this check writing facility is purely a means to redeem Fund shares. No
facilities characteristic of bank accounts, such as deposit insurance, are
provided along with the check writing option.
If you would like to initiate check writing, please call Shareholder Services
at 1-800-221-3137 or check the appropriate box on the Purchase Application.
Systematic Withdrawal Plan. A shareholder may establish a Systematic Withdrawal
Plan to receive regular periodic payments from the account. An initial balance
of $10,000 is required to establish a Systematic Withdrawal Plan. There are no
service charges for establishing or maintaining a Systematic Withdrawal
Plan. The minimum amount which the shareholder may withdraw periodically is
$100. Capital gain distributions and income dividends to the shareholder's
account are received in additional shares at net asset value. Payments are
then made from the liquidation of shares at net asset value to meet the
specified withdrawals. Liquidation of shares may reduce or possibly exhaust
the shares in the shareholder's account, to the extent withdrawals exceed
shares earned through dividends and distributions, particularly in the event of
a market decline. No payment pursuant to a Systematic Withdrawal Plan will be
made if there are insufficient shares on deposit on the date of the scheduled
distribution. A subsequent deposit of shares will not result in a payment under
the plan retroactive to the distribution date. As with other redemptions, a
liquidation to make a withdrawal payment is a sale for federal income tax
purposes. The entire Systematic Withdrawal Plan payment cannot be considered as
actual yield or income since part of the Plan's payment may be a return of
capital.
A Systematic Withdrawal Plan may be terminated upon written notice by the
shareholder, or by a Fund on a 30 day written notice, and it will terminate
automatically if all shares are liquidated or withdrawn from the account or
upon the Fund's receipt of notification of the death or incapacity of the
shareholder. Shareholders may change the amount (but not below the specified
minimums) and schedule of withdrawal payments, or suspend such payments, by
giving written notice to the Transfer Agent at least five business days prior
to the next scheduled payment. Share certificates may not be issued while a
Systematic Withdrawal Plan is in effect.
DIVIDENDS AND DISTRIBUTIONS
The Short and Intermediate Funds intend to make monthly distributions to their
shareholders of net investment income. The Equity Market Plus Fund intends to
make quarterly distributions of net investment income. All Funds will
distribute net realized gains at least annually. The Financial Services Fund
will most
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likely make only this annual distribution of net realized gains, and at this
time, will also distribute any net investment income. Each Fund may make
additional distributions if necessary to avoid imposition of a 4% excise tax or
other tax on undistributed income and gains.
The monthly distributions for the Short Fund's shares are quoted ex-dividend on
the business day after record date (the "ex-date"). Record date is usually the
first or second business day of the month. If a shareholder elects to reinvest
dividends, the date the dividends are reinvested is also the ex-date. Dividends
are paid in cash by the Short Fund generally one week after the ex-date.
The Intermediate Fund will declare daily dividends for shareholders of
record. The Intermediate Fund's dividend payable date, and the day that
dividends are reinvested for shareholders who have made this election, is the
last business day of the month. Shares begin accruing dividends on the business
day after federal funds (funds credited to a member bank's account at the
Federal Reserve Bank) are available from the purchase payment for such shares,
and continue to accrue dividends through and including the day the redemption
order for the shares is executed. If an investor closes his account, any
accrued dividends through and including the day of redemption will be paid as
part of the redemption proceeds.
Dividends and capital gains distributions may be declared more or less
frequently at the direction of the Trustees. In order to be entitled to a
dividend or a distribution, an investor must acquire a Fund's shares on or
before the record date. Caution should be exercised, however, before purchasing
shares immediately prior to a distribution record date. Since the value of a
Fund's shares is based directly on the amount of its net assets, rather than on
the principle of supply and demand, any distribution of income or capital gain
will result in a decrease in the value of its shares equal to the amount of the
distribution. While a dividend or capital gain distribution received shortly
after purchasing shares represents, in effect, a return of the shareholder's
investment, it may be taxable as dividend income or capital gain. You may
separately elect to reinvest income dividends and capital gains distributions
in shares of a Fund or receive cash as designated on the Purchase
Application. You may change your election at any time by sending written
notification to your Fund. The election is effective for distributions with a
dividend record date on or after the date that the Funds receive notice of the
election. If you do not specify an election, all income dividends and capital
gains distributions will automatically be reinvested in full and fractional
shares of the Fund from which they were paid. Shareholders may also elect to
have dividends automatically reinvested in a fund different than the one from
which the dividends were paid. A shareholder may write the transfer agent, or
complete the appropriate section of the Purchase Application, to designate such
an election, but must have already established an account in the other
fund. The transfer agent's address is on the back of the Prospectus. Reinvested
dividends and distributions receive the same tax treatment as those paid in
cash.
SHAREHOLDER REPORTS AND INFORMATION
The Funds will provide the following statements and reports:
Confirmation and Account Statements. After each transaction that affects the
account balance or account registration, including the payment of dividends,
you will receive a confirmation statement.
Form 1099. By January 31 of each year, all shareholders will receive Form 1099,
which will report the amount and tax status of distributions paid to you by the
Funds for the preceding calendar year.
Financial Reports. Financial reports are provided to shareholders
semiannually. Annual reports will include audited financial statements. To
reduce the Funds' expenses, one copy of each report will be mailed to each
Taxpayer Identification Number even though the investor may have more than one
account in a Fund.
Reports to Depository Institutions. Shareholders of the Short or Intermediate
Funds who are financial institutions may request receipt of monthly or
quarterly reports which provide information about the Short or Intermediate
Fund's investments considering regulatory risk-based asset categories.
If you need additional copies of previous statements, you may order statements
for the current and preceding year at no charge. Call 1-800-221-3137 to order
past statements. If you need information on your account
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with the Funds or if you wish to submit any applications, redemption requests,
inquiries or notifications, please contact: Smith Breeden Mutual Funds, 3200
Horizon Drive, P.O. Box 61503, King of Prussia, PA 19406-0903 or call
1-800-221-3137.
RETIREMENT PLANS
The Funds have a program under which you may establish an Individual Retirement
Account ("IRA") with the Funds and purchase shares through such
account. Shareholders wishing to establish an IRA should consult their tax
adviser regarding (1) their individual qualifying status and (2) the tax
regulations governing these accounts. The minimum initial investment in each
Fund for an IRA is $250. There is a $12 annual maintenance fee charged to
process an account. This fee is waived for accounts greater than $10,000. You
may obtain additional information regarding establishing such an account by
calling the Funds at 1-800-221-3138.
The Funds may be used as investment vehicles for established defined
contribution plans, including simplified employee, 401(k), 403(b),
profit-sharing, money purchase, and simple pension plans ("Retirement
Plans"). For details concerning Retirement Plans, please call 1-800-221-3138.
SERVICE AND DISTRIBUTION PLANS
Each Fund has adopted a Distribution and Services Plan (the "Plans") pursuant
to Rule 12b-1 under the 1940 Act. The purpose of the Plans is to permit the
Adviser to compensate investment dealers and other persons involved in
servicing shareholder accounts for services provided and expenses incurred in
promoting the sale of shares of the Funds, reducing redemptions, or otherwise
maintaining or improving services provided to shareholders by such dealers or
other persons. The Plans provide for payments by the Adviser out of its
advisory fee to dealers and other persons at an annual rate of up to 0.25% of a
Fund's average net assets, subject to the authority of the Trustees to reduce
the amount of payments permitted under the Plan or to suspend the Plan for such
periods as they may determine. Subject to these limitations, the Adviser shall
determine the amount of such payments and the purposes for which they are made.
Any distribution and service related payments made by the Adviser to investment
dealers or other persons are subject to the continuation of the Plans, the
terms of any related service agreements, and any applicable limits imposed by
the National Association of Securities Dealers, Inc.
TAXES
Each Fund intends to qualify as a regulated investment company under the
Internal Revenue Code. In each taxable year that a Fund so qualifies, such Fund
(but not its shareholders) will be relieved of federal income tax on the part
of its net investment income and net capital gain that is distributed to
shareholders. Each Fund will distribute at least annually substantially all of
the sum of its taxable net investment income, its net tax-exempt income and the
excess, if any, of net short-term capital gains over the net long-term capital
losses for such year.
All Fund distributions from net investment income (whether paid in cash or
reinvested in additional shares) will be taxable to its shareholders as
ordinary income, except that any distributions of a Fund's net long-term
capital gain will be taxable to its shareholders as long-term capital gain,
regardless of how long they have held their Fund shares. Pursuant to the
Taxpayer Relief Act of 1997, long-term capital gains are taxed at a maximum of
28% or 20%, depending on the Fund's holding period in the portfolio
investments. Each Fund provides federal tax information to its shareholders
annually about distributions paid during the preceding year.
It is not anticipated that any of the Funds' distributions will qualify for
either the corporate dividends-received deduction or tax-exempt interest
income. Distributions will also probably be subject to state and local taxes,
depending on each shareholder's tax situation. While many states grant tax-free
status to mutual fund distributions paid from interest income earned from
direct obligations of the U.S. Government, none of the Short or Intermediate
Fund's distributions are expected to qualify for such tax-free treatment, and
only an insignificant amount of the Equity Market Plus Fund's distributions are
expected to so qualify.
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The Funds will be required to withhold federal income tax at a rate of 31%
("backup withholding") from distribution payments and redemption and exchange
proceeds if you fail to properly complete the Purchase Application.
The foregoing is only a summary of some of the important federal tax
considerations generally affecting each Fund and its shareholders. See "Taxes"
in the relevant Statement of Additional Information for further
discussion. There may be other federal, state or local tax considerations
applicable to you as an investor. You therefore are urged to consult your tax
adviser regarding any tax-related issues.
CAPITAL STRUCTURE
The Smith Breeden Trust and the Smith Breeden Series Fund are both
Massachusetts business trusts. The Trust was organized under an Agreement and
Declaration of Trust, dated December 18, 1991. The Series Fund was organized
under an Agreement and Declaration of Trust dated October 3, 1991. Copies of
both Agreements, which are governed by Massachusetts law, are on file with the
Secretary of State of the Commonwealth of Massachusetts. The Trust and the
Series Fund have the same Trustees.
The Trustees have the authority to issue shares in an unlimited number of funds
of either the Series Fund or Trust. Each such fund's shares may be further
divided into classes. The assets and liabilities of each such fund will be
separate and distinct. All shares when issued are fully paid, non-assessable
and redeemable, and have equal voting, dividend and liquidation rights.
Shareholders of the separate funds of the Series Fund or Trust will vote
together in electing trustees and in certain other matters. Shareholders in
each fund of the Series Fund should be aware that the outcome of the election
of trustees and of certain other matters could be controlled by the
shareholders of another fund. The shares have non-cumulative voting rights,
which means that holders of more than 50% of the shares voting for the election
of the trustees can elect 100% of the trustees if they choose to do so.
Although neither the Series Fund nor the Trust is required to hold annual
meetings of its shareholders, shareholders have the right to call a meeting to
elect or remove trustees, or to take other actions as provided in the
respective Declaration of Trust. Upon written request by the holders of at
least 1% of the outstanding shares stating that such shareholders wish to
communicate with the other shareholders for the purpose of obtaining the
signatures necessary to demand a meeting to consider the removal of a trustee,
both the Series Fund and Trust have undertaken to provide a list of
shareholders or to disseminate appropriate materials (at the expense of the
requesting shareholders).
Under Massachusetts law, shareholders of a business trust may, under certain
circumstances, be held personally liable as partners for its
obligations. However, the risk of a shareholder incurring financial loss on
account of shareholder liability is limited to circumstances in which both (i)
any liability was greater than a Fund's insurance coverage and (ii) a Fund
itself was unable to meet its obligations.
TRANSFER AND DIVIDEND DISBURSING AGENT, CUSTODIAN AND
INDEPENDENT ACCOUNTANTS
FPS Services, Inc. ("FPS Services" or the "Transfer Agent"), 3200 Horizon
Drive, King of Prussia, PA 19406, acts as each Fund's Transfer and Dividend
Disbursing Agent. See "Management of the Funds." The Bank of New York acts as
the custodian of each Fund's assets. The Bank of New York's address is 48 Wall
Street, New York, New York 10286. Neither the Transfer and Dividend Disbursing
Agent nor the Custodian has any part in deciding the Funds' investment policies
or which securities are to be purchased or sold for the Funds'
portfolios. Deloitte & Touche, LLP, has been selected to serve as independent
auditors of the Company for the fiscal year ending March 31, 1998.
FUND PERFORMANCE
Each Fund may quote the Fund's average annual total and/or aggregate total
return for various time periods in advertisements or communications to
shareholders. An average annual total return refers to the rate of
30
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[SMITH BREEDEN LOGO]
return which, if applied to an initial investment at the beginning of a stated
period and compounded over that period, would result in the redeemable value of
the investment at the end of the period assuming reinvestment of all dividends
and distributions and reflecting the effect of all recurring fees. An
investor's principal in each Fund and the Fund's return are not guaranteed and
will fluctuate according to market conditions. When considering "average" total
return figures for periods longer than one year, you should note that a Fund's
annual total return for any one year in the period might have been greater or
less than the average for the entire period. Each Fund also may use "aggregate"
total return figures for various periods, representing the cumulative change in
value of an investment in the Fund for a specific period (again reflecting
changes in the Fund's share price and assuming reinvestment of dividends and
distributions).
The Short and Intermediate Funds may also advertise current yield and
distribution rate information. Current yield reflects the income per share
earned by the Short or Intermediate Fund's portfolio investments, and is
calculated by dividing a Fund's net investment income per share during a recent
30-day period by a Fund's net asset value on the last day of that period and
annualizing the result. The current yield (or "SEC Yield"), which is calculated
according to a formula prescribed by the SEC (see the relevant Statement of
Additional Information), is not indicative of the dividends or distributions
which were or will be paid to a Fund's shareholders. SEC regulations require
that net investment income be calculated on a "yield-to-maturity" basis, which
has the effect of amortizing any premiums or discounts in the current market
value of fixed income securities. Dividends or distributions paid to
shareholders are reflected in the current distribution rate which may be quoted
to shareholders, and may not reflect amortization in the same manner.
A Fund may also compare its performance to that of other mutual funds and to
stock and other relevant indices, or to rankings prepared by independent
services or industry publications. For example, a Fund's total return may be
compared to data prepared by Lipper Analytical Services, Inc., Morningstar,
Inc., Value Line Mutual Fund Survey and CDA Investment Technologies, Inc. Total
return data as reported in such national financial publications as The Wall
Street Journal, The New York Times, Investor's Business Daily, USA Today,
Barron's, Money and Forbes, as well as in publications of a local or regional
nature, may be used in comparing Fund performance.
The Equity Market Plus Fund's total return may also be compared to the return
of the Standard & Poor's 500 Composite Stock Price Index. For purposes of
showing the returns of large company stocks versus small company stocks, or to
compare returns versus inflation, the Equity Market Plus Fund's total return
may also be compared to the total return of the Nasdaq Composite OTC Index,
Nasdaq Industrials Index, Russell 2000 Index, or the Consumer Price Index. The
Short Fund's total return may also be compared to that of taxable money funds
as quoted in Donaghue's Money Fund Report and other suppliers, and to total
returns for the six month U.S. Treasury as published by Merrill Lynch or
others. The Intermediate Fund's return will most likely be compared to the
total return of the Salomon Brothers Mortgage Index, or the total return of
intermediate U.S. Treasury Notes as published by various brokerage firms and
others. The Financial Services Fund's return may be compared to the S&P 500
Index return, an investment of 80% in the S&P Financial Composite Index and 20%
in money market funds, the Keefe, Bruyette & Woods Index, or the average of the
mutual funds in the Morningstar Specialty Financial Category. Further
information on performance measurement may be found in the relevant Statement
of Additional Information.
Performance quotations of a Fund represent the Fund's past performance and
should not be considered representative of future results. The investment
return and principal value of an investment in a Fund will fluctuate so that an
investor's shares, when redeemed, may be worth more or less than their original
cost. The methods used to compute a Fund's total return and yield are described
in more detail in the relevant Statement of Additional Information.
31
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Shareholder Services
Account Inquiries, Balance
and Transaction Information
1-800-221-3137
Dealer Services
Current Prospectuses, Sales Literature
Yields, Prices, Fund Information
1-800-221-3138
Distributed by:
FPS Broker Services, Inc.
3200 Horizon Drive
P.0. Box 61503
King of Prussia, PA 19406-0903
[SMITH BREEDEN LOGO]
100 Europa Drive, Suite 200
Chapel Hill, NC 27514-2310
(919) 967-7221
<PAGE>
SMITH BREEDEN TRUST
SMITH BREEDEN EQUITY MARKET PLUS FUND
SMITH BREEDEN FINANCIAL SERVICES FUND
STATEMENT OF ADDITIONAL INFORMATION
DECEMBER 22, 1997
100 Europa Drive, Suite 200
Chapel Hill, North Carolina 27514-2310
(919) 967-7221
This Statement of Additional Information contains information
pertaining to Smith Breeden Equity Market Plus Fund and the Smith
Breeden Financial Services Fund, which may be useful to investors
and is not included in the Prospectus of the Smith Breeden Mutual
Funds. This Statement is not a Prospectus and is only authorized
for distribution when accompanied or preceded by the Prospectus
of the Smith Breeden Mutual Funds dated December 22, 1997, as may
be amended from time to time. The Statement should be read
together with the Prospectus.
Contents Page
DEFINITIONS 2
INVESTMENT RESTRICTIONS OF THE FUNDS 2
MISCELLANEOUS INVESTMENT PRACTICES AND RISK CONSIDERATIONS 3
HEDGING AND OTHER STRATEGIES USING DERIVATIVE CONTRACTS 10
TAXES 17
FUND CHARGES AND EXPENSES 19
MANAGEMENT OF THE FUNDS 19
THE INVESTMENT ADVISORY AGREEMENT AND OTHER SERVICES 20
PRINCIPAL HOLDERS OF SECURITIES AND CONTROLLING PERSONS 24
DETERMINATION OF NET ASSET VALUE 24
ADDITIONAL INFORMATION REGARDING PURCHASES
AND REDEMPTIONS OF FUND SHARES 25
SHAREHOLDER INFORMATION 26
SUSPENSION OF REDEMPTIONS 26
SHAREHOLDER LIABILITY 26
STANDARD PERFORMANCE MEASURES 27
INDEPENDENT AUDITORS 29
EXPERTS 30
REPORT OF INDEPENDENT AUDITORS AND FINANCIAL STATEMENTS 30
<PAGE>
1
SMITH BREEDEN TRUST
SMITH BREEDEN EQUITY MARKET PLUS FUND
SMITH BREEDEN FINANCIAL SERVICES FUND
Statement of Additional Information
DEFINITIONS
The "Trust" -- Smith Breeden Trust
The "Funds" -- Smith Breeden Equity Market Plus Fund and the
Smith Breeden Financial Services Fund
The "Adviser" -- Smith Breeden Associates, Inc., the
Fund's investment adviser.
The "Custodian" -- The Bank of New York, the Funds'
custodian.
"FPS Services" -- FPS Services, Inc., the Fund's investor
servicing agent.
INVESTMENT RESTRICTIONS OF THE FUNDS
Subject to the Funds' ability to invest all or substantially
all of its assets in another investment company with
substantially the same investment objective, as fundamental
investment restrictions, which may not be changed without a vote
of a majority of the outstanding voting securities, a Fund may
not and will not engage in the following activities. The
Investment Company Act of 1940 (the "Investment Company Act")
provides that a "vote of a majority of the outstanding voting
securities" of a Fund means the affirmative of the lesser of (1)
more than 50% of the outstanding shares of the Fund, or (2) 67%
or more of the shares present at a meeting if more than 50% of
the outstanding shares are represented at the meeting in person
or by proxy.)
1. Issue senior securities, borrow money or pledge its assets,
except that the Fund may borrow from banks or through reverse
repurchase agreements or dollar rolls up to 33 1/3% of the value
of its respective total assets (calculated when the loan is made)
for temporary, extraordinary or emergency purposes and to take
advantage of investment opportunities and may pledge up to 33
1/3% of the value of its total assets to secure such borrowings.
For purposes of this restriction, the purchase or sale of
securities on a "when-issued" or delayed delivery basis, the
purchase and sale of futures contracts, the entry into forward
contracts, reverse repurchase agreements and dollar roll
transactions, short sales, interest rate caps, floors and swaps,
mortgage swaps, and collateral arrangements with respect thereto
and such other practices as may be determined by counsel to the
Fund (consistent with pronouncements of the Securities and
Exchange Commission) are not deemed to be a pledge of assets and
none of such transactions or arrangements nor obligations of the
Fund to Trustees pursuant to deferred compensation arrangements
are deemed to be the issuance of a senior security.
2. Act as underwriter except to the extent that, in connection
with the disposition of portfolio securities, it may be
deemed to be an underwriter under certain federal securities
laws.
<PAGE>
2
3. Acquire, sell, lease or hold real estate or real estate
limited partnerships, except that it may invest in
securities of companies which deal in real estate and in
securities collateralized by real estate or interests
therein and it may acquire, sell, lease or hold real estate
in connection with protecting its rights as a creditor.
4. Purchase or sell commodities or commodity contracts, except
that the Fund may purchase and sell financial futures
contracts and options thereon. (Does not include caps,
floors, collars or swaps.)
5. Invest in interests in oil, gas, mineral leases or other
mineral exploration or development program.
6. Invest in companies for the purpose of exercising control or
management.
7. Purchase securities of other investment companies, except to
the extent permitted by the Investment Company Act.
8. Make loans of money or property to any person, except
through loans of portfolio securities to qualified
institutions, the purchase of debt obligations in which the
Fund may invest consistently with its investment objectives
and policies and investment limitations or the investment in
repurchase agreements with qualified institutions. The Fund
will not lend portfolio securities if, as a result, the
aggregate of such loans exceeds 33 1/3% of the value of the
Fund's total assets (including such loans).
9. Purchase securities on margin (but the Fund may obtain such
short-term credits as may be necessary for the clearance of
transactions); provided that the deposit or payment by the
Fund of initial or variation margin in connection with
options or futures contracts is not considered the purchase
of a security on margin.
10. Make short sales of securities or maintain a short
position if, when added together, more than 25% of the value
of the Fund's net assets would be (i) deposited as
collateral for the obligation to replace securities borrowed
to effect short sales, and (ii) allocated to segregated
accounts in connection with short sales. Short sales
"against the box" are not subject to this limitation.
In addition to the items listed above, the Equity Market Plus
Fund will not, as a matter of fundamental policy:
1. Purchase any security (other than obligations of the U.S.
Government, its agencies and instrumentalities) if as a
result 25% or more of the Fund's total assets (determined at
the time of investment) would be invested in one or more
issuers having their principal business activities in the
same industry.
2. Purchase any security, other than mortgage-backed
securities, obligations of the U.S. Government, its agencies
or instrumentalities or collateralized mortgage obligations,
<PAGE>
3
if as a result the Fund would have invested more than 5% of
its respective total assets in securities of issuers
(including predecessors) having a record of less than three
years of continuous operation.
It is contrary to the Funds' present policy, which may be changed
without shareholder approval, to:
(a) sell over-the-counter options which it does not own; or
(b) sell options on futures contracts which options it does not
own.
All percentage limitations on investments will apply at the time
of the making of an investment and shall not be considered
violated unless an excess or deficiency exist immediately after
and as a result of such investment.
MISCELLANEOUS INVESTMENT PRACTICES AND RISK CONSIDERATIONS
Unless so indicated, each Fund may engage in each of the
following investment practices or make the following investments.
However, the fact that a Fund may engage in a particular practice
does not necessarily mean that it will actually do so.
Repurchase Agreements. A repurchase agreement is a contract
under which the Fund acquires a security for a relatively short
period (usually not more than one week) subject to the obligation
of the seller to repurchase and the Fund to resell such security
at a fixed time and price (representing the Fund's cost plus
interest). It is the Funds' present intention to enter into
repurchase agreements only with commercial banks and registered
broker-dealers. Repurchase agreements may also be viewed as loans
made by a Fund which are collateralized by the securities subject
to repurchase. The Adviser will monitor such transactions to
determine that the value of the underlying securities is at least
equal at all times to the total amount of the repurchase
obligation, including the interest factor. If the seller
defaults, a Fund could realize a loss on the sale of the
underlying security to the extent that the proceeds of sale
including accrued interest are less than the resale price
provided in the agreement including interest. In addition, if
the seller should be involved in bankruptcy or insolvency
proceedings, a Fund may incur delay and costs in selling the
underlying security or may suffer a loss of principal and
interest if a Fund is treated as an unsecured creditor and
required to return the underlying collateral to the seller's
estate.
Forward Commitments. A forward commitment represents a contract
to purchase securities for a fixed price at a future date beyond
customary settlement time (referred to as "forward commitments"
or "when issued" or "delayed delivery" securities) if, when
entering into a forward commitment, a Fund will hold until the
settlement date, in a segregated account, liquid securities in an
amount sufficient to meet the purchase price, or the Fund will
enter into offsetting contracts for the forward sale of other
securities it owns. Forward commitments may be considered
securities in themselves, and involve a risk of loss if the value
<PAGE>
4
of the security to be purchased declines prior to the settlement
date. Where such purchases are made through dealers, a Fund
relies on the dealer to consummate the sale. The dealer's
failure to do so may result in the loss to the Fund of an
advantageous return or price. Although a Fund will generally
enter into forward commitments with the intention of acquiring
securities for its portfolio or for delivery pursuant to options
contracts it has entered into, a Fund may dispose of a commitment
prior to settlement if the Adviser deems it appropriate to do so.
A Fund may realize short-term profits or losses upon the sale of
forward commitments.
Securities Loans. The Fund may make secured loans of securities
amounting to not more than 33 1/3% of the Fund's total assets
thereby realizing additional income. The risks in lending
portfolio securities, as with other extensions of credit, consist
of possible delay in recovery of the securities or possible loss
of rights in the collateral should the borrower fail financially.
As a matter of the Funds' policy, securities loans are made to
broker-dealers pursuant to an agreement requiring that loans be
continuously secured by collateral in cash or short-term debt
obligations at least equal at all times to the value of the
securities on loan. The borrower pays to the Fund an amount
equal to any dividends or interest received on securities lent.
The Fund retains all or a portion of the interest received on
investment of the cash collateral or receives a fee from the
borrower. Although voting rights, or rights to consent, with
respect to the loaned securities pass to the borrower, the Fund
retains the right to call the loans at any time on reasonable
notice, and it will do so in order that the securities may be
voted by the Fund if the holders of such securities are asked to
vote upon or consent to matters materially affecting the
investment. A Fund may also call such loans in order to sell the
securities involved.
Borrowing. The Funds may borrow from banks and enter into
reverse repurchase agreements or dollar rolls up to 33 1/3% of
the value of the Fund's total assets (computed at the time the
loan is made) to take advantage of investment opportunities and
for extraordinary or emergency purposes, or for the clearance of
transactions. The Funds may pledge up to 33 1/3% of its total
assets to secure these borrowings. If a Fund's asset coverage
for borrowings falls below 300%, the Fund will take prompt action
to reduce its borrowings even though it may be disadvantageous at
that time from an investment point of view. A Fund will incur
borrowing costs when it leverages, including payment of interest
and any fee necessary to maintain a line of credit, and may be
required to maintain a minimum average balance. If the income and
appreciation on assets acquired with borrowed funds exceed their
borrowing cost, the Fund's investment performance will increase,
whereas if the income and appreciation on assets acquired with
borrowed funds are less than their borrowing costs, investment
performance will decrease. In addition, if a Fund borrows to
invest in securities, any investment gains made on the securities
in excess of the costs of the borrowing, and any gain or loss on
hedging, will cause the net asset value of the shares to rise
faster than would otherwise be the case. On the other hand, if
the investment performance of the additional securities purchased
fails to cover their cost (including any interest paid on the
<PAGE>
5
money borrowed) to a Fund, the net asset value of the Fund's
shares will decrease faster than would otherwise be the case.
This speculative characteristic is known as "leverage."
Reverse Repurchase Agreements and Dollar Roll Agreements. The
Funds may enter into reverse repurchase agreements and dollar
roll agreements with commercial banks and registered broker-
dealers to seek to enhance returns. Reverse repurchase
agreements involve sales by the Fund of portfolio assets
concurrently with an agreement by the Fund to repurchase the same
assets at a later date at a fixed price. During the reverse
repurchase agreement period, the Fund continues to receive
principal and interest payments on these securities and also has
the opportunity to earn a return on the collateral furnished by
the counterparty to secure its obligation to redeliver the
securities.
Dollar rolls are transactions in which the Fund sells securities
for delivery in the current month and simultaneously contracts to
repurchase substantially similar (same type and coupon)
securities on a specified future date. During the roll period,
the Fund forgoes principal and interest paid on the securities.
The Fund is compensated by the difference between the current
sales price and the forward price for the future purchase (often
referred to as the "drop") as well as by the interest earned on
the cash proceeds of the initial sale.
The Funds will establish a segregated account with its custodian
in which it will maintain cash, U.S. Government securities or
other liquid high-grade debt obligations equal in value to its
obligations in respect of reverse repurchase agreements and
dollar rolls. Reverse repurchase agreements and dollar rolls
involve the risk that the market value of the securities retained
by a Fund may decline below the price of the securities the Fund
has sold but is obligated to repurchase under the agreement. In
the event the buyer of securities under a reverse repurchase
agreement or dollar roll files for bankruptcy or becomes
insolvent, the Fund's use of the proceeds of the agreement may be
restricted pending a determination by the other party or its
trustee or receiver, whether to enforce the Fund's obligation to
repurchase the securities. Reverse repurchase agreements and
dollar rolls are considered borrowings by the Fund and result in
leverage.
Foreign Securities. The Financial Services Fund may hold
securities of foreign issuers that are not registered with
Securities and Exchange Commission ("SEC"), and foreign issuers
may not be subject to SEC reporting requirements. Accordingly,
there may be less publicly available information concerning
foreign issuers of securities held by Funds than is available
concerning U.S. companies. Foreign companies are not generally
subject to uniform accounting, auditing and financial reporting
standards or to other regulatory requirements comparable to those
applicable to U.S. companies. The securities of some foreign
companies are less liquid and at times more volatile than
securities of comparable U.S. companies.
The Financial Services Fund may invest in foreign securities by
purchasing American Depository Receipts ("ADRs"), European
<PAGE>
6
Depository Receipts ("EDRs"), Global Depository Receipts ("GDRs")
or other securities convertible into securities of issuers based
in foreign countries and may also purchase the securities
directly in the foreign markets. ADRs are generally in
registered form and are denominated in U.S. dollars and are
designed for use in U.S. securities markets. EDRs are similar to
ADRs but generally are in bearer form, may be denominated in
other currencies, and are designed for use in European securities
markets. GDRs are similar to EDRs and are designed for use in
several international markets. ADRs are typically receipts
issued by a U.S. Bank or trust company evidencing ownership of
the underlying securities. For purposes of the Fund's investment
policies, ADRs, EDRs and GDRs are deemed to have the same
classification as the underlying securities they represent.
Thus, an ADR, EDR, or GDR representing ownership of common stock
will be treated as common stock.
The Financial Services Fund anticipates that its brokerage
transactions involving foreign securities of companies
headquartered outside of the United States will be conducted
primarily on the principal exchanges of such countries.
Transactions on foreign exchanges are subject to fixed
commissions that are generally higher than negotiated commissions
on U.S. transactions, although the Fund will endeavor to achieve
the best net results in effecting its portfolio transactions.
There is generally less government supervision and regulation of
exchanges and brokers in foreign countries than in the United
States and as a result trade and settlement procedures in foreign
securities may involve certain risks or expenses not present in
the settlement of domestic transactions (such as delay in payment
or delivery of securities or in the recovery of the Fund's assets
held abroad).
Investment income on certain foreign securities in which the
Financial Services Fund may invest may be subject to foreign
withholding or other taxes that could reduce the return on these
securities. In addition, with respect to certain foreign
countries, there is a possibility of nationalization or
expropriation of assets, imposition of currency exchange
controls, confiscatory taxation, political or financial
instability, and domestic developments which could affect the
value of investments in those countries. In certain countries,
legal remedies available to investors may be more limited than
those available with respect to investments in the United States
or other countries. The laws of some foreign countries may limit
the Fund's ability to invest in securities of certain issuers
located in those countries.
Foreign Currency Transactions. The Financial Services Fund may
conduct foreign currency transactions on a spot (i.e. cash) or
forward basis (i.e. by entering into forward contracts to
purchase or sell foreign currencies). Although foreign exchange
dealers generally do not charge a fee for such conversions, they
do realize a profit based on the difference between the prices at
which they are buying and selling various currencies. Thus a
dealer may offer to sell a foreign currency at one rate, while
offering a lesser rate of exchange should the counterparty desire
to resell that currency to the dealer. Forward contracts are
customized transactions that require a specified amount of a
<PAGE>
7
currency to be delivered at a specific exchange rate on a
specific date or range of dates in the future. Forward contracts
are generally traded in an interbank market directly between
currency traders (usually large commercial banks) and their
customers. The parties to a forward contract may agree to offset
or terminate the contract before its maturity, or may hold the
contract to maturity and complete the contemplated currency
exchange.
The Financial Services Fund may use currency forward contracts to
hedge against a decline in the value of its investments
denominated in foreign currency. For example, if the Fund owned
securities denominated in pounds sterling, it could enter into a
forward contract to sell pounds sterling in return for U.S.
dollars to hedge against possible declines in the pound's value.
Such a hedge, called a "position hedge" would tend to offset both
positive and negative currency fluctuations, but would not offset
changes in the value of its investment caused by other factors.
Under certain conditions, SEC guidelines require mutual funds to
set aside liquid assets in a segregated custodial account to
cover currency forward contracts, if done for speculative
purposes. Currently, the Fund does not expect to use currency
forward contracts for speculative purposes. The Fund will not
segregate assets to cover its forward contracts entered into for
hedging, such as the position hedge described above.
Collateralized Mortgage Obligations ("CMOs"). The Fixed Income
Segment of the Equity Market Plus Fund may invest in CMOs. A CMO
is a security backed by a portfolio of mortgages or mortgage-
backed securities held under an indenture. The issuer's
obligation to make interest and principal payments is secured by
the underlying portfolio of mortgages or mortgage-backed
securities. CMOs are issued with a number of classes or series,
which have different maturities representing interests in some or
all of the interest or principal on the underlying collateral or
a combination thereof. Payments of interest or principal on some
classes or series of CMOs may be subject to contingencies, or
some classes or series may bear some or all of the risk of
default on the underlying mortgages. CMOs of different classes
are generally retired in sequence as the underlying mortgage
loans in the mortgage pools are repaid. In the event of
sufficient early prepayments on such mortgages, the class or
series of CMO first to mature generally will be retired prior to
its stated maturity. Thus, the early retirement of a particular
class or series of a CMO held by the Funds would have the same
effect as the prepayment of mortgages underlying a mortgage-
backed pass-through security. Another type of CMO is a real
estate mortgage investment conduit ("REMIC") which qualifies for
special tax treatment under the Internal Revenue Code and invests
in certain mortgages principally secured by interests in real
property and other permitted investments.
CMOs also include securities representing the interest in any
excess cash flow and/or the value of any collateral remaining
after the issuer has applied cash flow from the underlying
mortgages or mortgage-backed securities to the payment of
principal of and interest on all other CMOs and the
administrative expenses of the issuer ("Residuals"). Residuals
<PAGE>
8
have value only to the extent that income from such underlying
mortgages or mortgage-backed securities exceeds the amounts
necessary to satisfy the issuer's debt obligations represented by
all other outstanding classes or series of the CMOs. In
addition, if a CMO bears interest at an adjustable-rate, the cash
flows on the related Residual will also be extremely sensitive to
the level of the index upon which the rate adjustments are based.
In reliance on an interpretation by the SEC, the Funds'
investments in certain qualifying CMOs and REMICs are not subject
to the 1940 Investment Company Act's limitations on acquiring
interests in other investment companies. CMOs and REMICs issued
by an agency or instrumentality of the U.S. Government are
considered U.S. Government securities for the purposes of this
Prospectus.
Stripped Securities ("STRIPS"). The Fixed Income Segment of the
Equity Market Plus Fund may invest in STRIPS. STRIPS are usually
structured with two classes that receive different proportions of
the interest and principal distributions from a pool of
underlying assets. A common type of STRIP will have one class
receiving all of the interest from the underlying assets
("interest-only" or "IO" class), while the other class will
receive all of the principal ("principal-only" or "PO" class).
However, in some instances, one class will receive some of the
interest and most of the principal while the other class will
receive most of the interest and the remainder of the principal.
STRIPS are unusually volatile in response to changes in interest
rates. The yield to maturity on an IO class of STRIPS is
extremely sensitive not only to changes in prevailing interest
rates but also to the rate of principal payments (including
prepayments) on the underlying assets. A rapid rate of principal
prepayments may have a measurably adverse effect on the Fund's
yield to maturity to the extent it invests in IOs. Conversely,
POs tend to increase in value if prepayments are greater than
anticipated and decline if prepayments are slower than
anticipated. Thus, if the underlying assets experience greater
than anticipated prepayments of principal, the Fund may fail to
fully recover its initial investment in these securities, even if
the STRIPS were rated of the highest credit quality by S&P or
Moody's, respectively. The Adviser will seek to manage these
risks (and potential benefits) by investing in a variety of such
securities and by using certain hedging techniques, as described
in "Other Investment Practices and Risk Considerations" in the
Prospectus. In addition, the secondary market for STRIPS may be
less liquid than that for other mortgage-backed or asset-backed
securities, potentially limiting the Fund's ability to buy or
sell those securities at any particular time.
The Adviser expects that interest-only STRIPS will be
purchased for their hedging characteristics. Because of their
structure, interest-only STRIPS will most likely move differently
than typical fixed income securities in relation to changes in
interest rates. For example, with increases in interest rates,
these securities will typically increase rather than decrease in
value. As a result, since they move differently to changes in
interest rates than the typical investments held by a Fund,
interest-only STRIPS can be used as hedging instruments to reduce
the variance of a Fund's net asset value from its targeted
<PAGE>
9
option-adjusted duration. There can be no assurance that the use
of interest-only STRIPS will be effective as a hedging technique,
in which event, a Fund's overall performance may be less than if
the Fund had not purchased the STRIPS. It is not anticipated
that STRIPS will constitute more than 5% of a Fund's net assets.
The determination of whether certain IO and PO STRIPS issued
by the U.S. Government and backed by fixed-rate mortgages are
liquid shall be made by the Trustees in accordance with
applicable pronouncements of the SEC. At present all other IO
and PO STRIPS are treated as illiquid securities for the purposes
of the 15% limitation on illiquid securities as a percentage of a
Fund's net assets.
Zero Coupon Securities. The Fixed Income Segment of the Equity
Market Plus Fund may also invest in "zero coupon" securities,
which are issued at a significant discount from face value and
pay interest only at maturity rather than at intervals during the
life of the security. Zero coupon securities tend to be more
volatile than other securities with similar stated maturities,
but which make regular payments of either principal or interest.
The Fund is required to accrue and distribute income from zero
coupon securities on a current basis, even though it does not
receive the income currently. Thus, the Fund may have to sell
other investments to obtain cash needed to make income
distributions, which may reduce the Fund's assets and may thereby
increase its expense ratio and decrease its rate of return.
HEDGING AND OTHER STRATEGIES USING DERIVATIVE CONTRACTS
Futures Contracts. When a fund purchases a futures contract it
agrees to purchase a specified underlying instrument at a
specified future date. When a fund sells a futures contract, it
agrees to sell the underlying instrument at a specified future
date. The price at which the purchase and sale take place is
fixed when the fund enters the contract. Some currently
available futures contracts are based on specific securities,
such as U.S. Treasury bonds or notes, and some are based on
indices of securities prices, such as the Standard and Poor's 500
Index (S&P 500). Futures can be held until their delivery dates,
or can be closed out before then if a liquid secondary market is
available.
The value of a futures contract tends to increase and decrease in
tandem with the value of its underlying instrument. Therefore,
purchasing futures contracts will tend to increase a fund's
exposure to positive and negative price fluctuations in the
underlying instrument, much as if it had purchased the underlying
instrument directly. When a fund sells a future contract, by
contrast, the value of its futures position will tend to move in
a direction contrary to the market. Selling futures contracts,
therefore, will tend to offset both positive and negative market
price changes, much as if the underlying instrument had been
sold.
The Funds will not use futures contracts for leverage.
<PAGE>
10
Futures Margin Payments. The purchaser or seller of a futures
contract is not required to deliver or pay for the underlying
instrument unless the contract is held until delivery date, and
it is not cash settled. However, when the contract is entered
into, a purchaser or seller is required to deposit "initial
margin" with a futures broker, known as a futures commission
merchant ("FCM"). Initial margin deposits are typically a
percentage of the contract's value. If the value of either
party's position declines, that party will be required to make
additional "variation margin" payments to settle the change in
value on a daily basis. The party that has a gain may be
entitled to receive all or a portion of this amount. Initial and
variation margin payments do not constitute purchasing securities
on margin for purposes of a Fund's investment limitations. In
the event of the bankruptcy of an FCM that holds margin on behalf
of a fund, the fund may be entitled to return of the margin owed
to it only in proportion to the amount received by the FCM's
other customers, potentially resulting in losses to a Fund.
Asset Coverage and Limitations on Futures and Options
Transactions. The Funds will comply with guidelines established
by the SEC with respect to coverage of options and futures
strategies by mutual funds, and if the guidelines so require,
will set aside liquid assets in a segregated custodial account in
the amount prescribed. Securities held in a segregated account
cannot be sold while the futures and options strategy is
outstanding, unless they are replaced with other suitable assets.
As a result there is a possibility that segregation of a large
percentage of a Fund's assets could impede portfolio management
or a Fund's ability to meet redemption requests.
In accordance with regulations established by the Commodity
Futures Trading Commission, each Fund's aggregate initial margin
and premiums on all futures and options contract positions not
held for bona fide hedging purposes, will not exceed 5% of a
Fund's net assets, after taking into account unrealized profits
and losses on such contracts.
Risks Associated with Correlation of Price Changes. Because
there are a limited number of types of exchange-traded option and
future contracts, it is likely that the standardized contracts
available will not match a Fund's current or anticipated
investments directly. The Funds may invest in options and
futures contracts based on securities with different maturities
or other characteristics from the securities in which they
typically invest, which involves a risk that the options or
futures position will not track the performance of the Funds'
investment.
Options and futures prices can also diverge from the prices of
their underlying instruments, even if the underlying instruments
match a Fund's investments well. Options and futures prices are
affected by such factors as current and anticipated short-term
interest rates, changes in volatility of the underlying
instrument, and the time remaining until expiration of the
contract, which may not affect security prices the same way.
Imperfect correlation may also result from differing levels of
demand in the options and futures markets versus the securities
markets, from structural differences in how options and futures
<PAGE>
11
and securities are traded, or from the imposition of daily price
fluctuation limits or trading halts. A fund may purchase or sell
options or futures contracts with a greater or lesser value than
the securities it wishes to hedge or intends to purchase in order
to attempt to compensate for differences in volatility between
the contract and the securities, although this may not be
successful in all cases. If price changes in a Fund's options or
futures positions are poorly correlated with its other
investments, the positions may fail to produce anticipated gains
or result in losses that are not offset by gains in other
investments.
Liquidity of Options and Futures Contracts. There is no
assurance a liquid secondary market will exist for any particular
options or futures contract at any particular time. Options may
have relatively low trading volume and liquidity if their strike
prices are not close to the underlying instrument's current
price. In addition, exchanges may establish daily price
fluctuation limits for options and futures contracts, and may
halt trading if a contract's price moves upward or downward more
than the limit in a given day. On volatile trading days when the
price fluctuation limit is reached or a trading halt is imposed,
it may be impossible for a Fund to enter into new positions or
close out existing positions. If the secondary market for a
contract is not liquid because of price fluctuation limits or
otherwise, it could prevent prompt liquidation of unfavorable
positions, and potentially could require a Fund to continue to
hold a position until delivery or expiration regardless of
changes in its value. As a result, a Fund's access to other
assets held to cover its option or futures positions could also
be impaired.
OTC Options. Unlike exchange traded options, which are
standardized with respect to the underlying instrument,
expiration date, contract size and strike price, the terms of
over-the-counter (OTC) options (options not traded on exchanges)
generally are established through negotiation with the other
party to the option contract. While this type of arrangement
allows the Funds greater flexibility to tailor an option to its
needs, OTC options generally involve greater credit risk than
exchange traded options, which are guaranteed by the clearing
organization of the exchanges where they are traded.
The staff of the SEC currently considers OTC options to be
illiquid for purposes of the 15% limitation on illiquid
securities as a percentage of a Fund's net assets unless certain
arrangements have been made with the other party to the option
contract that permit the prompt liquidation of the option
position.
Purchasing Put and Call Options. By purchasing a put option, a
Fund obtains the right (but not the obligation) to sell the
option's underlying instrument at a fixed strike price. In
return for this right, a Fund pays the current market price for
the option (known as the option premium). Options have various
types of underlying instruments, including specified securities,
indices of securities prices, and futures contracts. A Fund may
terminate its position in a put option it has purchased by
allowing it to expire or by exercising the option. If the option
<PAGE>
12
is allowed to expire, a Fund will lose the entire premium it
paid. If a Fund exercises the option, it completes the sale of
the underlying instrument at the strike price. A Fund may also
terminate a put option position by closing it out in the
secondary market at its current price, if a liquid secondary
market exists.
The buyer of a typical put option can expect to realize a gain if
security prices fall substantially. However, if the underlying
instrument's price does not fall enough to offset the cost of
purchasing the option, a put buyer can expect to suffer a loss
(limited to the amount of the premium paid, plus related
transaction costs).
The features of call options are essentially the same as those of
put options, except that the purchaser of a call option obtains
the right to purchase, rather than sell, the underlying
instrument at the option's strike price. A call buyer typically
attempts to participate in potential price increases of the
underlying instrument with risk limited to the cost of the
option if security prices fall. At the same time, the buyer can
expect to suffer a loss if security prices do not rise
sufficiently to offset the cost of the option.
Writing Put and Call Options. When a Fund writes a put option,
it takes the opposite side of the transaction from the option's
purchaser. In return for receipt of the premium, the Fund
assumes the obligation to pay the strike price for the option's
underlying instrument if the other party to the option chooses to
exercise it. When writing an option on a futures contract, a
Fund will be required to make margin payments to an FCM as
described above for futures contracts. A Fund may seek to
terminate its position in a put option it writes before exercise
by closing out the option in the secondary market at its current
price. If the secondary market is not liquid for a put option
the Fund has written, however, the Fund must continue to be
prepared to pay the strike price while the option is outstanding,
regardless of price changes, and must continue to set aside
assets to cover its position.
If security prices rise, a put writer would generally expect to
profit although its gain would be limited to the amount of the
premium it received. If security prices remain the same over
time, it is likely that the writer will also profit, because it
should be able to close out the option at a lower price. If
security prices fall, the put writer would expect to suffer a
loss. This loss should be less than the loss from purchasing the
underlying instrument directly, however, because of the premium
received for writing the option.
Writing a call option obligates a Fund to sell or deliver the
option's underlying instrument, in return for the strike price,
upon exercise of the option. The characteristics of writing call
options are similar to those of writing put options, except that
writing calls generally is a profitable strategy if prices remain
the same or fall. Through receipt of the option premium, a call
writer mitigates the effects of a price decline. At the same
time, because a call writer must be prepared to deliver the
underlying instrument in return for the strike price, even if its
<PAGE>
13
current value is greater, a call writer gives up its ability to
participate in security price increases and will suffer a loss in
the event of an increase.
Combined Positions. A Fund may purchase and write options in
combination with each other, or in combination with futures or
forward contracts, to adjust the risk and return characteristics
of the overall position. For example, a Fund may purchase a put
option and write a call option on the same underlying instrument,
in order to construct a combined position whose risk and return
characteristics are similar to selling a futures contract.
Another possible combined position would involve writing a call
option at one strike price and buying a call option at a lower
price, in order to reduce the risk of the written call option in
the event of a substantial price increase. Because combined
positions involve multiple trades, they result in higher
transaction costs and may be more difficult to open and close
out.
Options and Futures Relating to Foreign Currencies. The
Financial Services Fund may utilize currency futures contracts.
Currency futures contracts are similar to forward currency
exchange contracts, except that they are traded on exchanges (and
have margin requirements) and are standardized as to contract
size and delivery date. Most currency futures contracts call for
payment or delivery in U.S. dollars. The underlying instrument
of a currency option may be a foreign currency, which generally
is purchased or delivered in exchange for U.S. dollars, or may be
a futures contract. The purchaser of a currency call obtains the
right to purchase the underlying currency, and the purchaser of a
currency put obtains the right to sell they underlying currency.
The Financial Services Fund may purchase and sell currency
futures and purchase and write currency options to increase or
decrease its exposure to different foreign currencies in order to
hedge against the currency risk implicit in the investments which
it owns that are denominated in other than U.S. dollars.
Currency futures and options values can be expected to correlate
with exchange rates, but may not reflect other factors that
affect the Fund's investments, such as a decline in an issuer's
creditworthiness. Because the value of the Financial Services
Fund's foreign denominated investments changes in response to
many factors other than exchange rates, it may not be possible to
march the amount of currency options and futures to the value of
the Fund's investments exactly over time.
Equity Swap Contracts. Both the Equity Market Plus Fund and the
Financial Services Fund may enter into equity swap contracts.
The counterparty to an equity swap contract will typically be a
bank, investment banking firm or broker-dealer. The counterparty
generally agrees to pay the Fund the amount, if any, by which the
notional amount of the equity swap contract would have increased
in value had it been invested in the basket of stocks comprising
the S&P 500 Index, plus the dividends that would have been
received on those stocks. The Fund agrees to pay to the
counterparty a floating rate of interest (typically the London
Inter Bank Offered Rate) on the notional amount of the equity
swap contract plus the amount, if any, by which that notional
amount would have decreased in value had it been invested in such
<PAGE>
14
stocks. Therefore, the return to the Fund on any equity swap
contract should be the gain or loss on the notional amount plus
dividends on the stocks comprising the S&P 500 Index (as if the
Fund had invested the notional amount in stocks comprising the
S&P 500 Index) less the interest paid by the Fund on the notional
amount. The Funds will enter into equity swap contracts only on
a net basis, i.e., where the two parties' obligations are netted
out, with the Fund paying or receiving, as the case may be, only
the net amount of any payments. Payments under an equity swap
contract may be made at the conclusion of the contract or
periodically during its term. If there is default by the
counterparty to an equity swap contract, a Fund will be limited
to contractual remedies pursuant to the agreements related to the
transaction. There is no assurance that the equity swap contract
counterparties will be able to meet their obligations or that, in
the event of default, the Funds will succeed in pursuing
contractual remedies. A Fund thus assumes the risk that it may
be delayed in or prevented from obtaining payments owed to it
pursuant to these contracts. The Funds will closely monitor the
credit of equity swap contract counterparties in order to
minimize this risk. The Funds will not use equity swap contracts
for leverage.
The Funds may from time to time enter into the opposite side of
equity swap contracts (i.e., where the Fund is obligated to pay
the increase (net of interest) or receive the decrease (plus
interest) on the S&P 500 Index) to reduce the amount of the
Fund's equity market exposure. These positions are sometimes
referred to as "reverse equity swap contracts".
The Funds will not enter into any equity swap contract unless,
at the time of entering into such transaction, the unsecured
senior debt of the counterparty is rated at least A by Moody's
Investors Service, Inc. ("Moody's") or Standard & Poor's ("S&P").
In addition, the staff of the SEC considers equity swap contracts
and reverse equity swap contracts to be illiquid securities.
Consequently, while the staff maintains this position, the Fund
will not invest in equity swap contracts or reverse equity swap
contracts if, as a result of the investment, the total value of
such investments together with that of all other illiquid
securities which the Fund owns would exceed 15% of the Fund's net
assets.
The Adviser and Funds do not believe that a Fund's obligations
under equity swap contracts or reverse equity swap contracts are
senior securities, so long as such a segregated account is
maintained, and accordingly, the Funds will not treat them as
being subject to its borrowing restrictions. The net amount of
the excess, if any, of a Fund's obligations over its entitlements
with respect to each equity swap contract and each reverse equity
swap contract will be accrued on a daily basis, and liquid
securities having an aggregate market value at least equal to the
accrued excess will be maintained in a segregated account by a
Fund's custodian.
Interest Rate and Mortgage Swaps, Caps, Floors and Collars.
Interest rate swaps involve the exchange by a Fund with another
party of their respective commitments to pay or receive interest,
for example, an exchange of floating-rate payments for fixed-rate
<PAGE>
15
payments. Mortgage swaps are similar to interest rate swaps in
that they represent commitments to pay and receive interest. The
notional principal amount, however, is tied to a reference pool
or pools of mortgages.
The purchase of an interest rate cap entitles the purchaser, to
the extent that a specified index exceeds a predetermined
interest rate, to receive payments of interest on a notional
principal amount from the party selling such interest rate cap.
The purchase of an interest rate floor entitles the purchaser, to
the extent that a specified index falls below a predetermined
interest rate, to receive payments of interest on a notional
principal amount from the party selling such interest rate floor.
An interest rate collar combines the elements of purchasing a cap
and selling a floor. The collar protects against an interest
rate rise above the maximum amount, but gives up the benefits of
an interest rate decline below the minimum amount. There can be
no assurance that the Funds will be able to enter into interest
rate swaps, caps, floors or collars on favorable terms.
Furthermore, there can be no assurance that any of the Funds will
be able to terminate an interest rate swap or sell or offset
interest rate caps, floors or collars notwithstanding any terms
in the agreements providing for such termination.
Inasmuch as these transactions are entered into for hedging
purposes, the Adviser and the Funds believe swaps, caps, floors
and collars do not constitute senior securities and, accordingly,
will not treat them as being subject to its borrowing
restrictions. The net amount of the excess, if any, of a Fund's
obligations over its entitlement with respect to each interest
rate swap will be accrued on a daily basis, and an amount of cash
or liquid securities having an aggregate net asset value at least
equal to the accrued excess will be maintained in a segregated
account by a custodian that satisfies the requirements of the
Investment Company Act.
The Funds will enter into these transactions with counter parties
who are rated at least A by Moody's and S&P at the time of
entering into a contract.
If there is default by the other party to such a transaction, the
Funds will have contractual remedies pursuant to the agreements
related to the transaction. There is no assurance that
interest-rate swap, cap, floor or collar counterparties will be
able to meet their obligations pursuant to their contracts, or
that, in the event of default, a Fund will succeed in pursuing
contractual remedies. The Funds thus assume the risk that one of
them may be delayed in or prevented from obtaining payments owed
to it pursuant to interest rate swaps, caps, floors or collars.
The swap, cap, floor and collar market has grown substantially in
recent years with a large number of banks and investment banking
firms acting both as principals and as agents utilizing
standardized documentation. As a result, this market has become
relatively liquid, although the Funds will still treat these
instruments as illiquid investments subject to the limitation on
such investments described under "Illiquid Securities" in the
Prospectus.
<PAGE>
16
TAXES
Taxation of the Funds. Each Fund intends to qualify each year
as a regulated investment company under Subchapter M of the
Internal Revenue Code of 1986, as amended (the "Code"). In order
so to qualify and to qualify for the special tax treatment
accorded regulated investment companies and their shareholders,
the Fund must, among other things:
(a) derive at least 90% of its gross income
from dividends, interest, payments with respect to
certain securities loans, and gains from the sale of
stock, securities and foreign currencies, or other
income (including but not limited to gains from
options, futures, or forward contracts) derived with
respect to its business of investing in such stock,
securities, or currencies;
(b) for the Equity Market Plus Fund, and only
until March 31, 1998, derive less than 30% of its gross
income from gains from the sale or other disposition of
certain assets (including securities) held for less
than three months;
(c) distribute with respect to each
taxable year at least 90% of the sum of its taxable net
investment income, its net tax-exempt income, and the
excess, if any, of net short-term capital gains over
net long-term capital losses for such year; and
(d) diversify its holdings so that, at the
end of each fiscal quarter (i) at least 50% of the
market value of the Fund's assets is represented by
cash and cash items, U.S. Government securities,
securities of other regulated investment companies, and
other securities limited in respect of any one issuer
to a value not greater than 5% of the value of the
Fund's total assets and 10% of the outstanding voting
securities of such issuer, and (ii) not more than 25%
of the value of its assets is invested in the
securities (other than those of the U.S. Government or
other regulated investment companies) of any one issuer
or of two or more issuers which the Fund controls and
which are engaged in the same, similar, or related
trades or businesses.
Qualification as a regulated investment company exempts a Fund
from federal income tax on income paid to its shareholders in the
form of dividends (including capital gain dividends). A dividend
paid to shareholders by the Fund in January of a year generally
is deemed to have been paid by the Fund on December 31 of the
preceding year, if the dividend was declared and payable to
shareholders of record on a date in October, November or December
of that preceding year.
If a Fund failed to qualify as a regulated investment company
accorded special tax treatment in any taxable year, the Fund
would be subject to tax on its taxable income at corporate rates,
and could be required to recognize unrealized gains, pay
<PAGE>
17
substantial taxes and interest and make substantial distributions
before requalifying as a regulated investment company that is
accorded special tax treatment.
If a Fund fails to distribute in a calendar year substantially
all of its ordinary income for such year and substantially all of
its net capital gain for the year ending October 31, plus any
retained amount from the prior year, the Fund will be subject to
a 4% excise tax on the undistributed amounts. Each Fund intends
generally to make distributions sufficient to avoid imposition of
the 4% excise tax. In calculating its income, each Fund must
include dividends in income not when received but on the date
when the stock in question is acquired or becomes ex-dividend,
whichever is later. Also, a portion of the yield on certain high
yield securities (including certain payment-in-kind bonds) issued
after July 10, 1989 may be treated as dividends.
Sale or redemption of shares. The sale, exchange, or
redemption of Fund Shares may give rise to a gain or loss. In
general, any gain realized upon a taxable disposition of shares
will be treated as mid-term capital gain if the shares have been
held for 12 months, but not more than 18 months, and as adjusted
net long-term capital gains if the shares have been held for more
than 18 months. Otherwise the gain on the sale, exchange, or
redemption of Fund shares will be treated as short-term capital
gain or loss. In addition, any loss (not already disallowed as
provided in the next sentence) realized upon a taxable
disposition of shares held for six months or less will be treated
as long-term, rather than short-term, to the extent of any long-
term capital gain distributions received by the shareholder with
respect to the shares. All or a portion of any loss realized
upon a taxable disposition of Fund shares will be disallowed if
other Fund shares are purchased within 30 days before or after
the disposition. In such a case, the basis of the newly
purchased shares will be adjusted to reflect the disallowed
loss.
Return of capital distributions. If a Fund makes a distribution
to you in excess of its current and accumulated "earnings and
profits" in any taxable year, the excess distribution will be
treated as a return of capital to the extent of your tax basis in
your shares, and thereafter as capital gain. A return of capital
is not taxable, but it reduces your tax basis in your shares.
Hedging Transactions. If a Fund engages in hedging
transactions, including hedging transactions in option, futures
contracts, and straddles, or similar transactions, it will be
subject to special tax rules (including constructive sale, market-
to-market, straddle, wash sales, and short sale rules), the
effect of which may be to accelerate income to the Fund, defer
losses to the Fund, cause adjustments in the holding periods of
the Fund's securities, or convert short-term capital losses into
long-term capital losses. These rules could therefore affect the
amount, timing and character of distributions to
shareholders.
Tax Implications of Certain Investments. Certain of a Fund's
investments, including investments in stripped securities, will
create taxable income in excess of the cash they generate. In
<PAGE>
18
such cases, a Fund may be required to sell assets (including when
it is not advantageous to do so) to generate the cash necessary
to distribute as dividends to its shareholders all of its income
and gains and therefore to eliminate any tax liability at the
Fund level.
FUND CHARGES AND EXPENSES
Management Fees. The Equity Market Plus Fund pays a monthly
fee to the Adviser based on the average net assets of the Fund,
as determined at the close of each business day during the month,
at an annual rate of 0.70%. The fee for the Financial Services
Fund is 1.50%. Advisory fees paid by Equity Market Plus Fund for
the fiscal year ended March 31, 1997 were $53,341. Advisory fees
paid by the Equity Market Plus Fund for each of the last three
fiscal years ended March 31 were $11,056, $21,727, and $53,341
respectively. For each of the last three fiscal years ended March
31, the Adviser reimbursed the Equity Market Plus Fund $128,959,
$114,100 and $131,965, respectively, under expense limitation
provisions. The Financial Services Fund commenced operations
December 22, 1997,and as such has not paid as yet any advisory
fees for its prior fiscal years.
Other Expenses. Each Fund pays its own expenses, including, but
not limited to auditing, legal, tax preparation and consulting,
insurance, custodial, accounting, shareholder servicing and
shareholder report expenses. Fees paid to FPS Services which
serves as the Funds' shareholder servicing and accounting agent
are determined by contract as approved by the Board of Trustees.
MANAGEMENT OF THE FUNDS
The Board of Trustees has the responsibility for the overall
management of the Funds, including general supervision and review
of its investment activities. The Trustees, in turn, elect the
officers of the Funds who are responsible for administering the
day-to-day operations of the Funds. Trustees and officers of the
Funds are identified in the Prospectus.
All of the Trustees are Trustees of all the other funds
managed by the Adviser and each independent trustee receives fees
for his or her services. The Trustees do not receive pension or
retirement benefits from the Funds. The table below shows the
fees paid by the Equity Market Plus Fund to each independent
Director for the fiscal year ended March 31, 1997 and total fees
paid by the entire Fund complex for the fiscal year ended March
31, 1997. There are two other funds in the complex besides the
Equity Market Plus Fund and the Financial Services Fund.
Director Total Compensation Total Compensation
Paid by Smith Breeden From Smith Breeden
Equity Market Plus Equity Market Plus
and Fund Complex
William F. Sharpe $ 1,400 $38,750
Myron S. Scholes $ 0 $38,750
Stephen M. Schaefer $ 3,373 $38,750
<PAGE>
19
The Financial Services Fund expects to pay $1,667 to each Trustee
listed above prior to March 31, 1998.
The Agreement and Declaration of Trust of the Funds provides that
the Funds will indemnify its Trustees and officers against
liabilities and expenses incurred in connection with litigation
in which they may be involved because of their offices with the
Funds, except if it is determined in the manner specified in the
Agreement and Declaration of Trust that they have not acted in
good faith in the reasonable belief that their actions were in
the best interests of the Funds or that such indemnification
would relieve any officer or Trustee of any liability to the
Funds or its shareholders by reason of willful misfeasance, bad
faith, gross negligence or reckless disregard of his or her
duties.
Trustees and officers of the Funds who are also officers or
shareholders of the Adviser will benefit from the advisory fees
paid by the Fund.
Potential Conflicts of Interest. Principals of the Adviser as
individuals own approximately 70% of the common stock of
Harrington Financial Group ("HFGI"), the holding company for
Harrington Bank, FSB of Richmond, Indiana (the "Bank"). As of
October 31, 1997, HFGI had total assets of $505 million. HFGI and
the Bank may invest in assets of the same types as those to be
held by the Funds.
Douglas T. Breeden, in combination with immediate family members,
controls over 75% of the common stock of Community First
Financial Group, Inc. ("CFFG"), the holding company for certain
banks and thrifts, to which the Adviser renders Investment
Advisory services. CFFG and its subsidiaries invest in assets of
the same types as those to be held by the Funds.
The Adviser may also manage advisory accounts with investment
objectives similar to or the same as those of the Funds, or
different from the Funds but trading in the same type of
securities and instruments as the Funds. Portfolio decisions and
results of the Funds' investments may differ from those of such
accounts managed by the Adviser. When two or more accounts
managed by the Adviser seek to purchase or sell the same assets,
the assets actually purchased or sold may be allocated among the
accounts on a basis determined by the Adviser in its good faith
discretion to be equitable. In some cases, this system may
adversely affect the size or the price of the position obtainable
for the Funds.
THE INVESTMENT ADVISORY AGREEMENT AND OTHER SERVICES
The investment manager of the Funds is Smith Breeden Associates,
Inc. (the "Adviser"). The table in the Prospectus indicates
which officers and trustees are affiliated persons of the
Adviser.
Under the Investment Advisory Agreements between the Funds and
the Adviser, subject to such policies as the Trustees may
determine, the Adviser, at its expense, furnishes continuously an
<PAGE>
20
investment program for the Funds and makes investment decisions
on behalf of the Funds. Subject to the control of the Trustees,
the Adviser also manages, supervises and conducts the other
affairs and business of the Funds, furnishes office space and
equipment, provides bookkeeping and clerical services and places
all orders for the purchase and sale of the Funds' portfolio
securities.
For details of the Adviser's compensation under the Investment
Advisory Agreements, see "Fund Charges and Expenses" in this
Statement. Under the Investment Advisory Agreements, the Adviser
may reduce its compensation to the extent that the Funds'
expenses exceed such lower expense limitation as the Adviser may,
by notice to the Funds, voluntarily declare to be effective. The
expenses subject to this limitation are exclusive of brokerage
commissions, interest, taxes, and extraordinary expenses. The
terms of the expense limitations currently in effect are
described in the Prospectus and on the following page. The Funds
pay all expenses not assumed by the Adviser including, without
limitation, auditing, legal, tax preparation and consulting,
custodial, investor servicing and shareholder reporting expenses.
The Investment Advisory Agreements provide that the Adviser shall
not be subject to any liability to the Funds or to any
shareholder of the Funds for any act or omission in the course of
or connected with rendering services to the Funds in the absence
of willful misfeasance, bad faith, gross negligence or reckless
disregard of its duties on the part of the Adviser.
The Investment Advisory Agreements may be terminated without
penalty by vote of the Trustees or the shareholders of either
Fund, or by the Adviser, on 60 days written notice. They may be
amended only by a vote of the shareholders of each Fund. The
Investment Advisory Agreements also terminate without payment of
any penalty in the event of its assignment as defined in the
Investment Company Act. The Investment Advisory Agreements
provide that they will continue in effect after their initial
term of two years only so long as such continuance is approved at
least annually by vote of either the Trustees or the
shareholders, and, in either case, by a majority of the Trustees
who are not "interested persons" of the Adviser or the Funds. In
each of the foregoing cases, the vote of the shareholders is the
affirmative vote of a "majority of the outstanding voting
securities".
Under the terms of the Investment Advisory Agreements, the
Adviser performs certain administrative services as follows: (1)
coordinates with the Funds' custodian and transfer agent and
monitors the services they provide to the Funds; (2) coordinates
with and monitors other third parties furnishing services to the
Funds; (3) provides the Funds with necessary office space,
telephones and other communications facilities and personnel
competent to perform administrative and clerical functions for
the Funds; (4) supervises the preparation by third parties of all
Federal, state and local tax returns and reports of the Funds
required by applicable law; (5) prepares and, after approval by
the Funds, files and arranges for the distribution of proxy
materials and periodic reports to shareholders of the Funds as
required by applicable law; (6) prepares and, after approval by
<PAGE>
21
the Funds, arranges for the filing of such registration
statements and other documents with the Securities and Exchange
Commission and other Federal and state regulatory authorities as
may be required by applicable law; (7) reviews and submits to the
officers of the Funds for their approval invoices or other
requests for payment of Fund expenses; and (8) takes such other
actions with respect to the Funds as may be necessary in the
opinion of the Advisor to perform its duties under the
agreements.
The Adviser has voluntarily undertaken to bear normal
operating expenses (excluding litigation, indemnification and
other extraordinary expenses) of the Funds, and, if necessary, to
waive its advisory fee, for the period ending August 1, 1998 such
that total operating expenses would not exceed 0.88% of the
average net assets of the Equity Market Plus Fund and 1.50% of
the Financial Services Fund. Such expense limitations, if any,
are calculated daily based on average net assets and may be
continued or modified by the Adviser at any time in its sole
discretion.
Portfolio Transactions
Investment decisions. Investment decisions for the Funds and
for the other investment advisory clients of the Adviser are made
with a view to achieving their respective investment objectives.
Investment decisions are the product of many factors in addition
to basic suitability for the particular client involved. Thus, a
particular security may be bought or sold for certain clients
even though it could have been bought or sold for other clients
at the same time. Likewise, a particular security may be bought
for one or more clients when one or more other clients are
selling the security. In some instances, one client may sell a
particular security to another client. It also sometimes happens
that two or more clients simultaneously purchase or sell the same
security, in which event each day's transactions in such security
are, insofar as possible, averaged as to price and allocated
between such clients in a manner which in the Adviser's opinion
is equitable to each and in accordance with the amount being
purchased or sold by each. There may be circumstances when
purchases or sales of portfolio securities for one or more
clients will have an adverse effect on other clients.
Brokerage and research services. Transactions on U.S. stock
exchanges, commodities markets and futures markets and other
agency transactions involve the payment by the Funds of
negotiated brokerage commissions. Such commissions vary among
different brokers. In addition, a particular broker may charge
different commissions according to such factors as the difficulty
and size of the transaction. There is generally no stated
commission in the case of securities traded in the over-the-
counter markets, but the price paid by the Funds usually includes
an undisclosed dealer commission or mark-up. In underwritten
offerings, the price paid by the Funds includes a disclosed,
fixed commission or discount retained by the underwriter or
dealer. The Equity Market Plus Fund paid approximately $3,000 in
brokerage commissions on futures and options transactions for the
last fiscal year and approximately $1,000 for each of the two
prior fiscal years ended March 31. The Financial Services Fund
<PAGE>
22
commenced operations December 22, 1997, and as of the date of
this Statement had not incurred any commission expense. For a
discussion of brokerage issues relating to investments by the
Financial Services Fund in foreign securities, see "Miscellaneous
Investment Practices and Risk Considerations-Foreign Securities".
The Adviser places all orders for the purchase and sale of
portfolio investments for the Funds and may buy and sell
investments for the Funds through a substantial number of brokers
and dealers. In so doing, the Adviser uses its best efforts to
obtain for the Funds the most favorable price and execution
available. In seeking the most favorable price and execution,
the Adviser, having in mind the Funds' best interests, considers
all factors it deems relevant, including, by way of illustration,
price, the size of the transaction, the nature of the market for
the security or other investment, the amount of the commission,
the timing of the transaction taking into account market prices
and trends, the reputation, experience and financial stability of
the broker-dealer involved and the quality of service rendered by
the broker-dealer in other transactions.
When it is determined that several brokers or dealers are equally
able to provide the best net price and execution, the Adviser may
execute transactions through brokers or dealers who provide
quotations and other services to its advisory clients, including
the quotations necessary to determine these clients' net assets,
in such amount of total brokerage as may reasonably be required
in light of such services, and through brokers and dealers who
supply statistical and other data to the Adviser and its clients
in such amount of total brokerage as may reasonably be required.
Consistent with the Rules of Fair Practice of the National
Association of Securities Dealers, Inc. and subject to seeking
the most favorable price and execution available and such other
policies as the Trustees may determine, the Adviser may consider
sales of shares of the Funds (and, if permitted by law, of the
other funds managed by the Adviser) as a factor in the selection
of broker-dealers to execute portfolio transactions for the
Funds.
The Adviser conducts extensive proprietary research. The Adviser
is not dependent on any broker for such research and analysis
and, thus is able to transact business with brokers regardless of
the brokers' research capabilities or provision of such research
to brokerage customers. The Adviser uses multiple electronic
quotation services for trading and pricing purposes. The Adviser
pays for these services directly out of its advisory fees. The
Adviser is not involved in any soft dollar arrangements. The
Adviser does utilize broker pricing guidance for certain assets
not consistently available through electronic quotation services.
Investor Servicing Agent and Underwriter
FPS Services is each Fund's investor servicing agent (transfer,
plan and dividend disbursing agent), for which it receives fees
which are paid monthly by each Fund as an expense of all its
shareholders. See "Fund Charges and Expenses" in this Statement
for information on fees and reimbursements received by FPS
Services. FPS Services is also investor-servicing agent for the
<PAGE>
23
other funds managed by the Adviser and receives fees from each of
those funds for its services.
Custodian
The Bank of New York ("Custodian") acts as custodian of each
of the Fund's assets. In carrying out its duties under its
custodian contract, the Custodian may employ one or more
subcustodians whose responsibilities will include safeguarding
and controlling each Fund's cash and securities, handling the
receipt and delivery of securities and collecting interest and
dividends on each Fund's investments. Each Fund pays the
Custodian an annual fee based on the assets of the Fund and the
Fund's securities transactions. Each Fund also pays the
Custodian an annual fee based on the Fund's securities holdings
for the year and reimburses the Custodian for certain out-of-
pocket expenses incurred by it or any subcustodian employed by it
in performing custodial services. The Custodian pays the fees and
other charges of any subcustodian employed by it.
PRINCIPAL HOLDERS OF SECURITIES AND CONTROLLING PERSONS
Listed below are the names and addresses of those shareholders
who, to the Equity Market Plus Fund's best knowledge, as of
November 30, 1997, owned 5% or more of the shares of the Fund.
NFSC FEBO
Texas Commerce Bank Pledged Co.
PO Box 2558
Houston, TX 77252 7.95%
Each Fund Trustee owns less than 1% of the shares of the
Equity Market Plus Fund as of November 30, 1997.
DETERMINATION OF NET ASSET VALUE
Each Fund determines net asset value as of the close of
regular trading on the New York Stock Exchange usually at 4 p.m.
If any securities held by a Fund are restricted as to resale, the
Adviser determines their fair value following procedures approved
by the Trustees. The Trustees periodically review such valuation
procedures. The fair value of such securities is generally
determined as the amount which the Fund could reasonably expect
to realize from an orderly disposition of such securities over a
reasonable period of time. The valuation procedures applied in
any specific instance are likely to vary from case to case.
However, consideration is generally given to the financial
position of the issuer and other fundamental analytical data
relating to the investment and to the nature of the restrictions
on disposition of the securities (including any registration
expenses that might be borne by the Fund in connection with such
disposition). In addition, specific factors are also generally
considered, such as the cost of the investment, the market value
of any unrestricted securities of the same class (both at the
time of purchase and at the time of valuation), the size of the
holding, the prices of any recent transactions or offers with
respect to such securities and any available analysts' reports
<PAGE>
24
regarding the issuer.
Trading in certain securities is substantially completed each day
at various times prior to the close of regular trading on the
Exchange. The values of these securities used in determining the
net asset value of the Fund's shares are computed as of such
times. Because regular trading in most foreign securities
markets is completed simultaneously with, or prior to, the close
of regular trading on the New York Stock Exchange, closing prices
for foreign securities usually are available for purposes of
computing the Financial Services Fund's net asset value.
However, in the event that the closing price of a foreign
security is not available in time to calculate the Financial
Services Fund's net asset value on a particular day, the Fund's
Board of Trustees has authorized the use of the market price for
the security obtained from an approved pricing service at an
established time during the day which may be prior to the close
of regular trading in the security. The value of all of the
Financial Services Fund's assets and liabilities expressed in
foreign currencies will be converted into U.S. dollars at the
spot rate of such currencies against U.S. dollars provided by an
approved pricing service. Because of the amount of time required
to collect and process trading information of large numbers of
securities issues, the values of certain securities (such as
convertible bonds and U.S. Government securities) are determined
based on market quotations collected earlier in the day at the
latest practicable time prior to the close of the Exchange.
Occasionally, events affecting the value of such securities may
occur between such times and the close of the Exchange that will
not be reflected in the computation of a Fund's net asset value.
If events materially affecting the value of such securities occur
during such period, then these securities will be valued at their
fair market value following procedures approved by the Trustees.
ADDITIONAL INFORMATION REGARDING PURCHASES
AND REDEMPTIONS OF FUND SHARES
All checks, drafts, wires and other payment mediums used for
purchasing or redeeming shares of a Fund must be denominated in
U.S. Dollars. A Fund reserves the right, in its sole discretion,
to either (a) reject any order for the purchase or sale of shares
denominated in any other currency, or (b) to honor the
transaction or make adjustments to shareholder's account for the
transaction as of a date and with a foreign currency exchange
factor
determined by the drawee bank.
Dividend checks which are returned to a Fund marked "unable to
forward" by the postal service will be deemed to be a request to
change the dividend option and the proceeds will be reinvested in
additional shares at the current net asset value until new
instructions are received.
Redemptions in Kind. The Funds are committed to pay in cash all
requests for redemption by any shareholder of record, limited in
amount, however, during any 90-day period to the lesser of
$250,000 or 1% of the value of a Fund's net assets at the
beginning of such period. Such commitment is irrevocable without
<PAGE>
25
the prior approval of the Securities and Exchange Commission. In
the case of requests for redemption in excess of such amounts,
the Trustees reserve the right to make payments in whole or in
part in securities or other assets of a Fund in case of any
emergency, or if the payment of such redemption in cash would be
detrimental to the existing shareholders of a Fund. In such
circumstances, the securities distributed would be valued at the
price used to compute the Fund's net assets. Should a Fund do
so, a shareholder may incur brokerage fees or other transaction
costs in converting the securities to cash.
Principal Underwriter. FPS Broker Services, Inc. (the "Principal
Underwriter"), 3200 Horizon Drive, P.O. Box 61503, King of
Prussia, PA 194060903, is the principal underwriter for the Funds
and is acting on a best efforts basis. The Principal Underwriter
is registered as a broker-dealer under the Securities Exchange
Act of 1934 and is a member of the National Association of
Securities Dealers, Inc. The offering of the Funds' shares is
continuous.
The Funds' underwriting agreement with the Principal
Underwriter provides that the Funds will pay all fees and
expenses in connection with: registering and qualifying their
shares under the various state "blue sky" laws; preparing,
setting in type, printing, and mailing its prospectuses and
reports to shareholders; and issuing their shares, including
expenses of confirming purchase orders. The Principal Underwriter
acts as the agent of the Funds in connection with the sale of
their shares in all states in which the shares are qualified and
in which the Principal Underwriter is qualified as a broker-
dealer. Under the underwriting agreement, the Principal
Underwriter may accept orders for Funds' shares at their offering
prices. For these services for the two Funds, the Adviser pays
the Principal Underwriter approximately $15,000. The Principal
Underwriter may enter into agreements with other broker-dealers
for the sale of the Funds' shares by them.
Reinvestment Date. The dividend reinvestment date is the date on
which the additional shares are purchased for the investor who
has its dividends reinvested. This date will vary and is not
necessarily the same date as the record date or the payable date
for cash dividends.
Special Services. The Funds may pay certain financial
institutions that maintain accounts with the Funds on behalf of
numerous beneficial owners for record keeping operations
performed with respect to such beneficial owners. Such financial
institutions may also charge a fee for their services directly to
their clients.
SHAREHOLDER INFORMATION
Each time shareholders buy, redeem or exchange shares or receive
a distribution, they will receive a statement confirming the
transaction and listing their current share balance. The Funds
also send annual and semiannual reports that keep shareholders
informed about each Fund's portfolio and performance, and year-
end tax information to simplify their recordkeeping. Shareholders
<PAGE>
26
may call FPS Services toll-free at 1-800 221-3137 for more
information, including account balances.
SUSPENSION OF REDEMPTIONS
The Funds may not suspend shareholders' right of redemption, or
postpone payment for more than seven days, unless the New York
Stock Exchange (the "Exchange") is closed for other than
customary weekends or holidays, or if permitted by the rules of
the Securities and Exchange Commission during periods when
trading on the Exchange is restricted or during any emergency
which makes it impracticable for the Funds to dispose of their
securities or to determine fairly the value of their net assets,
or during any other period permitted by order of the Commission
for protection of investors.
SHAREHOLDER LIABILITY
Under Massachusetts law, shareholders could, under certain
circumstances, be held personally liable for the obligations of
the Funds. However, the Agreement and Declaration of Trust
disclaims shareholder liability for acts or obligations of the
Funds and requires that notice of such disclaimer be given in
each agreement, obligation, or instrument entered into or
executed by the Funds or the Trustees. The Agreement and
Declaration of Trust provides for indemnification out of Fund
property for all loss and expense of any shareholder held
personally liable for the obligations of a Fund. Thus, the risk
of a shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which a Fund
would be unable to meet its obligations. The likelihood of such
circumstances is remote.
STANDARD PERFORMANCE MEASURES
Total return data for the Funds may from time to time be
presented in this Statement and in advertisements. Total return
for the one-year period and for the life of a Fund is determined
by calculating the actual dollar amount of investment return on a
$1,000 investment in a Fund made at the net asset value at the
beginning of the period, and then calculating the annual
compounded rate of return which would produce that amount. Total
return for a period of one year is equal to the actual return of
the Fund during that period. Total return calculations assume
reinvestment of all Fund distributions at net asset value on
their respective reinvestment dates. As of March 31, 1997, the
average annual total return for the Equity Market Plus Fund since
inception is 18.50% and the average annual total return for the
one-year period ended March 31, 1997 is 21.41%. For the five year
period, the average annual return was 21.3%. Since the Financial
Services Fund commenced operations as of the date of this
Statement, annualized total return information is not yet
available. At times, the Adviser may reduce its compensation or
assume expenses of a Fund in order to reduce a Fund's expenses.
The per share amount of any such fee reduction or assumption of
expenses for the life of a Fund, will be reflected in the
<PAGE>
27
Prospectus as updated. Any such fee reduction or assumption of
expenses would increase a Fund's total return during the period
of the fee reduction or assumption of expenses.
Independent statistical agencies measure a Fund's investment
performance and publish comparative information showing how the
Fund, and similar investment companies, performed in specified
time periods. The agencies whose reports are commonly used are
Morningstar, Inc, Lipper Analytical Services and Wiesenberger
Investment Companies Service. From time to time, a Fund may
distribute these comparisons to its shareholders or to potential
investors.
Both Funds' performance may also from time to time be compared
to Standard & Poor's 500 Composite Stock Price Index (the "S&P
500 Index"). Standard & Poor's performance figures reflect
changes of market prices and reinvestment of all regular cash
dividends and are not adjusted for commissions or other costs.
The Financial Services Fund's performance may also be compared to
the Standard & Poor's Financial Composite, an investment of 80%
in the S&P Financial Composite Index and 20% in Money Market
funds, the Keefe Bruyette & Woods Index, or the average of the
mutual funds in Morningstar's Specialty Financial category.
Because each Fund is a managed portfolio investing in a variety
of securities and derivative instruments, the securities it owns
will not match those in the Index. Other publications, indices,
and averages that may be used are as follows:
a) CDA Mutual Fund Report, published by CDA Investment
Technologies, Inc. - analyzes price, current yield, risk,
total return and average rate of return (average annual
compounded growth rate) over specified time periods for the
mutual fund industry.
b) Mutual Fund Source book, published by Morningstar, Inc.--
analyzes price, yield, risk and total return for equity and
fixed income funds.
c) Financial publications: Barron's, Business Week, Changing
Times, Financial World, Forbes, Fortune, and Money magazines
- rate fund performance over specified time periods.
d) Consumer Price Index (or Cost of Living Index) published by
the U.S. Bureau of Labor Statistics a statistical measure of
change, over time, in the price of goods and services in
major expenditure groups.
e) Stocks, Bonds, Bills, and Inflation, published by Ibbotson
Associates - historical measure of yield, price and total
return for common and small company stock, long-term
government bonds, treasury bills, and inflation.
f) Savings and Loan Historical Interest Rates - as published in
the U.S. Savings & Loan League Fact Book.
g) Salomon Brothers Broad Bond Index or its component indices -
The Broad Index measures yield, price and total return for
Treasury, Agency, Corporate, and Mortgage bonds.
<PAGE>
28
h) Salomon Brothers Composite High Yield Index or its component
indices - The High Yield Index measures yield, price and
total return for Long-Term High-Yield Index, Intermediate-
Term High-Yield Index and Long-Term Utility High-Yield
Index.
i) Lehman Brothers Aggregate Bond Index or its component
indices - The Aggregate Bond Index measures yield, price and
total return for Treasury, Agency, Corporate, Mortgage, and
Yankee bonds.
j) Lehman Brothers Government/Corporate Bond Index.
k) Other taxable investments including certificates of deposit
(CD's), money market deposit accounts (MMDA's), checking
accounts, savings accounts, money market mutual funds,
repurchase agreements, and government securities.
l) Historical data supplied by the research departments of
Lehman Brothers, First Boston Corporation, Morgan Stanley,
Salomon Brothers, Merrill Lynch, Goldman Sachs, Prudential
Securities and Donaldson Lufkin and Jenrette.
m) Donoghues's Money Fund Report--industry averages for seven-
day annualized and compounded yields taxable, tax-free and
government money funds.
n) Total returns and yields for Treasury Securities and fixed
income indices as published by Ryan Laboratories or other
suppliers.
Volatility. Occasionally statistics may be used to specify Fund
volatility or risk. Measures of volatility or risk are generally
used to compare fund net asset value or performance relative to a
market index. One measure of volatility is beta. The ratio of
the expected excess return on the portfolio to the expected
excess return on the market index is called beta. Equity funds
commonly use the S&P 500 as their market index. A beta of more
than 1.00 indicates volatility greater than the market, and a
beta of less than 1.00 indicates volatility less than the market.
Another measure of volatility or risk is standard deviation.
Standard deviation is used to measure variability of net asset
value or total return around an average, over a specified period
of time. The premise is that greater volatility connotes greater
risk undertaken in achieving performance. A statistic often used
by sophisticated institutional investors when comparing the
relative performance of portfolios is the Sharpe Ratio. This
statistic is the portfolio's excess return (relative to T-Bills)
divided by the standard deviation of its returns.
All data are based on past performance and do not predict future
results.
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey
08540, are the Funds' independent auditors, providing audit
services, tax return review and preparation services and
<PAGE>
29
assistance and consultation in connection with the review of
various Securities and Exchange Commission filings.
EXPERTS
The annual financial statements of the Equity Market Plus Fund
and related notes thereto attached to this Statement of
Additional Information have been so attached in reliance upon the
report of Deloitte & Touche LLP, independent auditors, given on
the authority of said firm as experts in auditing and accounting.
The semi-annual financial statements of the Equity Market Plus
Fund and related notes thereto attached to this Statement of
Additional Information have not been audited by Deloitte & Touche
LLP. As the Financial Services Fund commenced operations
December 22, 1997, the date of this Statement, there are no
financial statements (audited or unaudited) yet available for
that Fund.
REPORT OF INDEPENDENT AUDITORS AND FINANCIAL STATEMENTS
Attached are the audited financial statements for the fiscal
year ended March 31, 1997 and the unaudited financial statements
for the six-month period ended September 30, 1997, for the Equity
Market Plus Fund (formerly known as the Equity Plus Fund). As
the Financial Services Fund commenced operations December 22,
1997, there are no such statements for this Fund yet
available.
<PAGE>
30
<PAGE>
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
SCHEDULE OF INVESTMENTS (UNAUDITED) SEPTEMBER 30, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
MARKET
FACE AMOUNT SECURITY VALUE
- ----------- -------- -----------
<C> <S> <C>
U.S. GOVERNMENT & AGENCY OBLIGATIONS -- 69.17%
FEDERAL HOME LOAN MORTGAGE CORPORATION -- 11.78%*
FHLMC:
$ 6,983,120 7.50%, due date to be announced.............................................................. $ 7,106,416
83,392 9.50%, due 7/1/02............................................................................ 86,615
-----------
TOTAL FEDERAL HOME LOAN MORTGAGE CORPORATION
(COST $7,136,710).......................................................................... 7,193,031
-----------
FEDERAL NATIONAL MORTGAGE ASSOCIATION -- 1.20%*
FNMA:
101,671 12.50%, due 9/1/12........................................................................... 117,405
63,560 13.50%, due 1/1/15........................................................................... 75,988
FNMA ARM:
519,184 7.837%, due 9/1/18........................................................................... 541,095
-----------
TOTAL FEDERAL NATIONAL MORTGAGE ASSOCIATION (COST $714,843).................................. 734,488
-----------
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION -- 52.59%*
GNMA:
1,996,814 8.00%, due 4/15/27........................................................................... 2,065,601
GNMA ARM:
3,514,500 5.00%, due 9/20/27........................................................................... 3,469,034
22,273,555 5.50%, due 2/20/27 to 9/20/27................................................................ 22,250,777
839,359 6.50%, due 10/26/27.......................................................................... 859,024
1,621,509 7.00%, due 2/20/16 to 2/20/21................................................................ 1,674,976
203,818 7.125%, due 9/20/21 to 9/20/22............................................................... 209,708
1,544,630 7.375%, due 6/20/16 to 5/20/22............................................................... 1,595,705
-----------
TOTAL GOVERNMENT NATIONAL MORTGAGE ASSOCIATION
(COST $31,904,869)......................................................................... 32,124,825
-----------
U.S. GOVERNMENT OBLIGATIONS -- 3.60%
U.S. TREASURY BILL **
100,000 5.21%, due 11/13/97***....................................................................... 99,421
830,000 5.52%, due 5/28/98***........................................................................ 801,842
100,000 5.32%, due 5/28/98***........................................................................ 96,608
750,000 5.20%, due 5/28/98***........................................................................ 724,108
500,000 5.25%, due 8/20/98***........................................................................ 476,717
-----------
TOTAL U.S. GOVERNMENT OBLIGATIONS (COST $2,195,991).......................................... 2,198,696
-----------
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS (COST $41,952,413)................................ 42,251,040
-----------
<CAPTION>
CONTRACTS OPTION CONTRACTS -- 0.03%
- -----------
<C> <S> <C>
85 Call on Ten-Year US Treasury Note futures, expires 12/97, strike price $112.................. 15,938
74 Put on Ten-Year US Treasury Note futures, expires 12/97, strike price $105.5................. 4,625
-----------
TOTAL OPTION CONTRACTS (COST $60,309)........................................................ 20,563
-----------
TOTAL INVESTMENTS (COST $42,012,722) -- 69.20%............................................... 42,271,603
-----------
<CAPTION>
FACE AMOUNT REPURCHASE AGREEMENTS -- 30.12%:
- -----------
<C> <S> <C>
$13,000,000 Morgan Stanley, 5.58%, due 10/1/97 dated 9/24/97............................................. 13,000,000
5,400,000 Dresdner, 5.60%, due 10/6/97 dated 9/29/97................................................... 5,400,000
-----------
TOTAL REPURCHASE AGREEMENTS (COST $18,400,000)............................................... 18,400,000
-----------
CASH AND OTHER ASSETS LESS LIABILITIES -- 0.68%.............................................. 414,787
-----------
NET ASSETS -- 100.00%........................................................................ $61,086,390
-----------
-----------
</TABLE>
19
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
SCHEDULE OF INVESTMENTS (CONTINUED) (UNAUDITED) SEPTEMBER 30, 1997
- --------------------------------------------------------------------------------
- ---------------
* Mortgage-backed obligations are subject to principal paydowns as a result of
prepayments or refinancings of the underlying mortgage loans. As a result,
the average life may be substantially less than the original maturity. The
interest rate shown is the rate in effect at September 30, 1997. ARMs have
coupon rates which adjust periodically. The adjusted rate is determined by
adding a spread to a specified index.
** The interest rate shown is the discount rate paid at the time of purchase by
the Fund.
*** Security is segregated as collateral.
Portfolio Abbreviations:
ARM -- Adjustable-Rate Mortgage
FHLMC -- Federal Home Loan Mortgage Corporation
FNMA -- Federal National Mortgage Association
GNMA -- Government National Mortgage Association
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
20
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
STATEMENT OF ASSETS AND LIABILITIES
SEPTEMBER 30, 1997 (UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
ASSETS:
Investments at market value (identified cost $42,012,722)(Note 1)........................................... $42,271,603
Cash........................................................................................................ 759,321
Repurchase Agreements (Cost $18,400,000)) (Note 1).......................................................... 18,400,000
Receivables:
Subscriptions............................................................................................ 7,661,442
Interest................................................................................................. 197,890
Maturities............................................................................................... 3,229
Securities sold.......................................................................................... 7,568,995
Other Assets................................................................................................ 25,365
-----------
TOTAL ASSETS............................................................................................. 76,887,845
-----------
LIABILITIES:
Variation margin on futures contracts (Note 2).............................................................. 467,645
Payables:
Redemptions.............................................................................................. 621,824
Securities purchased..................................................................................... 14,655,973
Due to adviser (Note 3)..................................................................................... 29,492
Accrued expenses............................................................................................ 26,521
-----------
TOTAL LIABILITIES........................................................................................ 15,801,455
-----------
NET ASSETS:
(Applicable to outstanding shares of 4,015,310; unlimited number of shares of beneficial interest
authorized; no stated par)............................................................................... $61,086,390
-----------
-----------
Net asset value, offering price and redemption price per share ($61,086,39044,015,310)...................... $ 15.21
-----------
-----------
SOURCE OF NET ASSETS:
Paid in capital............................................................................................. $56,240,220
Undistributed net investment income......................................................................... 217,425
Accumulated net realized gain on investments................................................................ 4,017,695
Net unrealized appreciation of investments.................................................................. 611,050
-----------
NET ASSETS............................................................................................... $61,086,390
-----------
-----------
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
21
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
INVESTMENT INCOME:
Interest and discount earned, net of premium amortization (Note 1)........................................... $ 919,615
EXPENSES:
Advisory fees (Note 3)....................................................................................... 110,914
Accounting and pricing services fees......................................................................... 13,312
Custodian fees............................................................................................... 8,875
Audit and tax preparation fees............................................................................... 2,855
Legal fees................................................................................................... 3,895
Amortization of organization expenses (Note 1)............................................................... 6,929
Transfer agent fees.......................................................................................... 18,329
Registration fees............................................................................................ 18,655
Trustees fees and expenses................................................................................... 7,195
Insurance expense............................................................................................ 3,448
Other........................................................................................................ 9,712
----------
TOTAL EXPENSES BEFORE REIMBURSEMENT....................................................................... 204,119
Expenses reimbursed by Adviser (Note 3)................................................................... (64,685)
----------
NET EXPENSES.............................................................................................. 139,434
----------
NET INVESTMENT INCOME..................................................................................... 780,181
----------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gain on investments............................................................................. 3,582,275
Change in unrealized appreciation (depreciation) of investments.............................................. 1,099,360
----------
Net realized and unrealized gain on investments.............................................................. 4,681,635
----------
Net increase in net assets resulting from operations......................................................... $5,461,816
----------
----------
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
22
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED
SEPTEMBER 30, 1997 MARCH 31, 1997
(UNAUDITED) (AUDITED)
------------------ --------------
<S> <C> <C>
OPERATIONS:
Net investment income................................................................ $ 780,181 $ 406,086
Net realized gain on investments..................................................... 3,582,275 1,374,343
Change in unrealized appreciation (depreciation) of investments...................... 1,099,360 (526,585)
------------------ --------------
Net increase in net assets resulting from operations................................. 5,461,816 1,253,844
------------------ --------------
DISTRIBUTIONS TO SHAREHOLDERS:
Dividends from net investment income................................................. (598,989) (382,446)
Distributions from net realized gains on investments................................. (429,677) (808,371)
------------------ --------------
Total distributions.................................................................. (1,028,666) (1,190,817)
------------------ --------------
CAPITAL SHARE TRANSACTIONS:
Shares sold.......................................................................... 50,138,951 8,844,701
Shares issued on reinvestment of distributions....................................... 930,749 1,125,870
Shares redeemed...................................................................... (7,923,837) (1,292,755)
------------------ --------------
Increase in net assets resulting from capital share transactions (a)................. 43,145,863 8,677,816
------------------ --------------
TOTAL INCREASE IN NET ASSETS...................................................... 47,579,013 8,740,843
NET ASSETS:
Beginning of year.................................................................... 13,507,377 4,766,534
------------------ --------------
End of year.......................................................................... $ 61,086,390 $ 13,507,377
------------------ --------------
------------------ --------------
(a) Transactions in capital shares were as follows:
Shares sold....................................................................... 3,404,871 695,525
Shares issued on reinvestment of distributions.................................... 63,589 93,492
Shares redeemed................................................................... (528,659) (102,037)
------------------ --------------
Net increase...................................................................... 2,939,801 686,980
Beginning balance................................................................. 1,075,509 388,529
------------------ --------------
Ending balance.................................................................... 4,015,310 1,075,509
------------------ --------------
------------------ --------------
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
23
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
The following average per share data, ratios and supplemental information
has been derived from information provided in the financial statements.
<TABLE>
<CAPTION>
SIX MONTHS
ENDED YEAR YEAR YEAR YEAR PERIOD
SEPTEMBER 30, ENDED ENDED ENDED ENDED ENDED
1997 MARCH 31, MARCH 31, MARCH 31, MARCH 31, MARCH 31,
(UNAUDITED) 1997 1996 1995 1994 1993 (1)
------------- ----------- ---------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF
PERIOD.......................... $ 12.56 $ 12.27 $ 10.84 $ 9.88 $ 10.85 $ 10.00
------------- ----------- ---------- ---------- ---------- ---------
INCOME FROM INVESTMENT
OPERATIONS
Net investment income........... 0.250 0.592 0.615 0.568 0.476 0.355
Net realized and unrealized gain
(loss) on investments........ 2.877 1.813 2.768 1.081 (0.216) 1.281
------------- ----------- ---------- ---------- ---------- ---------
Total from investment
operations................. 3.127 2.405 3.383 1.649 0.260 1.636
------------- ----------- ---------- ---------- ---------- ---------
LESS DISTRIBUTIONS
Dividends from net investment
income....................... (0.230) (0.590) (0.583) (0.568) (0.472) (0.311)
Dividends in excess of net
investment income............ -- -- -- (0.001) -- --
Distributions from net realized
gains on investments......... (0.247) (1.525) (1.370) (0.047) (0.701) (0.420)
Distributions in excess of net
realized gains on
investments.................. -- -- -- (0.073) (0.057) (0.055)
------------- ----------- ---------- ---------- ---------- ---------
Total distributions.......... (0.477) (2.115) (1.953) (0.689) (1.230) (0.786)
------------- ----------- ---------- ---------- ---------- ---------
NET ASSET VALUE, END OF PERIOD.... $ 15.21 $ 12.56 $ 12.27 $ 10.84 $ 9.88 $ 10.85
------------- ----------- ---------- ---------- ---------- ---------
TOTAL RETURN...................... 25.08% 21.41% 32.30% 17.18% 2.19% 16.52%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period....... $ 61,086,390 $13,507,377 $4,766,534 $2,107,346 $1,760,519 $ 903,846
Ratio of expenses to average net
assets (1)................... 0.88%* 0.88% 0.90% 0.90% 0.90% 0.57%*
Ratio of net investment income
to average net assets (2).... 4.95%* 5.30% 5.53% 7.44% 8.02% 5.28%*
Portfolio turnover rate......... 196% 182% 107% 120% 119% 271%
Ratio of expenses to average net
assets before reimbursement
of expenses by the Adviser... 1.28%* 2.60% 4.58% 7.75% 7.08% 28.48%*
Ratio of net investment income
to average net assets before
reimbursement of expenses by
the Adviser.................. 4.54%* 3.58% 1.85% 0.59% 1.84% -22.63%*
</TABLE>
- ---------------
(1) Commenced operations June 30, 1992.
* Annualized
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
24
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Breeden Equity Plus Fund (the "Fund") is a series of the Smith Breeden
Trust (the "Trust"), an open-end, diversified management investment company
registered under the Investment Company Act of 1940, as amended. The following
is a summary of significant accounting policies consistently followed by the
Fund.
A. SECURITY VALUATION: Portfolio securities are valued at current market value
provided by a pricing service or by a bank or broker/dealer experienced in such
matters, when over-the-counter market quotations are readily available.
Securities and other assets for which market prices are not readily available
are valued at fair market value as determined in accordance with procedures
approved by the Board of Trustees.
B. DISTRIBUTIONS AND TAXES: Dividends to shareholders are recorded on the
ex-dividend date. The Fund intends to continue to qualify for and elect the
special tax treatment afforded regulated investment companies under Subchapter M
of the Internal Revenue Code, thereby relieving the Fund of federal income
taxes. To so qualify, the Fund intends to distribute substantially all of its
net investment income and net realized capital gains, if any, less any available
capital loss carryforward. As of March 31, 1997, the Fund had no net capital
loss carryforward.
C. REPURCHASE AGREEMENTS: The Fund may enter into repurchase agreements with
member banks of the Federal Reserve System having total assets in excess of $500
million and securities dealers, provided that such banks or dealers meet the
credit guidelines of the Fund's Board of Trustees. In a repurchase agreement,
the Fund acquires securities from a third party with the commitment that they
will be repurchased by the seller at a fixed price on an agreed upon date. The
Fund's custodian maintains control or custody of these securities which
collateralize the repurchase agreements until maturity of the repurchase
agreements. The value of the collateral is monitored daily, and if necessary,
additional collateral is received to ensure that the market value of the
underlying assets remains sufficient to protect the Fund in the event of the
seller's default. However, in the event of default or bankruptcy of the seller,
the Fund's right to the collateral may be subject to legal proceedings.
D. REVERSE REPURCHASE AGREEMENTS: A reverse repurchase agreement involves the
sale by the Fund of portfolio assets concurrently with an agreement by the Fund
to repurchase the same assets at a later date at a fixed price. The Fund will
maintain a segregated account with its custodian, which will be marked to market
daily, consisting of cash, U.S. Government securities or other liquid high-grade
debt obligations equal in value to its obligations under reverse repurchase
agreements. In the event the buyer of securities under a reverse repurchase
agreement files for bankruptcy or becomes insolvent, the Fund's use of the
proceeds of the agreement may be restricted pending a determination by the other
party, or its trustee or receiver, whether to enforce the Fund's obligation to
repurchase the securities.
E. DETERMINATION OF GAINS OR LOSSES ON SALES OF SECURITIES: Gains or losses on
the sale of securities are calculated for accounting and tax purposes on the
identified cost basis.
F. DEFERRED ORGANIZATION EXPENSES: Deferred organization expenses are being
amortized on a straight-line basis over five years.
G. SECURITIES TRANSACTIONS AND INVESTMENT INCOME: Interest income is accrued
daily on both long-term bonds and short-term investments. Interest income also
includes net amortization from the purchase of fixed-income securities.
Discounts and premiums on securities purchased are amortized over the life of
the respective securities. Transactions are recorded on the first business day
following the trade date. Realized gains and losses from security transactions
are determined and accounted for on the basis of identified cost.
2. FINANCIAL INSTRUMENTS
A. DERIVATIVE FINANCIAL INSTRUMENTS HELD OR ISSUED FOR PURPOSES OTHER THAN
TRADING: The Fund uses interest rate futures contracts for risk management
purposes in order to manage the Fund's interest-rate risk relative to its
benchmark. Upon entering into a futures contract, the Fund is required to
deposit either cash or securities in an amount (initial margin) equal to a
certain percentage of the contract value. Subsequent payments (variation margin)
are made or received by the Fund each day. The variation margin payments are
equal to the daily changes in
25
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED)
- --------------------------------------------------------------------------------
2. FINANCIAL INSTRUMENTS -- CONTINUED
the contract value and are recorded as unrealized gains or losses. The Fund
recognizes a realized gain or loss when the contract is closed or expires equal
to the difference between the value of the contract at the time it was opened
and the value at the time it was closed.
Futures contracts involve costs and may result in losses. The effective use of
futures strategies depends on the Fund's ability to terminate futures positions
at times when the Fund's investment adviser deems it desirable to do so. The use
of futures also involves the risk of imperfect correlation among movements in
the values of the securities underlying the futures purchased and sold by the
Fund, of the futures contract itself, and of the securities which are the
subject of a hedge.
The Fund had the following open futures contracts as of September 30, 1997:
<TABLE>
<CAPTION>
NOTIONAL EXPIRATION UNREALIZED
TYPE AMOUNT POSITION MONTH GAIN/(LOSS)
----- ------------ --------- ---------------- -----------
<S> <C> <C> <C> <C>
3 Month Eurodollar.................................. $ 88,000,000 Long December, 1997 $ 17,716
3 Month Eurodollar.................................. (31,000,000) Short March, 1998 (22,602)
3 Month Eurodollar.................................. (34,000,000) Short September, 1998 (33,003)
3 Month Eurodollar.................................. (30,000,000) Short March, 1999 (20,885)
3 Month Eurodollar.................................. (36,000,000) Short September, 1999 (40,362)
3 Month Eurodollar.................................. (31,000,000) Short March, 2000 (22,039)
3 Month Eurodollar.................................. (36,000,000) Short September, 2000 (30,137)
3 Month Eurodollar.................................. (32,000,000) Short March, 2001 (23,169)
3 Month Eurodollar.................................. (36,000,000) Short September, 2001 (35,837)
5 Year Treasury..................................... (21,000,000) Short December, 1997 (12,781)
10 Year Treasury.................................... (38,000,000) Short December, 1997 (38,171)
-----------
Total $ (261,270)
-----------
-----------
</TABLE>
B. DERIVATIVE FINANCIAL INSTRUMENTS HELD OR ISSUED FOR TRADING PURPOSES: The
Fund invests in futures contracts on the S&P 500 Index whose returns are
expected to track movements in the S&P 500 Index.
The Fund had the following open futures contracts on the S&P 500 Index as of
September 30, 1997:
<TABLE>
<CAPTION>
NOTIONAL EXPIRATION UNREALIZED
TYPE AMOUNT POSITION MONTH GAIN
----- ----------- --------- --------------- -----------
<S> <C> <C> <C> <C>
S&P 500............................................... $11,912,500 Long December, 1997 $ 372,284
S&P 500............................................... 3,853,200 Long March, 1998 241,155
-----------
Total $ 613,439
-----------
-----------
</TABLE>
The aggregate market value of investments pledged to cover margin requirements
for the open positions at September 30, 1997 was $2,198,696.
3. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES
Smith Breeden Associates, Inc. (the "Adviser"), a registered investment adviser,
provides the Fund with investment management services. As compensation for these
services, the Fund pays the Adviser a fee computed daily and payable monthly, at
an annual rate equal to 0.70% of the Fund's average daily net asset value.
The Adviser has voluntarily agreed to reduce or otherwise limit the expenses of
the Fund to 0.88% of the Fund's average daily net assets. This voluntary
agreement may be terminated or modified at any time by the Adviser in its sole
discretion, except that the Adviser has agreed to limit expenses of the Fund to
0.88% through August 1, 1998. For the six-months ended September 30, 1997, the
Adviser received fees of $110,914 and reimbursed the Fund $64,685.
26
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED)
- --------------------------------------------------------------------------------
3. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES -- CONTINUED
Effective August 1, 1994, the Fund adopted a Distribution and Services Plan (the
"Plan") pursuant to Rule 12b-1 under the Investment Company Act of 1940. The
purpose of the Plan is to permit the Adviser to compensate investment dealers
and other persons involved in servicing shareholder accounts for services
provided and expenses incurred in promoting the sale of shares of the Fund,
reducing redemptions, or otherwise maintaining or improving services provided to
shareholders by such dealers or other persons. The Plan provides for payments by
the Adviser, out of its advisory fee paid to it by the Fund, to dealers and
other persons at the annual rate of up to 0.25% of the Fund's average net assets
subject to the authority of the Trustees of the Fund to reduce the amount of
payments permitted under the Plan or to suspend the Plan for such periods as
they may determine. Subject to these limitations, the amount of such payments
and the purposes for which they are made shall be determined by the Adviser.
Certain officers and trustees of the Fund are also officers and directors of the
Adviser.
4. INVESTMENT TRANSACTIONS
During the six-months ended September 30, 1997, purchases and proceeds from
sales of securities, other than short-term investments, aggregated $77,305,082
and $47,990,202, respectively. The cost of securities for federal income tax
purposes is $42,012,723. Net unrealized depreciation of investments and futures
contracts consists of:
<TABLE>
<S> <C>
Gross unrealized appreciation................................................ $650,797
Gross unrealized depreciation................................................ (39,747)
--------
Net unrealized depreciation.................................................. $611,050
--------
--------
</TABLE>
27
<PAGE>
Smith Breeden Equity Plus Fund Annual Report and Performance
Review
(Effective December 22, 1997, the name of the Equity Plus
Fund
will be changed to the Equity Market Plus Fund)
Performance Review
The Smith Breeden Equity Plus Fund provided a total
return of
21.41% in the year ending March 31, 1997. The Fund's
return exceeded
the 19.84% return of its benchmark, the S&P 500 Index, by
1.57%. Since
the Fund's inception on June 30, 1992, its return has
exceeded that of its
benchmark by 14.22%, and on an annualized basis by 1.62%.
The graph
below plots the Fund's return versus its benchmark and
versus the average
return of Morningstar Inc.'s Growth and Income fund
category.
THE LINE GRAPH DETAILING PERFORMANCE VERSUS THE EQUITY PLUS'
INDEX
ACCORDING TO ITEM 5a. OF FORM N1-A IS LOCATED HERE IN THE
TEXT AND IS
DESCRIBED BELOW IN ACCORDANCE WITH REG 232.304 OF REGULATION
S-T:
THE GRAPH DEPICTS THE CHANGE IN VALUE OF A $10,000
INVESTMENT IN
THE VERSUS THE S&P 500 AND VERSUS THE AVERAGE OF
THE FUNDS IN MORNINGSTAR'S GROWTH AND INCOME CATEGORY.
THE EQUITY PLUS' AVERAGE ANNUAL RETURN WAS 21.41% FOR THE
ONE YEAR PERIOD,
23.47% THE THREE YEAR PERIOD, 18.50% FOR THE PERIOD
SINCE INCEPTION. THE AVERAGE ANNUAL RETURN OF THE S&P 500
WAS 19.84%
FOR THE ONE YEAR PERIOD, 22.31% FOR THE THREE YEAR PERIOD,
16.88% FOR THE
PERIOD FROM INCEPTION. THE AVERAGE ANNUAL
RETURN OF THE AVERAGE OF THE FUNDS IN MORNINGSTAR'S GROWTH
AND INCOME
CATEGORY WAS 16.10% FOR THE ONE YEAR PERIOD, 18.35% FOR THE
THREE YEAR PERIOD,
AND 14.87% FOR THE FIVE YEAR AND SINCE INCEPTION RETURNS.
FROM INCEPTION THROUGH MARCH 31, 1997, AN INVESTMENT
OF $10,000 IN THE EQUITY PLUS WOULD HAVE GROWN TO $22,411,
VERSUS
$20,988 IN ITS BENCHMARK, AND $19,320 OF THE AVERAGE OF THE
FUNDS IN
MORNINGSTAR'S GROWTH AND INCOME CATEGORY.
The S&P 500 index return was produced by strong
corporate
earnings rather than by falling interest rates in the year
ending March 31,
1997. Corporate earnings were approximately 15% higher in
the year
ending December 1996 over a year earlier. First quarter
1997 earnings
were also generally strong, in many cases exceeding
analysts' expectations.
The growth in corporate earnings, combined with low
unemployment
rates, caused some concern that the U.S. economy is growing
too fast and
this led to moderately rising interest rates due to
increased fears of
inflation. The thirty-year U.S. Treasury bond yield rose
from 6.66% in
March 1996 to 7.09% in March 1997. Rising interest rates in
turn
produced several small sell-offs in the stock market,
resulting in declines in
the S&P 500 Index in three out of the last twelve months.
It is by no
means clear that inflation is on the rise however, and much
of the gain in
corporate earnings can be explained by the high levels of
productive
investment made by corporations during this economic
expansion.
The strategy employed by the Equity Plus Fund to achieve its
goal
of providing a return in excess of the S&P 500 index has two
components.
The Fund uses equity index futures contracts to track the
S&P 500 index,
and it uses a hedged bond portfolio to provide income to
cover the
operating costs of the fund as well as the financing costs
of the equity index
futures contracts. Equity index futures contracts are
available with
different maturity dates. Because the fund controls when it
sells one equity
futures contract and buys a new one, it can take advantage
of times when
one futures contract is cheap relative to another.
Approximately 0.30% of
the Fund's return in excess of its benchmark for the year
ending March
1997 was due to purchasing equity index futures at favorable
prices relative
to the price of the contracts sold.
U.S. Government agency mortgage securities produced
excellent
hedged returns in the year ended March 31, 1997, and the
Equity Plus
Fund was able to take advantage of this performance to
generate the rest of
the Fund's excess return over the S&P 500 index. One factor
explaining
the superior performance by mortgages was a decline in
interest rate
volatility. Mortgage buyers demand a yield premium when
they purchase
mortgage bonds against the risk that interest rates will
move in an
unfavorable direction. Because interest rate volatility
measures the
likelihood of changes in the level of interest rates, when
volatility falls
mortgage buyers demand a smaller premium and consequently
the yield on
mortgages falls relative to the yield on U.S. Treasury
securities. The
Equity Plus Fund held approximately 60% of its assets in
adjustable-rate
mortgages during the year ended on March 31, 1997, and about
20% in
fixed-rate mortgages. The remaining assets were invested in
U.S. Treasury
Bills.
SMITH BREEDEN EQUITY PLUS FUND
SCHEDULE OF INVESTMENTS MARCH 31, 1997
Market
Face Amount Security
Value
U.S. GOVERNMENT & AGENCY OBLIGATIONS - 121.45%
FEDERAL HOME LOAN MORTGAGE CORPORATION - 7.92% *
FHLMC:
$983,120 7.50%, due (a) ...................................
$963,150
103,239 9.50%, due 7/1/02 ................................
106,178
TOTAL FEDERAL HOME LOAN MORTGAGE CORPORATION
(Cost $1,090,669) 1,069,328
FEDERAL NATIONAL MORTGAGE ASSOCIATION - 6.94% *
FNMA:
110,165 12.50%, due 9/1/12 ..............................
126,541
104,722 13.50%, due 11/1/14 to 1/1/15 ..................
120,635
FNMA ARM:
660,968 7.753%, due 9/1/18..............................
689,968
TOTAL FEDERAL NATIONAL MORTGAGE ASSOCIATION
(Cost $916,731)
937,144
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION - 66.09%
*
GNMA ARM:
2,020,000 5.00%, due 3/20/27 ...........................
1,953,136
1,990,000 5.50%, due (a) ...............................
1,944,294
2,632,161 6.50%, due 2/20/16 to 10/20/26 ...............
2,676,380
2,295,509 7.125%, due 4/20/16 to 9/20/22 ...............
2,353,002
TOTAL GOVERNMENT NATIONAL MORTGAGE ASSOCIATION
(Cost $8,904,340) 8,926,812
U.S. GOVERNMENT OBLIGATIONS - 40.50%
U.S. TREASURY BILL **
20,000 5.38%, due 5/29/97 .............................
19,832
1,000,000 5.05%, due 5/29/97 .............................
991,622
600,000 4.94%, due 5/29/97*** ..........................
594,973
2,000,000 5.12%, due 5/29/97 .............................
1,983,244
600,000 5.08%, due 5/29/97 .............................
594,973
700,000 5.06%, due 5/29/97 .............................
694,136
500,000 5.02%, due 5/29/97 .............................
495,812
100,000 5.21%, due 11/13/97*** .........................
96,566
TOTAL U.S. GOVERNMENT OBLIGATIONS (Cost
$5,472,482) 5,471,158
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(Cost $16,384,222) 16,404,442
Contracts OPTION CONTRACTS - 0.13%
3 Call on 5 Year US Treasury Note futures, expires
5/97,
strike price $110 47
37 Put on 5 Year US Treasury Note futures, expires
5/97,
strike price $104 17,922
TOTAL OPTION CONTRACTS (Cost $10,196)
................ 17,969
TOTAL INVESTMENTS (Cost $16,394,418) - 121.58%
.... 16,422,411
CASH AND OTHER ASSETS LESS LIABILITIES - (21.58%)
(2,915,034)
NET ASSETS - 100.00% ........................
$13,507,377
* Mortgage-backed obligations are subject to principal
paydowns as a result
of prepayments or refinancings of the underlying
mortgage loans. As a
result, the average life may be substantially less
than the original
maturity. The interest rate shown in the rate in
effect at March 31,
1997. ARMs have coupon rates which adjust
periodically. The adjusted
rate is determined by adding a spread to a specified
index.
** The interest rate shown is the discount rate paid at
the time of purchase
by the Fund.
*** Security is segregated as collateral.
(a) To be Announced
Portfolio Abbreviations:
ARM - Adjustable-Rate Mortgage
FHLMC - Federal Home Loan Mortgage Corporation
FNMA - Federal National Mortgage Association
GNMA - Government National Mortgage Association
The accompanying notes are an integral part of these
financial statements.
SMITH BREEDEN EQUITY PLUS FUND
STATEMENT OF ASSETS AND LIABILITIES
31-Mar-97
ASSETS:
Investments at market value (identified cost $16,394,418)
(Note 1) $16,422,411
Cash........................................................
62,780
Receivables:
Subscriptions............................................
180,877
Interest.................................................
53,648
Maturities...............................................
2,590
Securities
sold.........................................
2,925,313
Deferred organization expenses (Note
1)................... 6,796
TOTAL
ASSETS..........................................
19,654,415
LIABILITIES:
Variation margin on futures contracts (Note
2).............. 192,294
Payables:
Redemptions
..............................................
50,041
Securities
purchased......................................
5,876,144
Due to adviser (Note
3)..................................... 8,343
Accrued
expenses.............................................
20,216
TOTAL
LIABILITIES.........................................
6,147,038
NET ASSETS:
(Applicable to outstanding shares of 1,075,509; unlimited
number of shares
of beneficial interest authorized; no stated
par)....... $13,507,377
Net asset value, offering price and redemption
price per share ($13,507,377/
1,075,509)................ $12.56
SOURCE OF NET ASSETS:
Paid in
capital.............................................
$13,094,357
Undistributed net investment
income.......................... 36,234
Accumulated net realized gain on
investments................. 865,097
Net unrealized depreciation of
investments................... (488,311)
NET
ASSETS............................................
$13,507,377
The accompanying notes are an integral part of these
financial statements.
SMITH BREEDEN EQUITY PLUS FUND
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1997
INVESTMENT INCOME:
Interest and discount earned, net of premium
amortization
(Note 1)...... $473,488
EXPENSES:
Advisory fees (Note
3)........................................... 53,341
Accounting and pricing services
fees........................... 25,141
Custodian
fees.................................................
13,067
Audit and tax preparation
fees.................................... 10,250
Legal
fees.......................................................
2,799
Amortization of organization expenses (Note 1)..........
27,791
Transfer agent
fees..............................................
29,506
Registration
fees...............................................
27,132
Trustees fees and
expenses................................... 3,751
Insurance expense....................................
6,549
Other.......................................................
....... 40
TOTAL EXPENSES BEFORE REIMBURSEMENT............
199,367
Expenses reimbursed by Adviser (Note
3)....................... (131,965)
NET
EXPENSES................................................
67,402
NET INVESTMENT
INCOME....................................... 406,086
REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gain on
investments............................... 1,374,343
Change in unrealized appreciation (depreciation) of
investments (526,585)
Net realized and unrealized gain on
investments................ 847,758
Net increase in net assets resulting from
operations......... $1,253,844
The accompanying notes are an integral part of these
financial statements.
SMITH BREEDEN EQUITY PLUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
Year Ended Year Ended
March 31, 1997 March 31, 1996
OPERATIONS:
Net investment income.......................
$406,086 $171,628
Net realized gain on investments...............
1,374,343 709,594
Change in unrealized appreciation (depreciation)
of investments..... (526,585)
(66,654)
Net increase in net assets resulting from
operations.................. 1,253,844
814,568
DISTRIBUTIONS TO SHAREHOLDERS:
Dividends from net investment income..........
(382,446) (159,034)
Distributions from net realized gains on
investments............ (808,371)
(371,974)
Total distributions........................
(1,190,817) (531,008)
CAPITAL SHARE TRANSACTIONS:
Shares sold................................
8,844,701 2,256,010
Shares issued on reinvestment of distributions
1,125,870 502,798
Shares redeemed.......................... (1,292,755)
(383,180)
Increase in net assets resulting from capital
share transactions (a) 8,677,816
2,375,628
TOTAL INCREASE IN NET ASSETS..... 8,740,843
2,659,188
NET ASSETS:
Beginning of year..........................
4,766,534 2,107,346
End of year.................................
$13,507,377 $4,766,534
(a) Transactions in capital shares were as follows:
Shares sold...........................
695,525 183,531
Shares issued on reinvestment of distributions
93,492 42,520
Shares redeemed........................
(102,037) (32,004)
Net increase...........................
686,980 194,047
Beginning balance .....................
388,529 194,482
Ending balance........................
1,075,509 388,529
The accompanying notes are an integral part of these
financial statements.
SMITH BREEDEN EQUITY PLUS FUND
FINANCIAL HIGHLIGHTS
<TABLE>
The following average per share data, ratios and
supplemental information has been derived from information
provided in the
financial statements.
<CAPTION>
Year Year Year Year Period
Ended Ended Ended Ended Ended
31-Mar-97 31-Mar-96 31-Mar-95 31-Mar-94 31-Mar-93*
<S>
<C> <C> <C> <C> <C>
Net Asset Value, Beginning of
Period...........................$12.27 $10.84
$9.88 $10.85 $10.00
Income From Investment Operations
Net investment
income......................................... 0.592
0.615 0.568 0.476 0.355
Net realized and unrealized gain (loss) on
investments.........1.813 2.768 1.081
(0.216) 1.281
Total from investment
operations.......................... 2.405 3.383
1.649 0.26 1.636
Less Distributions
Dividends from net investment
income.......................... (0.59) (0.583)
(0.568) (0.472) (0.311)
Dividends in excess of net investment
income.................. - - 0.001
- - -
Distributions from net realized gains on
investments......... (1.525) (1.37) (0.047)
(0.701) (0.42)
Distributions in excess of net realized gains on
investments. - - (0.073)
(0.057) (0.055)
Total
distributions........................................(2.115)
(1.953) (0.689) (1.23) (0.786)
Net Asset Value, End of Period..............................
$12.56 $12.27 $10.84 $9.88
$10.85
Total
Return....................................................
21.41% 32.30% 17.18% 2.19% 22.59%**
Ratios/Supplemental Data
Net assets, end of period................................
$13,507,377 $4,766,534 $2,107,346 $1,760,519
$903,846
Ratio of expenses to average net assets
<F1>................. 0.88% 0.90% 0.90%
0.90% 0.57%**
Ratio of net investment income to average net assets
<F2>.......5.30% 5.53% 7.44% 8.02%
5.28%**
Portfolio turnover
rate.........................................182%
107% 120% 119% 271%
<FN>
<F1>
The annualized ratio of expenses to average net assets prior
to reimbursement of expenses by the Adviser was 2.60%,
4.58%,
7.75%, 7.08%, and 28.48% for the years ended March 31, 1997,
March 31, 1996, March 31, 1995, March 31, 1994, and the
period ended
March 31, 1993, respectively.
</FN>
<FN>
<F2> The annualized ratio of net investment income to
average net assets prior to reimbursement of expenses by the
Adviser was
3.58%, 1.85%, 0.59%, 1.84%, and (22.63%) for the years ended
March 31, 1997, March 31, 1996, March 31, 1995, March 31,
1994,
and the period ended March 31, 1993, respectively.
</FN>
</TABLE>
* Commenced operations June 30, 1992.
** Annualized
The accompanying notes are an integral part of these
financial
statements.
SMITH BREEDEN EQUITY PLUS FUND
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Breeden Equity Plus Fund (the "Fund") is a series
of the
Smith Breeden Trust (the "Trust"), an open-end, diversified
management investment company registered under the
Investment
Company Act of 1940, as amended. The following is a summary
of
significant accounting policies consistently followed by the
Fund.
A. Security Valuation: Portfolio securities are valued at
current
market value provided by a pricing service or by a bank or
broker/dealer experienced in such matters, when over-the-
counter
market quotations are readily available. Securities and
other assets for
which market prices are not readily available are valued at
fair market
value as determined in accordance with procedures approved
by the
Board of Trustees.
B. Distributions and Taxes: Dividends to shareholders are
recorded on the ex-dividend date. The Fund intends to
continue to
qualify for and elect the special tax treatment afforded
regulated
investment companies under Subchapter M of the Internal
Revenue
Code, thereby relieving the Fund of federal income taxes.
To so
qualify, the Fund intends to distribute substantially all of
its net
investment income and net realized capital gains, if any,
less any
available capital loss carryforward. As of March 31, 1997,
the Fund
had no net capital loss carryforward.
C. Repurchase Agreements: The Fund may enter into
repurchase agreements with member banks of the Federal
Reserve
System having total assets in excess of $500 million and
securities
dealers, provided that such banks or dealers meet the credit
guidelines
of the Fund's Board of Trustees. In a repurchase agreement,
the Fund
acquires securities from a third party with the commitment
that they
will be repurchased by the seller at a fixed price on an
agreed upon
date. The Fund's custodian maintains control or custody of
these
securities which collateralize the repurchase agreements
until maturity
of the repurchase agreements. The value of the collateral
is monitored
daily, and if necessary, additional collateral is received
to ensure that
the market value of the underlying assets remains sufficient
to protect
the Fund in the event of the seller's default. However, in
the event of
default or bankruptcy of the seller, the Fund's right to the
collateral
may be subject to legal proceedings.
D. Reverse Repurchase Agreements: A reverse repurchase
agreement involves the sale by the Fund of portfolio assets
concurrently with an agreement by the Fund to repurchase the
same
assets at a later date at a fixed price. The Fund will
maintain a
segregated account with its custodian, which will be marked
to market
daily, consisting of cash, U.S. Government securities or
other liquid
high-grade debt obligations equal in value to its
obligations under
reverse repurchase agreements. In the event the buyer of
securities
under a reverse repurchase agreement files for bankruptcy or
becomes
insolvent, the Fund's use of the proceeds of the agreement
may be
restricted pending a determination by the other party, or
its trustee or
receiver, whether to enforce the Fund's obligation to
repurchase the
securities.
NOTES TO FINANCIAL STATEMENTS (cont.)
E. Determination Of Gains Or Losses On Sales Of
Securities: Gains or losses on the sale of securities are
calculated for
accounting and tax purposes on the identified cost basis.
F. Deferred Organization Expenses: Deferred organization
expenses are being amortized on a straight-line basis over
five years.
G. Securities Transactions and Investment Income:
Interest
income is accrued daily on both long-term bonds and short-
term
investments. Interest income also includes net amortization
from the
purchase of fixed-income securities. Discounts and premiums
on
securities purchased are amortized over the life of the
respective
securities. Transactions are recorded on the first business
day
following the trade date. Realized gains and losses from
security
transactions are determined and accounted for on the basis
of
identified cost.
2. FINANCIAL INSTRUMENTS
A. Derivative Financial Instruments Held or Issued for
Purposes other than Trading: The Fund uses interest rate
futures
contracts for risk management purposes in order to manage
the Fund's
interest-rate risk relative to its benchmark. Upon entering
into a
futures contract, the Fund is required to deposit either
cash or
securities in an amount (initial margin) equal to a certain
percentage of
the contract value. Subsequent payments (variation margin)
are made
or received by the Fund each day. The variation margin
payments are
equal to the daily changes in the contract value and are
recorded as
unrealized gains or losses. The Fund recognizes a realized
gain or loss
when the contract is closed or expires equal to the
difference between
the value of the contract at the time it was opened and the
value at the
time it was closed.
Futures contracts involve costs and may result in losses.
The effective
use of futures strategies depends on the Fund's ability to
terminate
futures positions at times when the Fund's investment
adviser deems it
desirable to do so. The use of futures also involves the
risk of
imperfect correlation among movements in the values of the
securities
underlying the futures purchased and sold by the Fund, of
the futures
contract itself, and of the securities which are the subject
of a hedge.
NOTES TO FINANCIAL STATEMENTS (cont.)
The Fund had the following open futures contracts as of
March 31,
1997:
Type Notional Position Expiration
Unrealized
Amount Month
Gain/(Loss)
3 Month Eurodollar $18,000,000 Long June, 1997
$(6,781)
3 Month Eurodollar 9,000,000 Short March, 1998
8,297
3 Month Eurodollar 9,000,000 Short September,
1998 2,210
3 Month Eurodollar 13,000,000 Short March, 1999
9,692
3 Month Eurodollar 9,000,000 Short September,
1999 584
3 Month Eurodollar 12,000,000 Short March, 2000
8,322
3 Month Eurodollar 1,000,000 Short June, 2000
1,845
3 Month Eurodollar 10,000,000 Short September,
2000 10,705
3 Month Eurodollar 13,000,000 Short March, 2001
10,016
10 Year Treasury 400,000 Short June,
1997 5,982
Total
$50,872
B. Derivative Financial Instruments Held or Issued for
Trading Purposes:
The Fund invests in futures contracts on the S&P 500 Index
and New
York Stock Exchange Index whose returns are expected to
track
movements in the S&P 500 Index and New York Stock Exchange
Index.
The Fund had the following open futures contracts on the S&P
500
and New York Stock Exchange Indices as of March 31, 1997:
Type Notional Position Expiration Unrealized
Amount Month Gain/Loss
S&P 500 $10,599,680 Long June, 1997 $(423,940)
S&P 500 2,271,360 Long September, 1997 (134,280)
NYSE 199,275 Long June, 1997 (8,956)
Total $(567,176)
The aggregate market value of investments pledged to cover
margin
requirements for the open positions at March 31, 1997 was
$691,539.
3. INVESTMENT ADVISORY FEES AND OTHER
TRANSACTIONS WITH AFFILIATES
Smith Breeden Associates, Inc. (the "Adviser"), a registered
investment adviser, provides the Fund with investment
management
services. As compensation for these services, the Fund pays
the
NOTES TO FINANCIAL STATEMENTS (cont.)
Adviser a fee computed daily and payable monthly, at an
annual rate
equal to 0.70% of the Fund's average daily net asset value.
The Adviser has voluntarily agreed to reduce or otherwise
limit the
expenses of the Fund to 0.88% of the Fund's average daily
net assets.
This voluntary agreement may be terminated or modified at
any time
by the Adviser in its sole discretion, except that the
Adviser has
agreed to limit expenses of the Fund to 0.88% through March
31,
1997. For the year ended March 31, 1997, the Adviser
received fees
of $53,341 and reimbursed the Fund $131,965.
Effective August 1, 1994, the Fund adopted a Distribution
and
Services Plan (the "Plan") pursuant to Rule 12b-1 under the
Investment Company Act of 1940. The purpose of the Plan is
to
permit the Adviser to compensate investment dealers and
other
persons involved in servicing shareholder accounts for
services
provided and expenses incurred in promoting the sale of
shares of the
Fund, reducing redemptions, or otherwise maintaining or
improving
services provided to shareholders by such dealers or other
persons.
The Plan provides for payments by the Adviser, out of its
advisory fee
paid to it by the Fund, to dealers and other persons at the
annual rate
of up to 0.25% of the Fund's average net assets subject
to the authority of the Trustees of the Fund to reduce the
amount of
payments permitted under the Plan or to suspend the Plan for
such
periods as they may determine. Subject to these
limitations, the
amount of such payments and the purposes for which they are
made
shall be determined by the Adviser.
Certain officers and trustees of the Fund are also officers
and directors
of the Adviser.
4. INVESTMENT TRANSACTIONS
During the year-ended March 31, 1997, purchases and proceeds
from
sales of securities, other than short-term investments,
aggregated
$19,129,765 and $11,798,195, respectively. The cost of
securities for
federal income tax purposes is $16,394,418. Net unrealized
depreciation of investments and futures contracts consists
of:
Gross unrealized appreciation $ 81,061
Gross unrealized depreciation (569,372)
Net unrealized depreciation $ (488,311)
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders,
Smith Breeden Equity Plus Fund of the Smith Breeden Series
Trust:
We have audited the accompanying statement of assets and
liabilities,
including the schedule of investments, of the Smith Breeden
Equity
Plus Fund of the Smith Breeden Series Trust as of March 31,
1997, and
the related statements of operations and cash flows for the
year then
ended, the statements of changes in net assets for each of
the years in
the two-year period then ended and the financial highlights
for each of
the years in the four-year period then ended and the period
June 30,
1992 (commencement of operations) to March 31, 1993. These
financial statements and the financial highlights are the
responsibility of
the Fund's management. Our responsibility is to express an
opinion on
these financial statements and the financial highlights
based on our
audits.
We conducted our audits in accordance with generally
accepted
auditing standards. Those standards require that we plan
and perform
the audit to obtain reasonable assurance about whether the
financial
statements and the financial highlights are free of material
misstatement.
An audit includes examining, on a test basis, evidence
supporting the
amounts and disclosures in the financial statements. Our
procedures
included confirmation of securities owned at March 31, 1997
by
correspondence with the custodian and brokers. An audit
also includes
assessing the accounting principles used and significant
estimates made
by management, as well as evaluating the overall financial
statement
presentation. We believe that our audits provide a
reasonable basis for
our opinion.
In our opinion, the financial statements and financial
highlights referred
to above present fairly, in all material respects, the
financial position of
the Smith Breeden Equity Plus Fund of the Smith Breeden
Series Trust
as of March 31, 1997, the results of its operations and its
cash flows,
the changes in its net assets, and the financial highlights
for the
respective stated periods in conformity with generally
accepted
accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
May 12, 1997
