As filed with the Securities and Exchange Commission
on April 25, 1997
File No. 33-44909
File No. 811-6520
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
F O R M N-1A
Registration Statement Under the Securities Act of 1933
Post-Effective Amendment No. 9
and
Registration Statement Under the Investment Company Act of 1940
Amendment No. 11
____________________
SMITH BREEDEN TRUST
(Exact Name of Registrant as Specified in Charter)
100 Europa Drive, Suite 200
Chapel Hill, North Carolina 27514
(Address of Principal Executive Office)
(919) 967-7221
(Registrant's Telephone Number, Including Area Code)
MICHAEL J. GIARLA
100 Europa Drive, Suite 200
Chapel Hill, North Carolina 27514
(Name and Address of Agent for Service)
_______________
Please Send Copy of Communications to:
MARIANTHE S. MEWKILL
Smith Breeden Associates, Inc.
100 Europa Drive, Suite 200
Chapel Hill, NC 27514
(919)-967-7221
It is proposed that this filing will become effective 60 days
after filing pursuant to paragraph (a) of Rule 485 under the Securities
Act of 1933.
The Registrant has previously registered an indefinite number of
shares of beneficial interest pursuant to Rule 24f-2 under the
Investment Company Act of 1940, as amended. The Rule 24f-2 notice for
the Registrant's most recent fiscal year will be filed on or before
May 30, 1997.
_______________
<PAGE>
SMITH BREEDEN TRUST
SMITH BREEDEN EQUITY INDEX PLUS FUND
CROSS REFERENCE SHEET
FORM N-1A
Part A: Information Required in Prospectus
N-1A
Item No. Item Location in the
Registration Statement
by Prospectus Heading
1. Cover Page Cover Page
2. Synopsis Expense Table
3. Condensed Financial
Information Financial Highlights
4. General Information
and History "Description of the Trust"
5. Managment of the Fund "Management of the Fund"
5a. Management's Discussion
of Fund's Performance Contained in the Fund's Annual
Report to shareholders
6. Capital Stock and Other
Securities "Distributions and Taxes";
"Description of the Trust"
7. Purchase of Securities
Being Offered "Purchase and Redemption
of Shares"; "Valuation of
Fund Shares"
8. Redemption or Repurchase "Purchase and Redemption
of Shares"
9. Pending Legal Proceedings Not Applicable
<PAGE>
JUNE 24, 1997
SMITH BREEDEN EQUITY INDEX PLUS FUND
Smith Breeden Equity Index Plus Fund (the
"Equity Index Plus Fund" or the "Fund") seeks to provide
a total return exceeding the Standard & Poor's 500
Composite Stock Price Index without
additional equity market risk. The Fund is a series of
Smith Breeden Trust. Smith Breeden Associates, Inc. (the "Adviser")
serves as investment adviser to the Fund. This Fund does not invest principally
in the common stocks that make up the S&P 500 Index or
any other index. The Fund utilizes index futures contracts
and equity swap contracts to track the return of the
S&P 500 Index, and invests substantially all of its assets
in fixed-income securities and related hedging and other
instruments. Whether the Fund's total return equals or
exceeds the performance of the S&P 500 Index depends
on whether the total return on the Fund's fixed income
investments equals or exceeds the Fund's total
operating expenses, as well as other factors. See
"Investment Objectives, Policies, and Risk
Considerations."
An investment in the Fund is neither insured
nor guaranteed by the U.S. Government. There can
be no assurance that the Fund will meet its
investment objective. This Prospectus sets forth concisely
the information about the Fund that you should
know before investing. You are advised to read
this Prospectus carefully and keep it for future
reference. A Statement of Additional Information,
date June 24, 1997 which is incorporated herein by
reference, has been filed with the Securities and
Exchange Commission with respect to the Fund. The
Statement of Additional Information, which may be
revised from time to time, contains further
information about the Fund, and is available
without charge by writing to the Fund 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>
TABLE OF CONTENTS
Expense Table 3
Financial Highlights 5
Smith Breeden Equity Index Plus Fund 6
Investment Objective, Policies and Risk
Considerations 6
Other Investment Practices and Risk
Considerations 16
Management of the Fund 18
Pricing of Fund Shares 22
How to Purchase Shares 23
How to Exchange Shares 26
How to Redeem Shares 27
Dividends and Distributions 29
Shareholder Reports and Information 30
Retirement Plans 31
Service and Distribution Plans 31
Taxes 31
Capital Structure 32
Transfer, Dividend Disbursing Agent,
Custodian and Independent Auditors 33
Fund Performance 33
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
Fund. The Prospectus does not constitute an
offering by the Fund in any jurisdiction in which
such offering may not be lawfully made.
- -2-
<PAGE>
EXPENSE TABLE
The following table is designed to assist you in understanding
the expenses you will bear as a shareholder in the Equity Index Plus Fund.
Shareholder Transaction Expenses are charges that you pay when
buying or selling shares of the Fund. Annual Fund Operating
Expenses are paid out of the Fund's assets and include fees for
portfolio management, maintenance of shareholder accounts,
shareholder servicing, accounting and other services. The
expenses shown below are based on the Fund's expenses for the
fiscal year ended March 31, 1996.
Shareholder Transaction Expenses
Maximum Sales Load Imposed on Purchases None
Maximum Sales Load Imposed on
Reinvested Dividends None
Deferred Sales Load Imposed on Redemptions None
Redemption Fees 1 None
Exchange Fees None
Annual Fund Operating Expenses
(as a percentage of average net assets)
Management Fees 2 0.70%
Other Expenses (net of reimbursement) 0.18%
Total Fund Operating Expenses
(net of reimbursement) 3 0.88%
_____________________________
1 A transaction cost of $9 may be imposed on redemptions by
wire transfer.
2 Pursuant to a distribution and services plan in respect of
the Fund, the Adviser may pay annual distribution and
servicing fees of up to 0.25% of the Fund's net assets out
of its management fee. See "Service and Distribution
Plans."
3 The Other Expenses in the table and Total Fund Operating
Expenses reflect undertakings by the Adviser to bear
expenses of the Fund and/or waive its fees to the extent
necessary to limit Total Fund Operating Expenses to 0.88%
for the Equity Index Plus Fund through March 31, 1998 and
are estimates which are based upon Total Fund Operating
Expenses for the fiscal year ended March 31, 1996. Absent
the expense limitation, Other Expenses and Total Fund
Operating Expenses would be 3.88% and 4.58% for the Equity
Index Plus Fund. Actual Total Fund Operating Expenses for
the fiscal year ended March 31, 1996 were 0.90% for the
Equity Index Plus Fund.
- -3-
<PAGE>
The following example illustrates the expenses that apply to a
$250 investment in the 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 Fund charges no redemption fees.
1 Year 3 Years 5 Years 10 Years
$ 3 $ 8 $ 12 $ 27
This example is 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 Fund may be recommended to investors by registered
investment advisors. Such advisors customarily impose fees which
would be in addition to any fees and expenses presented in the
above table. According to recent financial articles, such fees
may be as high as 2% of assets per year. Neither the Fund, nor
the Adviser, exercises any control over such advisory fees and
may not be informed of the level of such fees.
- -4-
<PAGE>
<TABLE>
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, 1996 and except for the six months ended
September 30, 1996, are a part of the Fund's financial
statements. All financial information shown below, with the exception of
the information shown for the six months ended September 30, 1996
has 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 &
Touch LLP thereon which appear in the Fund's Statement of Additional
Information. (The Equity Index Plus Fund was previously named The
Equity Plus Fund.)
<CAPTION>
Six Months
Ended
September 30, Period
1996 Year Ended Year Ended Year Ended Ended
(Unaudited) March 31, 1996 March 31, 1995 March 31, 1994 March 31, 1993
<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...... 0.294 0.615 0.568 0.476 0.355
Net realized and unrealized
gain (loss) on investments 0.627 2.768 1.081 (0.216) 1.281
Total from investment
operations................. 0.921 3.383 1.649 0.260 1.636
Less Distributions
Dividends from net
investment income.......... (0.240) (0.583) (0.568) (0.472) (0.311)
Dividends in excess of net
investment income........ -- -- (0.001) -- --
Distributions from net
realized gains on
investments.............. (0.821) (1.370) (0.047) (0.701) (0.420)
Distributions in excess of
net realized gains on
investments.............. -- -- (0.073) (0.057) (0.055)
Total distributions........ (1.061) (1.953) (0.689) (1.230) (0.786)
Net Asset Value,
End of Period.............. $12.13 $12.27 $10.84 $9.88 $10.85
Total Return............... 16.26% 32.30% 17.18% 2.19% 22.59%<F1>
Ratios/Supplemental Data
Net assets, end of period.. $7,314,905 $4,766,534 $2,107,346 $1,760,519 $903,846
Ratio of expenses to
average net assets
Before expense
limitation............... 3.25% 4.58% 7.75% 7.08% 28.48%<F1>
After expense
limitation............... 0.89% 0.90% 0.90% 0.90% 0.57%<F1>
Ratio of net income to
average net assets
Before expense
limitation............... 3.29% 1.85% 0.59% 1.84% (22.63%)<F1>
After expense
limitation............... 5.65% 5.53% 7.44% 8.02% 5.28%<F1>
Portfolio turnover rate.... 88% 107% 120% 119% 271%
<FN>
<F1> Annualized
Additional performance information is presented in the Fund's Annual
Report, which is available without charge upon request.
</FN>
</TABLE>
- -5-
<PAGE>
SMITH BREEDEN EQUITY INDEX PLUS FUND
The Equity Index Plus Fund is currently the only series of the
Smith Breeden Trust (the "Trust"), an open-end diversified
management investment company registered under the Investment
Company Act of 1940 (the "1940 Act").
Smith Breeden Associates, Inc. ("Smith Breeden" or the "Adviser")
acts as investment adviser to the Trust. 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. The firm
specializes in mortgage securities, interest-rate risk
management, and the application of option pricing to investments
and banking. Smith Breeden currently advises, or manages on a
discretionary basis, assets totalling over $20 billion.
INVESTMENT OBJECTIVES, POLICIES, AND RISK CONSIDERATIONS
The investment objective of the Equity Index Plus Fund is not
fundamental, and may be changed without a vote of the majority of
the shareholders of the Fund. Shareholders of the Fund will
receive a written notification at least thirty days prior to any
change in the Fund's investment objective. If such a change in
the investment objective of the Fund occurs, such changes may
result in the Fund having an investment objective different from
the objective which the shareholders considered appropriate at
the time of their investment in the Fund.
Because shares of the Fund represent an investment in
securities with fluctuating market prices, you should understand
that the net asset value per share of the Fund will vary as the
aggregate value of the Fund's portfolio securities increases or
decreases. Because of the risks inherent in all investments,
there can be no assurance that the objective of the Fund will be
met.
The Equity Index Plus Fund seeks to provide a total return
exceeding the Standard & Poor's Composite Stock Price Index (the
"S&P 500 Index") without additional equity market risk. The Fund
does not invest principally in the common stocks that make up the
S&P 500 Index or any other index. The Fund utilizes index futures
contracts and equity swap contracts to track the return of the S&P
500 Index, and invests substantially all of its assets in fixed-income
securities and related hedging and other instruments. With these fixed-income
investments, the Fund seeks to produce a total return in excess of the
Fund's operating costs.
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.
- -6-
<PAGE>
The Equity Index Plus Fund seeks its objective by
dividing its portfolio into two segments- an "Equity
Simulation Segment" and a "Fixed Income Segment." Through the
Equity Simulation 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 Fund seeks to achieve the same
investment opportunity and risk profile for the Equity
Simulation 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 weight in the
S&P 500 Index. In the Equity Simulation Segment, the Fund
expects its use of stock index futures other than S&P 500 stock
index futures to be minimal.
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 Fund may also engage
in loans of portfolio securities, dollar rolls, and reverse repurchase
agreements as investment techniques 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
Equity Simulation Segment). Thus, whether the Fund's total
return equals or exceeds the performance of the S&P 500 Index
depends 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 Fixed Income Segment of the Equity Plus Fund will invest
substantially all of its assets in U.S. Government securities. U.S.
Government Securities 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 or instrumentalities, including, but not limited to,
Government National Mortgage Association ("GNMA"), Federal
National Mortgage Association ("FNMA") and Federal Home Loan
Mortgage Corporation ("FHLMC") securities. (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.) It is anticipated that
the Fixed-Income Segment will invest substantially all of its assets
in FNMA, FHLMC, and GNMA mortgage-backed certificates and
other U.S. Government Securities representing ownership interests
in mortgage pools.
The Fixed Income Segment also may invest in bank
certificates of deposit, corporate debt obligations,
and mortgage-backed and other asset-backed securities of non-
governmental issuers. At the time of purchase, with the
exception of mortgage-backed and asset-backed securities, the
Fixed Income Segment's investments will be either of
investment grade (as rated by Standard & Poor's ("S&P") or
Moody's Investors Services, Inc. ("Moody's")), or, if unrated,
determined by the Adviser to be of comparable quality. Investments
- -7-
<PAGE>
in mortgage-backed and other asset-backed securities
will be rated at the time of purchase at least A by Moody's and S&P.
The lowest quality investment grade fixed income securities are rated
BBB by Moody's or Baa by S&P, have certain speculative
characteristics, and are more susceptible to adverse changes in
circumstances and economic conditions than higher rated fixed
income securities. The Adviser will monitor the Equity Index Plus
Fund's investments in fixed income securities and will cause the
Fund to dispose of any such security whose rating is reduced to
below investment grade.
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 Fund 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 Fund will seek to minimize this risk of default
by investing in securities of investment grade. 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.
The Fund will engage in various hedging strategies so that the
volatility of the Fixed Income Segment will be similar to that of a
one-year Treasury Bill. Such investment techniques and hedging
strategies include mortgage and interest rate swaps, interest rate
futures and options on such futures, short sales and interest rate
caps, floors and collars. Appendix A provides information about
these hedging techniques and the risks they entail.
There can be no assurance that the hedging techniques employed
by the Fixed Income Segment will be successful. As a result,
the Fund may not achieve, and may at times exceed, its targeted
option-adjusted duration. The Fund's hedging techniques may not be
successful because the Adviser's computation of option-adjusted
duration is based on estimates of expected prepayment rates,
valuation of homeowners' prepayment options, and the correlation of
changes in the market prices of the securities and the hedge instruments
owned by the Fund (as described in Appendix A).
The Fixed Income Segment of the Equity Index Plus Fund may
also engage in loans of portfolio securities, dollar rolls and
reverse repurchase agreements as investment techniques. These
techniques will be undertaken to enhance income and total
return. See "Other Investment Practices and Risk Considerations."
Set forth below is an example of how the 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.
- -8-<PAGE>
Because equity swap contracts and futures contracts may generally be
initially entered into without making cash payments, the Fixed Income
Segment would then invest $95 million 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 will 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 Equity Simulation 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 Equity Simulation Segment's return would total 7.42%.
Therefore, the Fund will 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 will be $114 million - an increase of 14%
and a total return equal to the S&P 500 Index. If the Fixed
Income Segment's total return is greater or less than 6.93% per
annum, the Fund's total return will, in turn, be greater or less
than the S&P 500 Index.
The Equity Simulation Segment's actual opportunities for gain
and loss may be greater than a hypothetical portfolio
invested in the stocks comprising the S&P 500 Index depending upon
the Fund's exposure to the S&P 500 Index, which could at times be
higher or lower than the Fund's total assets. For example, the total
net notional amount of the Fund's equity swap contracts, S&P 500
or other stock index futures plus the market value of
common stocks owned by the Fund may exceed the Fund's total net
assets as a result of purchases and redemptions of Fund shares. In
addition, since S&P 500 Index Futures can only be purchased for
specific amounts, the Fund might not be able to match accurately
a notional amount of futures contracts to the Fund's total net assets.
Under normal market conditions, the Fund expects that such
variations in S&P 500 Index exposure will generally be up to 5% greater
or less than the Fund's total net assets. Also, the ability
of the Equity Simulation 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 and 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,
- -9-<PAGE>
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) of (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."
Characteristics of Investments.
Equity Swap Contracts. The Equity Simulation Segment will use
equity swap contracts whose return (before deducting interest
costs) is expected to track closely the return of the S&P 500
Index. The Fund will not use equity swap contracts for leverage.
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 in proportion to the composition of
the 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 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 directly in
stocks comprising the S&P 500 Index) less the interest paid by
the Fund on the notional amount. The Fund 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 a default by the counterparty to an equity swap
contract, the Fund will be limited to contractual remedies
pursuant to the agreements related to the transaction. There is
no assurance that equity swap contract counterparties will be
able to meet their obligations or that, in the event of default, the
Fund will succeed in pursuing contractual remedies. The Fund
thus assumes the risk that it may be delayed in or prevented from
obtaining payments owed to it pursuant to these contracts.
The Fund will closely monitor the credit of equity swap contract
counterparties in order to minimize this risk.
The Fund may from time to time enter into the opposite side of
equity swap contracts (i.e., where the Fund is obligated to pay
the increase (net of interest) or receive the decrease (plus
interest) on the S&P 500 Index) to reduce the amount of the
Fund's equity market exposure. These positions are sometimes
referred to as "reverse equity swap contracts".
The Equity Index Plus Fund 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 or S&P.
In addition, the staff of the SEC considers equity swap contracts and reverse
equity swap contracts to be illiquid securities. Consequently,
- -10-<PAGE>
while the staff maintains this position, the Fund will not invest
in equity swap contracts or reverse equity swap contracts if, as
a result of the investment, the total value of such investments
together with that of all other illiquid securities which the
Fund owns would exceed 15% of the Fund's total assets.
The Adviser and the Equity Index Plus Fund do not believe that
the 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 Fund will
not treat them as being subject to its borrowing restrictions.
The net amount of the excess, if any, of the Fund's obligations
over its entitlements with respect to each equity swap contract
and each reverse equity swap contract will be accrued on a daily
basis and an amount of cash, U.S. Government Securities or other
liquid high quality debt securities having an aggregate market
value at least equal to the accrued excess will be maintained in
a segregated account by the Fund's custodian.
S&P 500 Index and Other Stock Index Futures.
S&P 500 and other stock index futures represent contracts to
buy a number of units of the S&P 500 Index or some other stock
index at a specified future date at a price agreed upon when the
contract is made. Upon entering into a contract, the Fund will
be required to deposit with its custodian in a segregated account
in the name of the futures broker a specified amount of cash or
securities, generally not exceeding 5% of the face amount of the
contract. This amount is known as "initial margin" and is in the
nature of a performance bond or good faith deposit on the
contract which is returned to the Fund upon termination of the
futures contract, assuming all contractual obligations have been
satisfied. Subsequent payments, called "variation margin" to and
from the broker will be made on a daily basis as the value of the
futures contract fluctuates.
Purchased futures contracts may be closed out only by entering
into a futures contract sale with the same terms as the contract to be
closed out on the futures exchange on which the futures are traded.
The liquidity of the market in futures contracts could be adversely
affected by daily price fluctuation limits established by an exchange
which limit the amount of fluctuation in the price of a futures contract
during a single trading day. In such case, it may not be possible for
the Fund to close out its futures contract position, and, in the event
of adverse price movements, the Fund would continue to be required
to make daily cash payments of variation margin.
The Equity Index Plus Fund will not purchase S&P 500 or other
stock index futures, except for bona fide hedging purposes, if as
a result the Fund's aggregate initial margin deposits and
premiums would be greater than 5% of the Fund's total assets. In
addition to margin deposits, when the Fund purchases an S&P 500
or other stock index futures contract, it is required to maintain
at all times while the contract is held by the Fund, cash, U.S.
government securities or other appropriate 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. These
amounts on deposit will constitute a portion of the Fund's Fixed
Income Segment. The Fund will not use futures contracts for leverage.
- -11-<PAGE>
Common Stocks. When index futures contracts and/or equity
swap contracts are, in the judgement 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.
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 Equity Index Plus Fund may invest in other mortgage-backed
and asset-backed securities. 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 when the entire principal
amount comes due, payments on certain mortgage-backed and asset-
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<PAGE>
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 Fund
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 Fund may purchase certain
options and options on futures contracts as described more fully
in Appendix A.
Adjustable-Rate Securities. Adjustable-rate securities are
securities that have interest rates that are reset at periodic
intervals, usually by reference to some interest rate index or
market interest rate. Some adjustable-rate securities are backed
by pools of mortgage loans. The Fixed Income Segment of the
Equity Index Plus Fund may 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 rates 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
with mortgage-backed securities generally.
Collateralized Mortgage Obligations ("CMOs") A CMO is a
security backed by a portfolio of mortgages or mortgage-backed
securities held under an indenture. The issuer's obligation to
make interest and principal payments is secured by the underlying
portfolio of mortgages or mortgage-backed securities. CMOs are
issued with a number of classes or series which have different
maturities representing interests in some or all of the interest
or principal on the underlying collateral or a combination
thereof. Payments of interest or principal on some classes or
series of CMOs may be subject to contingencies, or some classes
- -13-
<PAGE>
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 Fund 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
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 Securities and
Exchange Commission ("SEC"), the Fund's investments in certain
qualifying CMOs and REMICs are not subject to the 1940 Act's
limitations on acquiring interests in other investment companies.
See "Investment Restrictions" in the Statement of Additional
Information with respect to the Fund. 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 Equity Index 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
- -14-
<PAGE>
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 below in "Hedging Instruments" and in
Appendix A. 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.
New instruments and variations of existing mortgage-backed
securities continue to be developed. The Fund may invest in any
such instruments or variations to the extent consistent with
their investment objectives and policies and applicable
regulatory requirements.
Zero Coupon Securities. The Fund may also invest in "zero
coupon" securities (which are issued at a significant discount
from face value and pay interest only at maturity rather than at
intervals during the life of the security). 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 Equity Index Plus Fund is required to accrue and
distribute income from zero coupon securities on a current basis,
even though the Fund 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 Instruments. The Equity Index Plus Fund may employ
certain active management techniques to achieve its duration
objective and to hedge the interest-rate risks associated with
its fixed-income securities in accordance with such objectives.
Since some of the securities may have longer or shorter
durations than the Fund's specified duration objectives, hedging
may be required either to lengthen or to shorten the duration of
the Fund's portfolio. The Fund will seek continually to manage
duration within a narrow range.
The Fund intends to use hedging transactions primarily to
protect against interest-rate fluctuations and not as speculative
transactions. The Fund may also use hedging transactions as a
temporary substitute for purchasing particular securities. The
Fund may enter into mortgage and interest-rate swaps, purchase or
sell interest-rate floors, caps or collars, enter into interest-
rate futures contracts and related options, and engage in short
sales to hedge against interest rate fluctuations. In addition,
the Fund may use SMBS to better maintain its targeted
option-adjusted duration.
Any or all of these techniques may be used at one time. Use
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<PAGE>
of any particular transaction is a function of market conditions.
The hedging transactions that the Fund currently contemplates
using are described in detail in Appendix A, including a
discussion of its risks.
OTHER INVESTMENT PRACTICES AND RISK CONSIDERATIONS
The Equity Index Plus Fund may also engage in the following
investment practices, each of which may involve certain special
risks. The Statement of Additional Information for the Fund
contains more detailed information about these practices,
including limitations designed to reduce these risks.
Securities Loans, Repurchase Agreements and Forward
Commitments. The Fund may lend portfolio securities to
broker-dealers and may enter into repurchase agreements. These
transactions must be fully collateralized at all times but
involve some risk to the Fund if the other party should default
on its obligations and the Fund is delayed or prevented from
recovering the collateral. The Fund will not 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 Fund
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 Fund 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 the Fund enters into a transaction
on a when-issued or forward commitment basis, a segregated
account consisting of cash, U.S. Government securities or other
liquid high grade debt securities equal to at least 100% of the
value of the when-issued or forward commitment securities will be
established and maintained with the Fund's custodian. Subject to
this requirement, the Fund 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. In order to increase income, the Fund 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 Statement of Additional Information
for the Fund contains a more detailed explanation of these
practices. Reverse repurchase agreements and dollar rolls are
considered borrowings by the Fund and require segregation of
assets with the Fund's custodian in an amount equal to the Fund's
obligations pending completion of such transactions. The Fund
may also borrow money from banks in an amount up to 33 1/3% of
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<PAGE>
the Fund's total assets to realize investment opportunities, for
extraordinary or emergency purposes, or for the clearance of
transactions. Borrowing from banks usually involves certain
transaction and ongoing costs and may require the Fund to
maintain minimum bank account balances. Use of these borrowing
techniques to purchase securities is a speculative practice known
as "leverage." Depending on whether the performance of the
investments purchased with borrowed funds is sufficient to meet
the costs of borrowing, the Fund's net asset value per share will
increase or decrease, as the case may be, more rapidly than if
the Fund did not employ leverage.
Short Sales. The Fund may make short sales of securities. A
short sale is a transaction in which the Fund sells a security it
does not own in anticipation that the market price of that
security will decline. The Fund expects to engage in short sales
as a form of hedging to shorten the overall duration of the
portfolio and in order to maintain portfolio flexibility.
When the Fund makes a short sale, it must borrow the security
sold short and deliver it to the broker-dealer through which it
made the short sale as collateral for its obligation to deliver
the security upon completion of the transaction. The Fund may
have to pay a fee to borrow particular securities and is often
obligated to relinquish any payments received on such borrowed
securities.
Until the Fund replaces a borrowed security, it will maintain
daily a segregated account with its custodian containing cash,
U.S. Government securities, or other liquid high-grade debt
obligations, 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, the 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 the Fund replaces the
borrowed security, the Fund will incur a loss; conversely, if the
price declines, the Fund will realize a gain. Although the
Fund's gain is limited to the amount at which it sold the
security short, its potential loss is limited only by the maximum
attainable price of the security less the price at which the
security was sold.
The Fund will not make a short sale if, after giving effect to
such sale, the market value of all securities sold exceeds 25% of
the value of the Fund's total net assets. The Fund may also
effect 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").
Illiquid Securities. The Fund may invest up to 15% of its net
assets in securities for which there are legal or contractual
restrictions on resale or for which there is no readily available
market or other illiquid securities, including non-terminable
repurchase agreements having maturities of more than seven days.
See "Investment Restrictions" in the Statement of Additional
Information for the Fund. The Adviser will monitor the Fund's
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<PAGE>
investments in illiquid securities under the supervision of the
Trustees. The determination of whether certain IO/PO Strips
issued by the U.S. Government and backed by fixed-rate mortgages
or any other securities in which the Fund desires to invest are
liquid shall be made by the Trustees or the Adviser under
guidelines established by the Trustees in accordance with
applicable pronouncements of the SEC. At present, all other
IO/PO Strips, other residual interests of CMOs and OTC options
are treated as illiquid securities. The SEC staff also currently
takes the position that the interest rate swaps, caps and floors
discussed in Appendix A, as well as Equity Swap Contracts and
Reverse Equity Swap Contracts, are illiquid.
Portfolio Turnover. The Adviser buys and sells securities for
the Fund whenever it believes it is appropriate to do so.
Portfolio turnover generally involves some expense to the Fund,
including brokerage commissions or dealer mark-ups and other
transaction costs on the sale of securities and reinvestment in
other securities. Such transactions may result in realization of
taxable capital gains. The portfolio turnover rate for the
Fund's previous fiscal periods is shown in the table under the
heading "Financial Highlights".
While the Fund will pay commissions in connection with options
and future transactions and possibly in relation to any purchase
of common stocks, most of the securities in which the Fund
invests are generally traded on a "net" basis with dealers acting
as principals for their own account without a stated commission.
Nevertheless, high portfolio turnover may involve
correspondingly greater brokerage commissions and other
transaction costs which will be borne directly by the Fund.
Another potential consequence of high portfolio turnover is
that if 30% or more of the Fund's gross income for a taxable year
is derived from gains from the sale of securities held for less
than three months, the Fund would not qualify as a regulated
investment company and, therefore, would be subject to corporate
income tax during that taxable year. The Adviser endeavors to
manage the investment composition of the Fund and to adjust the
portfolio turnover, if necessary, to ensure that the Fund will be
eligible for treatment as a regulated investment company.
MANAGEMENT OF THE FUND
The business affairs of the Fund are managed by its Board of
Trustees. The Fund has entered into an investment advisory
agreement with Smith Breeden Associates, Inc., 100 Europa Drive,
Chapel Hill, North Carolina, 27514 (the "Investment Advisory
Agreement"). Pursuant to such investment advisory agreement, the
Adviser furnishes continuous investment advisory services to the
Fund.
Trustees and Officers
The following is a listing of the Trustees and officers of the
Trust, the legal entity that has issued shares in the Fund.
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<PAGE>
Douglas T. Breeden* Trustee and Chairman
Dr. Breeden, the Chairman of the Board of Smith Breeden
Associates, co-founded the firm in 1982. Dr. Breeden has served
on business school faculties at Duke University, Stanford
University and the University of Chicago, and as a visiting
professor at Yale University and at the Massachusetts Institute
of Technology. He is the Editor of the Journal of Fixed Income.
Dr. Breeden has served as Associate Editor for five journals in
financial economics, and was elected to the Board of Directors of
the American Finance Association. He has published several
well-cited articles in finance and economics journals. He holds
a Ph.D. in Finance from the Stanford University Graduate School
of Business, and a B.S. in Management Science from the
Massachusetts Institute of Technology. He is a Director of
Roosevelt Bank of St. Louis, the nation's tenth largest thrift,
and served as Chairman in 1995-96. He also is a principal
investor and strategist for Community First Financial Group, a
commercial bank holding company with three small banks located in
Indiana and California. 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
Mr. Giarla is Chief Operating Officer, President and Director of
Smith Breeden Associates. 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 has served on the
editorial board of a number of professional journals including,
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<PAGE>
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 the Frank E. Buck Professor of Finance at the
Graduate School of Business at Stanford University (since 1983);
a Senior Research Fellow at the Hoover Institution (since 1987);
and is currently on leave as a Professor of Law, Stanford Law
School. He is a Principal in the money management firm Long-Term
Capital Management Co. (since 1993). He is a Research Associate
of the National Bureau of Economic Research and is a member of
the Econometric Society. Professor Scholes was also a Managing
Director and co-head of the fixed income derivatives group at
Salomon Brothers between 1991-1993. Prior to coming to Stanford
University, Professor Scholes was the Edward Eagle Brown
Professor of Finance at the Graduate School of Business,
University of Chicago (1974-1983). He served as the Director of
the University of Chicago's Center for Research in Security
Prices from 1974-1980. Prior to coming to the University of
Chicago, Professor Scholes was first an Assistant Professor then
an Associate Professor at the Sloan School of Management at
M.I.T. from 1968 to 1973. He received his 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 (May
1973) (with Fischer Black). His other papers include such topics
as risk-return relationships, the effects of dividend policy on
stock prices, and the effects of taxes and tax policy on
corporate decision making. His book with Mark Wolfson (Stanford
University) Taxes and Business Strategy: A Planning Approach was
published by Prentice Hall in 1991.
William F. Sharpe Trustee
William F. Sharpe is the STANCO 25 Professor of Finance at
Stanford University's Graduate School of Business. He is best
known as one of the developers of the Capital Asset Pricing
Model, including the beta and alpha concepts used in risk
analysis and performance measurement. He developed the
widely-used binomial method for the valuation of options and
other contingent claims. He also developed the computer
algorithm used in many asset allocation procedures, and a
procedure for estimating the style of an investment manager from
its historic returns. 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),
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<PAGE>
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 has
also served as consultant to a number of corporations and
investment organizations. He is also a member of the Board of
Trustees of Rosenberg Series Trust, an investment company, and a
director at CATS Software and Stanford Management Company. He
received the Nobel Prize in Economic Sciences in 1990.
John B. Sprow Vice President, Smith Breeden Trust
Portfolio Manager, Equity Index Plus Fund
Principal, Director and Executive Vice President, Smith Breeden
Associates. Mr. Sprow has been primarily responsible for the
day-to-day management of the Equity Index 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
manages S&P 500 indexed accounts. Prior to directly managing
discretionary accounts, Mr. Sprow's research and programming
efforts 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.
Marianthe S. Mewkill Vice President, Secretary,
Treasurer, and Chief Accounting Officer
Principal, Vice President and Chief Financial Officer, 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 company'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.
* Interested Party
Investment Adviser
Smith Breeden Associates, Inc., a registered investment adviser,
acts as investment adviser to the Fund. Approximately 66% of the
Adviser's voting stock is owned by Douglas T. Breeden, its
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<PAGE>
Chairman and President. Under its Investment Advisory Agreement
with the Fund, the Adviser, subject to the general supervision of
the Board of Trustees, manages the Fund's portfolio and provides
for the administration of all of the Fund's other affairs. For
these services, the Adviser receives a fee, computed daily, and
payable monthly, at the annual rate of 0.70% of the Fund's
average daily net assets. Until March 31, 1998, the Adviser has
voluntarily agreed to reduce its compensation, and to the extent
necessary absorb other expenses of the Fund, 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 the Equity Index Plus Fund.
The Adviser places all orders for purchases and sales of the
Fund's securities. Subject to seeking the most favorable price
and execution available, the Adviser may consider sales of shares
of the Fund as a factor in the selection of broker-dealers.
Distribution
FPS Broker Services, Inc. (the "Principal Underwriter") acts as
distributor for the Fund for which the Adviser pays the Principal
Underwriter a fee of $25,000. Shares also may be sold by
authorized dealers who have entered into dealer agreements with
the Principal Underwriter or the Adviser.
Expenses
The Fund pays all of its own expenses, including without
limitation, the cost of preparing and printing its registration
statement required under the Securities Act of 1933 and the 1940
Act and any amendments thereto, the expense of registering its
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 its 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 the Fund's shares, and the price
you receive when selling (redeeming) the 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 a redemption. The Fund
currently charges a $9 fee for each redemption made by wire. See
"How to Redeem Shares."
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<PAGE>
The per share net asset value of the 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
(currently 4:00 p.m. Eastern time) each day that the Adviser and
Transfer Agent are open for business and on which there is a
sufficient degree of trading in the Fund's securities such that
the net asset value of the 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 Fund, prior to 4:00 p.m. Eastern time,
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 4 p.m Eastern Time by the Transfer Agent, or
other agent designated by the Fund, will be confirmed at the net
asset value of the following business day.
Current holiday schedules indicate that the Fund's net asset
values will not be calculated on New Year's Day, President's Day,
Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day, the day following Thanksgiving, Christmas Eve
and Christmas Day.
Under procedures approved by the Board of Trustees, the 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 may be valued at
amortized cost, which approximates market value. All other
securities and assets are valued at fair market value as
determined following procedures approved by the Board of
Trustees.
HOW TO PURCHASE SHARES
The Equity Index Plus Fund is no-load, so you may purchase,
redeem or exchange shares directly at net asset value without
paying a sales charge. Because the Fund's net asset value changes
daily, your purchase price will be the next net asset value
determined after the Fund's Transfer Agent, or other agent
designated by the Fund, receives and accepts your purchase order.
See "Pricing of Fund Shares."
Initial Minimum Additional Minimum
Type of Account Investment Investment
Regular $250 $50
Automatic Investment Plan $50 $50
Individual Retirement
Account $250 $50
Gift to Minors $250 $50
The Fund reserves the right to reject any order 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.
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<PAGE>
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
Fund by calling 1-800-221-3138. (Please note that you must use a
different application than the one provided in the prospectus for
an IRA.)
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 Fund will delay the
mailing of a redemption check until the purchase check has
cleared your bank, which may take up to 10 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 Fund 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 Smith Breeden Equity Index Plus Fund
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 Fund at the following
address: Smith Breeden Mutual Funds, 3200 Horizon Drive, P.O. Box
61503, King of Prussia, PA 19406-0903. Shares will not be
redeemed until the Fund receives a properly completed and
executed Purchase Application.
Telephone Transactions. The privilege to initiate redemption
or exchange transactions by telephone will be made available to
shareholders when opening an account, if they check the
appropriate boxes on the Purchase Application. The Fund will
employ reasonable procedures to ensure that instructions
communicated by telephone are genuine. If reasonable procedures
are not implemented, the Fund 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. The Fund
reserves the right to refuse a telephone transaction if it
believes it advisable to do so.
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<PAGE>
If you have any questions, please call the Fund at
1-800-221-3137.
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
Fund 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
the Fund automatically on a regular basis ($50 minimum per
transaction). You must meet the Automatic Investment Plan's ("the
Plan") minimum initial investment of $50 before the Plan may be
established. Under the Plan, your designated bank or other
financial institution debits a preauthorized amount from your
account each month and applies the amount to the purchase of Fund
shares. The Plan can be implemented with any financial
institution that is a member of the Automated Clearing House. No
service fee is currently charged by the Fund for participation in
the Plan. A $20 fee will be imposed by the Fund if sufficient
funds are not available in your account or if your account has
been closed at the time of the automatic transaction. You may
adopt the Plan at the time an account is opened by completing the
appropriate section of the Purchase Application. You may obtain
an application to establish the Automatic Investment Plan after
an account is opened by calling the Fund at 1-800-221-3138. In
the event you discontinue participation in the Plan, the Fund
reserves the right to redeem your Fund account involuntarily,
upon sixty days' written notice, if the account's net asset value
is $250 or less.
Purchasing Shares Through Other Institutions. If you purchase
shares through a program of services offered or administered by a
broker-dealer, financial institution, or other service provider,
you should read the program materials, including information
relating to fees, in addition to this Prospectus. Certain
services of the 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
Fund 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 orders on
behalf of their customers by phone, with payment to follow within
several days as specified in the agreement. The Fund may effect
such purchase orders at the net asset value next determined after
receipt of the telephone purchase order. It is the responsibility
of the broker-dealer, financial institution, or other service
provider to place the order with the Fund 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.
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<PAGE>
Miscellaneous. The Fund 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 Fund as a result. In order to relieve you of
responsibility for the safekeeping and delivery of stock
certificates, the Fund does not currently issue certificates.
HOW TO EXCHANGE SHARES
Shares of the Fund may be exchanged for shares of another
Smith Breeden Mutual Fund at any time. This exchange offer is
available only in states where shares of the other Smith Breeden
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 minimum ($250).
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 privilege
can be adopted by checking the appropriate box on the Purchase
Application. 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 Fund at any time
upon 60 days' notice to the shareholders. To exchange by
telephone, you must follow the instructions below under "How to
Redeem by Telephone."
The Fund 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 a Fund's relative net asset
value. 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 "Additional Information on
Distributions and Taxation" in the Fund's Statement of Additional
Information.
There are differences between the Trust and the Series Fund.
Before making an exchange, a shareholder should obtain and review
the current prospectus of the Fund into which the shareholder
wishes to transfer. When exchanging shares, shareholders should
be aware that the Fund may have different dividend payment dates.
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<PAGE>
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 10 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 Fund at
1-800-221-3137 for further information.
The Fund reserves 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 five 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 Fund for additional
information concerning the exchange privilege.
HOW TO REDEEM SHARES
You may redeem shares of the Fund 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
Fund. 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 Fund specifying the number of shares or dollar amount to be
redeemed, the name(s) on the account registration and the account
number. A request for redemption must be signed exactly as the
shares are registered. If the amount requested is greater than
$25,000, or the proceeds are to be sent to a person other than
the recordholder or to a location other than the address of
record, each signature must be guaranteed by a commercial bank or
trust company in the United States, a member firm of the National
Association of Securities Dealers, Inc. or other eligible
guarantor institution. A notary public is not an acceptable
guarantor. Guarantees must be signed by an authorized signatory
of the bank, trust company, or member firm and "Signature
Guaranteed" must appear with the signature. Additional
documentation may be required for the redemption of shares held
in corporate, partnership or fiduciary accounts. In case of any
questions, please contact the Fund in advance.
The Fund will mail payment for redemption within seven days
after receiving proper instructions for redemption. However, the
Fund will delay payment for 10 calendar days on redemptions of
recent purchases made by check. This allows the Fund 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.
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<PAGE>
How to Redeem by Telephone. To redeem shares by telephone, you
must have selected this option on the Purchase Application. Once
this feature has been requested, shares may be redeemed by
calling the Fund at 1-800-221-3137. Proceeds redeemed by
telephone will be mailed to your address, or wired or credited to
your preauthorized 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 the 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 Fund reserves 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. It will be deducted from your
account.
The Fund reserves the right to refuse a telephone redemption
or exchange transaction if it believes it is advisable to do so.
Procedures for redeeming or exchanging shares of the Fund by
telephone may be modified or terminated by the Fund at any time.
In an effort to prevent unauthorized or fraudulent redemption or
exchange requests by telephone, the Fund has 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 preauthorized
designations. Other procedures may be implemented from time to
time. If reasonable procedures are not implemented, the Fund 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 Fund 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 Fund reserves 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
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<PAGE>
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 the Fund not reasonably practicable.
Due to the relatively high cost of maintaining small accounts,
if your account balance falls below the $250 minimum as a result
of a redemption or exchange or if you discontinue the Automatic
Investment Plan before your account balance reaches the required
minimum, you will be given a 60-day notice to reestablish the
minimum balance or activate an Automatic Investment Plan. If this
requirement is not met, your account may be closed and the
proceeds sent to you.
Systematic Withdrawal Plan. A shareholder may establish a
Systematic Withdrawal Plan and receive regular periodic payments
from the account. An initial balance of $10,000 is required to
establish 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 the Fund on 30 days 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 Equity Index Plus Fund intends to make quarterly
distributions of net investment income. The Fund will distribute
net realized gains at least annually. The Fund may make
additional distributions if necessary to avoid imposition of a 4%
excise tax or other tax on undistributed income and gains.
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<PAGE>
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 the Fund's shares on or before the record date. Caution
should be exercised, however, before purchasing shares
immediately prior to a distribution record date. Because the
value of the 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 the Fund or receive cash as designated on the Purchase
Application. You may change your election at any time by sending
written notification to the Fund. The election is effective for
distributions with a dividend record date on or after the date
that the Fund receives 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. Reinvested dividends and
distributions receive the same tax treatment as those paid in
cash.
SHAREHOLDER REPORTS AND INFORMATION
The Fund 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 Fund for the preceding calendar
year.
Financial Reports. Financial reports are provided to shareholders
semiannually. Annual reports will include audited financial
statements. To reduce the Fund's 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 the Fund.
If you need additional copies of previous statements, you may
order statements for the current and preceding year at no charge.
Call 1-800-221-3137 to order past statements. If you need
information on your account with the Fund 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.
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<PAGE>
RETIREMENT PLANS
The Equity Index Plus Fund has a program under which you may
establish an Individual Retirement Account ("IRA") with the Fund
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 the
Fund for an IRA is $250. There is a $12 annual maintenance fee
charged to process an account. You may obtain additional
information regarding establishing such an account by calling the
Fund at 1-800-221-3138.
The Fund may be used as investment vehicles for established
defined contribution plans, including simplified employee
(including SAR-SEPs), 401(k), profit-sharing and money purchase
pension plans ("Retirement Plans"). For details concerning
Retirement Plans, please call 1-800-221-3138.
SERVICE AND DISTRIBUTION PLANS
The Fund has adopted a Distribution and Services Plan (the
"Plan") pursuant to Rule 12b-1 under the 1940 Act. The purpose
of the Plan is to permit the Adviser to compensate investment
dealers and other persons involved in servicing shareholder
accounts for services provided and expenses incurred in promoting
the sale of shares of the Fund, reducing redemptions, or
otherwise maintaining or improving services provided to
shareholders by such dealers or other persons. The Plan provides
for payments by the Adviser out of its advisory fee to dealers
and other persons at an annual rate of up to 0.25% of the Fund's
average net assets, subject to the authority of the Trustees to
reduce the amount of payments permitted under the Plan or to
suspend the Plan for such periods as they may determine. Subject
to these limitations, the amount of such payments and the
purposes for which they are made shall be determined by the
Adviser.
Any distribution and servicing related payments made by the
Adviser to investment dealers or other persons are subject to the
continuation of the Plan, the terms of any related service
agreements, and any applicable limits imposed by the National
Association of Securities Dealers, Inc.
TAXES
The Equity Index Plus Fund intends to qualify as a regulated
investment company under the Internal Revenue Code. In each
taxable year that the Fund so qualifies, the 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. The Fund will distribute annually
substantially all of its net investment income and net capital
gains on a current basis.
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
- -31-
<PAGE>
distributions of the 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. The Fund provides
federal tax information to its shareholders annually about
distributions paid during the preceding year.
It is not anticipated that the Fund's 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, only an insignificant
amount of the Fund's distributions are expected to so
qualify.
The Fund 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 the 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, which issues shares in the Equity Index
Plus Fund, is a Massachusetts business trust. The Trust was
organized under an Agreement and Declaration of Trust, dated
December 18, 1991. Copies of the Agreement, which is governed by
Massachusetts law, are on file with the Secretary of State of the
Commonwealth of Massachusetts.
The Trustees have the authority to issue shares in an
unlimited number of series of either the the Trust or the Series
Fund. Each such series of shares may be further divided into
classes. The assets and liabilities of each such series 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 Trust will vote together in electing
trustees and in certain other matters. The shares have
noncumulative 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 the Trust is not required to hold annual meetings of
its shareholders, shareholders have the right to call a meeting
to elect or remove trustees, or to take other actions as provided
in the 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
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<PAGE>
for the purpose of obtaining the signatures necessary to demand a
meeting to consider the removal of a trustee, the Trust has
undertaken to provide a list of shareholders or to disseminate
appropriate materials (at the expense of the requesting
shareholders).
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 the Fund's insurance coverage and (ii) the 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 the Fund's
Transfer and Dividend Disbursing Agent. See "Management of the
Fund." The Bank of New York acts as the custodian of the 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
Fund's investment policies or which securities are to be
purchased or sold for the Fund's 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
The Fund may quote the Fund's average annual total and/or
aggregate total return for various time periods in advertisements
or communications to shareholders. An average annual total
return refers to the rate of return which, if applied to an
initial investment at the beginning of a stated period and
compounded over that period, would result in the redeemable value
of the investment at the end of the period assuming reinvestment
of all dividends and distributions and reflecting the effect of
all recurring fees. An investor's principal in the 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
the 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. The 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 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, the Fund's total return may be
compared to data prepared by Lipper Analytical Services, Inc.,
Morningstar, Inc., Value Line Mutual Fund Survey and CDA
- -33-
<PAGE>
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 Fund's total return may also be compared to the returns of
such indices as the Dow Jones Industrial Average, Standard &
Poor's 500 Composite Stock Price Index, Nasdaq Composite OTC
Index or Nasdaq Industrials Index, Consumer Price Index and
Russell 2000 Index. Further information on performance
measurement may be found in the relevant Statement of Additional
Information.
Performance quotations of the 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 the 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 the Fund's total
return and yield are described in more detail in the Statement of
Additional Information.
APPENDIX A
Hedging Instruments and Transactions of the Equity Index Plus
Fund's Fixed Income Segment
Hedging and risk management techniques require different skills
from those involved in the selection of portfolio securities.
One such skill is the ability to predict the correlation of
interest rate changes between markets. The Adviser has been
engaged in hedging target duration portfolios for more than ten
years. There can be no assurance that the Adviser will accurately
predict market movements which accompany interest rate changes,
in which event the Fund's overall performance may be less than if
the Fund had not entered into hedging transactions.
Interest Rate and Mortgage Swaps, Caps, Floors and Collars.
Interest rate swaps involve the exchange by the Fund with another
party of their respective commitments to pay or receive interest,
for example, an exchange of floating-rate payments for fixed-rate
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 Fixed Income Segment of the Equity Index Plus Fund may
enter into interest rate swaps on other than a net basis.
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
- -34-
<PAGE>
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 Fund will be able to enter into interest
rate swaps, caps, floors or collars on favorable terms.
Furthermore, there can be no assurance that the Fund 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 hedging transactions are entered into for
hedging purposes, the Adviser and the Fund 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
the Fund's obligations over its entitlement with respect to each
interest rate swap will be accrued on a daily basis and an amount
of cash or liquid 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 1940 Act. To the extent that the Fixed Income Segment of
the Equity Index Plus Fund enters into interest rate swaps on
other than a net basis, the amount maintained in its segregated
account will be the full amount of the Fund's obligations, if
any, with respect to such interest rate swaps, accrued on a daily
basis.
The Fixed Income Segment of the Equity Index Plus Fund may
enter into such transactions with counterparties who are rated at
least A by Moody's and S&P at the time of entering into the
contract. The Fund and the Adviser will closely monitor,
subject to the oversight of the Board of Trustees, the
creditworthiness of the contract counterparties in order to
minimize risk.
If there is a default by the other party to such a
transaction, the Fund 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, the Fund will succeed in pursuing
contractual remedies. The Fund thus assumes 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 Fund will still treat these
instruments as illiquid investments subject to the limitation on
such investments described in the Prospectus at "Illiquid
Securities".
- -35-
<PAGE>
Calls and Puts on Securities. In order to reduce fluctuations
in net asset value and portfolio holdings relative to their
targeted option-adjusted duration, the Fund may purchase call or
put options or sell options where it owns the security which is
the subject of the option (a "covered option") on United States
Treasury securities, mortgage-backed securities and Eurodollar
instruments that are traded on United States and
foreign-securities exchanges and in over-the-counter markets
("OTC Options"). The Fund will not sell options which are not
covered. The premiums paid on call options purchased and any
related transaction costs will increase the cost of securities
acquired upon exercise of the option, and unless the price of the
underlying security rises sufficiently, the options may expire
worthless to the Fund.
The Fund's ability to purchase put and call options may be
limited by Internal Revenue Code requirements.
The Adviser monitors the creditworthiness of dealers with whom
the Fund would enter into OTC option transactions under the
general supervision of the Board of Trustees. The Fund will
engage in OTC option transactions only with primary United States
government securities dealers recognized by the Federal Reserve
Bank of New York.
Futures and Related Options. In order to reduce fluctuations
in net asset value of portfolio holdings relative to their
targeted option-adjusted durations or to employ temporary
substitutes for anticipated future transactions, the Fund may buy
or sell financial futures contracts, purchase call or put
options, or sell covered call options on such futures. There is
no overall limitation on the percentage of the Fund's assets
which may be subject to a hedge position.
Options and futures transactions involve costs and may result
in losses. The effective use of options and futures strategies
depends on the 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 existence of a
liquid secondary market. Although the 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 the 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 the Fund, of the option and futures contract itself, and
of the securities which are the subject of a hedge. The Fund,
therefore, bears the risk that prices of hedged securities will
not move to the same degree as the hedging instrument or that
price movements in the hedging instrument will not accurately
reflect price movements in the security underlying the hedging
instrument. It is also possible for the Fund to incur a loss on
both the hedged securities and the hedging instrument.
- -36-
<PAGE>
At times, the Fund may sell interest rate futures in a
different dollar amount than the dollar amount of securities
being hedged, depending on the expected relationship between the
volatility of the prices of such securities and the volatility of
the futures contracts, based on duration calculations by the
Adviser. If the actual price movements of the securities and
futures are inconsistent with their durations as so calculated,
the hedge may not be fully effective.
The Fund will not maintain open short positions in interest
rate futures contracts if, in the aggregate, the value of the
open positions (marked to market) exceeds the current market
value of its securities portfolio plus or minus the unrealized
gain or loss on these open positions, adjusted for the expected
volatility relationship between the portfolio and the futures
contracts based on duration calculations. If this limitation
should be exceeded at any time, the Fund will take prompt action
to close out the appropriate number of open contracts to bring
its open futures position into compliance with this
limitation.
The Fund's ability to engage in options and futures
transactions and to sell related securities may be limited by tax
considerations and by certain regulatory requirements. See
"Additional Information Regarding Taxation" in the Statement of
Additional Information.
The Equity Index Plus Fund's Equity Simulation Segment
Any investment in warrants, valued at the lower of cost or
market, may not exceed 5% of the value of the Fund's net assets.
Included within that amount, but not to exceed 2% of the value
of the Fund's net assets, may be warrants which are not listed on
the New York or American Stock Exchange. Warrants acquired by
the Fund in units or attached to securities may be deemed to be
without value.
- -37-
<PAGE>
Part B: Information Required in
Statement of Additional Information
N-1A
Item No. Item Location in the Registration
Statement
10. Cover Page Cover Page
11. Table of Contents "Table of Contents"
12. General Information
and History See Part A Item 4.
13. Investment Objective "Miscellaneous
and Policies Investment Practices and
Risk Considerations"
14. Management of the
Registrant "Management of the Fund
15. Control Persons and
Principal Holders of "Principal Holders of Securities
Securities and Controlling Persons"
16. Investment Advisory "The Investment Advisory
and Other Services Agreement and Other Services"
17. Brokerage Allocation "The Investment Advisory
Agreement and Other
Services"
18. Capital Stock and "Additional Information
Other Securities Regarding Purchases and
Redemptions of Fund Shares"
19. Purchase, Redemption "Additional Information
and Pricing of Regarding Purchases and
Securities Being Redemptions of Fund
Offered Shares"
20. Tax Status "Taxes"
21. Underwriters Additional Information
Regarding Purchases and
Redemptions of Fund
Shares"
22. Calculation of
Performance Data "Standard Performance
Measures"
23. Financial Statements "Report of Independent
Auditors and Financial
Statements"
<PAGE>
SMITH BREEDEN TRUST
SMITH BREEDEN EQUITY INDEX PLUS FUND
STATEMENT OF ADDITIONAL INFORMATION
JUNE 24, 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
Index Plus Fund which may be useful to investors
and is not included in the Prospectus of the Smith
Breeden Equity Index Plus Fund. The former name
of the Equity Index Plus Fund was the Smith
Breeden Equity Plus Fund. This Statement is not a
Prospectus and is only authorized for distribution
when accompanied or preceded by the Prospectus of
the Smith Breeden Equity Index Plus Fund dated
June 24, 1997, as may be amended from time to time.
The Statement should be read together with the
Prospectus.
Contents Page
DEFINITIONS 1
INVESTMENT RESTRICTIONS OF THE FUND 1
MISCELLANEOUS INVESTMENT PRACTICES AND
RISK CONSIDERATIONS 3
TAXES 6
FUND CHARGES AND EXPENSES 7
MANAGEMENT OF THE FUND 7
THE INVESTMENT ADVISORY AGREEMENT
AND OTHER SERVICES 9
PRINCIPAL HOLDERS OF SECURITIES AND
CONTROLLING PERSONS 12
DETERMINATION OF NET ASSET VALUE 13
ADDITIONAL INFORMATION REGARDING
PURCHASES AND REDEMPTIONS
OF FUND SHARES 13
SHAREHOLDER INFORMATION 15
SUSPENSION OF REDEMPTIONS 15
SHAREHOLDER LIABILITY 15
STANDARD PERFORMANCE MEASURES 15
INDEPENDENT AUDITORS 18
EXPERTS 18
REPORT OF INDEPENDENT AUDITORS AND
FINANCIAL STATEMENTS 18
<PAGE>
SMITH BREEDEN TRUST,
SMITH BREEDEN EQUITY INDEX PLUS FUND
Statement of Additional Information
DEFINITIONS
The "Trust" -- Smith Breeden Trust
The "Fund" -- Smith Breeden Equity Index Plus Fund, a
series of the Trust offering its shares to the
public.
The "Adviser" -- Smith Breeden Associates, Inc., the Fund's
investment adviser.
The "Custodian" -- The Bank of New York, the Fund's custodian.
"FPS Services"-- FPS Services, Inc., the Fund's investor
servicing agent.
INVESTMENT RESTRICTIONS OF THE FUND
Subject to the Fund's ability to invest all or substantially all
of its assets in another investment company with substantially
the same investment objective, as fundamental investment
restrictions, which may not be changed without a vote of a
majority of the outstanding voting securities, the Fund may not
and will not:
1. Issue senior securities, borrow money or pledge its assets,
except that the Fund may borrow from banks or through
reverse repurchase agreements or dollar rolls up to 33 1/3%
of the value of its respective total assets (calculated when
the loan is made) for temporary, extraordinary or emergency
purposes and to take advantage of investment opportunities
and may pledge up to 33 1/3% of the value of its total
assets to secure such borrowings. For purposes of this
restriction, the purchase or sale of securities on a
"when-issued" or delayed delivery basis, the purchase and
sale of futures contracts, the entry into forward contracts,
reverse repurchase agreements and dollar roll transactions,
short sales, interest rate caps, floors and swaps, mortgage
swaps, and collateral arrangements with respect thereto and
such other practices as may be determined by counsel to the
Fund (consistent with pronouncements of the Securities and
Exchange Commission) are not deemed to be a pledge of assets
and 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.
- -1-
<PAGE>
3. Purchase any security (other than obligations of the U.S.
Government, its agencies and instrumentalities) if as a
result 25% or more of the Fund's total assets (determined at
the time of investment) would be invested in one or more
issuers having their principal business activities in the
same industry.
4. Purchase any security, other than mortgage-backed
securities, obligations of the U.S. Government, its agencies
or instrumentalities or collateralized mortgage obligations,
if as a result the Fund would have invested more than 5% of
its respective total assets in securities of issuers
(including predecessors) having a record of less than three
years of continuous operation.
5. Acquire, sell, lease or hold real estate or real estate
limited partnerships, except that it may invest in
securities of companies which deal in real estate and in
securities collateralized by real estate or interests
therein and it may acquire, sell, lease or hold real estate
in connection with protecting its rights as a creditor.
6. Purchase or sell commodities or commodity contracts, except
that the Fund may purchase and sell financial futures
contracts and options thereon. (Does not include caps,
floors, collars or swaps.)
7. Invest in interests in oil, gas, mineral leases or other
mineral exploration or development program.
8. Invest in companies for the purpose of exercising control or
management.
9. Purchase securities of other investment companies, except to
the extent permitted by the Investment Company Act.
10. Make loans of money or property to any person, except
through loans of portfolio securities to qualified
institutions, the purchase of debt obligations in which the
Fund may invest consistently with its investment objectives
and policies and investment limitations or the investment in
repurchase agreements with qualified institutions. The Fund
will not lend portfolio securities if, as a result, the
aggregate of such loans exceeds 33 1/3% of the value of the
Fund's total assets (including such loans).
11. Purchase securities on margin (but the Fund may obtain such
short-term credits as may be necessary for the clearance of
transactions); provided that the deposit or payment by the
Fund of initial or variation margin in connection with
options or futures contracts is not considered the purchase
of a security on margin.
12. Make short sales of securities or maintain a short position
if, when added together, more than 25% of the value of the
Fund's net assets would be (i) deposited as collateral for
the obligation to replace securities borrowed to effect
short sales, and (ii) allocated to segregated accounts in
- -2-
<PAGE>
connection with short sales. Short sales "against-the-box"
are not subject to this limitation.
It is contrary to the Fund's present policy, which may be changed
without shareholder approval, to:
(a) sell over-the-counter options which it does not own; or
(b) sell options on futures contracts which options it does
not own.
As noted in the Prospectus, the Fund may invest up to 15% of its
total net assets in illiquid securities.
In order to comply with certain "blue sky" restrictions, the Fund
will not, as a matter of operating policy, invest in securities
of any issuer if, to the knowledge of the Fund, any officer or
Trustee of the Fund or the Fund's Adviser owns more than one half
of 1% of the outstanding securities of such issuer, and such
officers and Trustees who own more than one half of 1% own in the
aggregate more than 5% of the outstanding securities of such
issuer.
All percentage limitations on investments will apply at the time
of the making of an investment and shall not be considered
violated unless an excess or deficiency occurs or exists
immediately after and as a result of such investment.
The Investment Company Act of 1940 provides that a "vote of a
majority of the outstanding voting securities" of the Fund means
the affirmative of the lesser of (1) more than 50% of the
outstanding shares of the Fund, or (2) 67% or more of the shares
present at a meeting if more than 50% of the outstanding shares
are represented at the meeting in person or by proxy.
MISCELLANEOUS INVESTMENT PRACTICES AND RISK CONSIDERATIONS
The Fund's Prospectus states that the Fund may engage in each of
the following investment practices. However, the fact that the
Fund may engage in a particular practice does not necessarily
mean that it will actually do so.
Repurchase Agreements. The Fixed Income Segment may invest in
repurchase agreements. A repurchase agreement is a contract
under which the Fund acquires a security for a relatively short
period (usually not more than one week) subject to the obligation
of the seller to repurchase and the Fund to resell such security
at a fixed time and price (representing the Fund's cost plus
interest). It is the Fund's present intention to enter into
repurchase agreements only with commercial banks and registered
broker- dealers and only with respect to obligations of the U.S.
Government or its agencies or instrumentalities. Repurchase
agreements may also be viewed as loans made by the Fund which are
collateralized by the securities subject to repurchase. The
Adviser will monitor such transactions to determine that the
value of the underlying securities is at least equal at all times
to the total amount of the repurchase obligation, including the
interest factor. If the seller defaults, the Fund could realize
- -3-
<PAGE>
a loss on the sale of the underlying security to the extent that
the proceeds of sale including accrued interest are less than the
resale price provided in the agreement including interest. In
addition, if the seller should be involved in bankruptcy or
insolvency proceedings, the Fund may incur delay and costs in
selling the underlying security or may suffer a loss of principal
and interest if the Fund is treated as an unsecured creditor and
required to return the underlying collateral to the seller's
estate.
Forward Commitments. The Fixed Income Segment may enter into
contracts to purchase securities for a fixed price at a future
date beyond customary settlement time ("forward commitments" and
"when issued" and "delayed delivery" securities) if the Fund
holds until the settlement date, in a segregated account, cash or
high-grade debt obligations in an amount sufficient to meet the
purchase price, or if the Fund enters into offsetting contracts
for the forward sale of other securities it owns. Forward
commitments may be considered securities in themselves, and
involve a risk of loss if the value of the security to be
purchased declines prior to the settlement date. Where such
purchases are made through dealers, the Fund relies on the dealer
to consummate the sale. The dealer's failure to do so may result
in the loss to the Fund of an advantageous return or price.
Although the Fund will generally enter into forward commitments
with the intention of acquiring securities for its portfolio or
for delivery pursuant to options contracts it has entered into,
the Fund may dispose of a commitment prior to settlement if the
Adviser deems it appropriate to do so. The Fund may realize
short-term profits or losses upon the sale of forward
commitments.
Securities Loans. The Fund may make secured loans of Fixed
Income Segment securities amounting to not more than 33 1/3% of
the Fund's total assets thereby realizing additional income. The
risks in lending portfolio securities, as with other extensions
of credit, consist of possible delay in recovery of the
securities or possible loss of rights in the collateral should
the borrower fail financially. As a matter of policy, securities
loans are made to broker-dealers pursuant to agreement requiring
that loans be continuously secured by collateral in cash or
short-term debt obligations at least equal at all times to the
value of the securities on loan. The borrower pays to the Fund
an amount equal to any dividends or interest received on
securities lent. The Fund retains all or a portion of the
interest received on investment of the cash collateral or
receives a fee from the borrower. Although voting rights, or
rights to consent, with respect to the loaned securities pass to
the borrower, the Fund retains the right to call the loans at any
time on reasonable notice, and it will do so in order that the
securities may be voted by the Fund if the holders of such
securities are asked to vote upon or consent to matters
materially affecting the investment. The Fund may also call such
loans in order to sell the securities involved.
Borrowing. The Fixed Income Segment may borrow from banks and
enter into reverse repurchase agreements or dollar rolls (as
described in Appendix A of the Prospectus) up to 33 1/3% of the
- -4-
<PAGE>
value of the Fund's total assets (computed at the time the loan
is made) to take advantage of investment opportunities and for
extraordinary or emergency purposes, or for the clearance of
transactions. The Fund may pledge up to 33 1/3% of its total
assets to secure these borrowings. If the Fund's asset coverage
for borrowings falls below 300%, the Fund will take prompt action
to reduce its borrowings even though it may be disadvantageous at
that time from an investment point of view. The Fund will incur
borrowing costs when it leverages, including payment of interest
and any fee necessary to maintain a line of credit, and may be
required to maintain a minimum average balance. If the income and
appreciation on assets acquired with borrowed funds exceed their
borrowing cost, the Fund's investment performance will increase,
whereas if the income and appreciation on assets acquired with
borrowed funds are less than their borrowing costs, investment
performance will decrease. In addition, if the Fund borrows to
invest in securities, any investment gains made on the securities
in excess of the costs of the borrowing, and any gain or loss on
hedging, will cause the net asset value of the shares to rise
faster than would otherwise be the case. On the other hand, if
the investment performance of the additional securities purchased
fails to cover their cost (including any interest paid on the
money borrowed) to the Fund, the net asset value of the Fund's
shares will decrease faster than would otherwise be the case.
This speculative characteristic is known as "leverage."
Reverse Repurchase Agreements and Dollar Roll Agreements. The
Fixed Income Segment may enter into reverse repurchase agreements
and dollar roll agreements with commercial banks and registered
broker-dealers to seek to enhance returns.
Reverse repurchase agreements involve sales by the Fund of
portfolio assets concurrently with an agreement by the Fund to
repurchase the same assets at a later date at a fixed price.
During the reverse repurchase agreement period, the Fund
continues to receive principal and interest payments on these
securities and also has the opportunity to earn a return on the
collateral furnished by the counterparty to secure its obligation
to redeliver the securities.
Dollar rolls are transactions in which the Fund sells securities
for delivery in the current month and simultaneously contracts to
repurchase substantially similar (same type and coupon)
securities on a specified future date. During the roll period,
the Fund forgoes principal and interest paid on the securities.
The Fund is compensated by the difference between the current
sales price and the forward price for the future purchase (often
referred to as the "drop") as well as by the interest earned on
the cash proceeds of the initial sale.
The Fund will establish a segregated account with its custodian
in which it will maintain cash, U.S. Government securities or
other liquid high grade debt obligations equal in value to its
obligations in respect of reverse repurchase agreements and
dollar rolls. Reverse repurchase agreements and dollar rolls
involve the risk that the market value of the securities retained
by the Fund may decline below the price of the securities the
Fund has sold but is obligated to repurchase under the agreement.
- -5-
<PAGE>
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.
TAXES
Taxation of the Fund. The Fund intends to qualify each year as a
regulated investment company under Subchapter M of the Internal
Revenue Code of 1986, as amended (the "Code"). In order so to
qualify and to qualify for the special tax treatment accorded
regulated investment companies and their shareholders, the Fund
must, among other things:
(a) Derive at least 90% of its gross income from dividends,
interest, payments with respect to certain securities
loans, and gains from the sale of stock, securities and
foreign currencies, or other income (including but not
limited to gains from options, futures, or forward
contracts) derived with respect to its business of
investing in such stock, securities, or currencies;
(b) derive less than 30% of its gross income from gains
from the sale or other disposition of certain assets
(including securities) held for less than three months;
(c) distribute with respect to each taxable year at least
90% of its taxable and tax-exempt income for such year;
and
(d) diversify its holdings so that, at the end of each
fiscal quarter (i) at least 50% of the market value of
the Fund's assets is represented by cash and cash
items, U.S. Government securities, securities of other
regulated investment companies, and other securities
limited in respect of any one issuer to a value not
greater than 5% of the value of the Fund's total assets
and 10% of the outstanding voting securities of such
issuer, and (ii) not more than 25% of the value of its
assets is invested in the securities (other than those
of the U.S. Government or other regulated investment
companies) of any one issuer or of two or more issuers
which the Fund controls and which are engaged in the
same, similar, or related trades or businesses.
Qualification as a regulated investment company exempts the Fund
from federal income tax on income paid to its shareholders in the
form of dividends (including capital gain dividends). A dividend
paid to shareholders by the Fund in January of a year generally
is deemed to have been paid by the Fund on December 31 of the
preceding year, if the dividend was declared and payable to
shareholders of record on a date in October, November or December
of that preceding year.
- -6-
<PAGE>
If the Fund failed to qualify as a regulated investment company
accorded special tax treatment in any taxable year, the Fund
would be subject to tax on its taxable income at corporate rates,
and could be required to recognize unrealized gains, pay
substantial taxes and interest and make substantial distributions
before requalifying as a regulated investment company that is
accorded special tax treatment.
If the Fund fails to distribute in a calendar year substantially
all of its ordinary income for such year and substantially all of
its net capital gain for the year ending October 31 (or later if
the Fund is permitted so to elect and so elects), plus any
retained amount from the prior year, the Fund will be subject to
a 4% excise tax on the undistributed amounts. The Fund intends
generally to make distributions sufficient to avoid imposition of
the 4% excise tax. In calculating its income, the Fund must
include dividends in income not when received but on the date
when the stock in question is acquired or becomes ex-dividend,
whichever is later. Also, a portion of the yield on certain high
yield securities (including certain payment-in-kind bonds) issued
after July 10, 1989 may be treated as dividends.
Return of capital distributions. If the Fund makes a
distribution to you in excess of its current and accumulated
"earnings and profits" in any taxable year, the excess
distribution will be treated as a return of capital to the extent
of your tax basis in your shares, and thereafter as capital gain.
A return of capital is not taxable, but it reduces your tax
basis in your shares.
FUND CHARGES AND EXPENSES
Management Fees. The Fund pays a monthly fee to the Adviser
based on the average net assets of the Fund, as determined at the
close of each business day during the month, at an annual rate of
0.70%. Advisory fees paid for the fiscal year ended March 31,
1996 were $21,727. Advisory fees for each of the last three
fiscal years ended March 31 were $5,931, $11,056 and $21,727,
respectively. The amounts paid in prior fiscal years from June
30, 1992 through August 1, 1994 reflect a previous advisory
contract rate of 0.35% of average net assets. For each of the
last three fiscal years ended March 31, the Adviser reimbursed
the Fund $104,828, $128,959 and $114,100, respectively, under
expense limitation provisions.
Other Expenses. The Fund pays its own expenses, including, but
not limited to auditing, legal, tax preparation and consulting,
insurance, custodial, accounting, shareholder servicing and
shareholder report expenses. Fees paid to FPS Services which
serves as the Fund's shareholder servicing and accounting agent
are determined by contract as approved by the Board of Trustees.
MANAGEMENT OF THE FUND
The Board of Trustees has the responsibility for the overall
management of the Fund, including general supervision and review
of its investment activities. The Trustees, in turn, elect the
officers of the Fund who are responsible for administering the
- -7-
<PAGE>
day-to-day operations of the Fund. Trustees and officers of the
Fund are identified in the Prospectus.
All of the Trustees are Trustees of all the other funds managed
by the Adviser and each independent trustee receives fees for his
or her services. The Trustees do not receive pension or
retirement benefits from the Fund.
The table below shows the fees paid to each independent Director
for the fiscal year ended March 31, 1996:
Director Aggregate Compensation
William F. Sharpe $ 4,250
Myron S. Scholes $ 0
Stephen M. Schaefer $ 0
The Agreement and Declaration of Trust of the Fund provides that
the Fund will indemnify its Trustees and officers against
liabilities and expenses incurred in connection with litigation
in which they may be involved because of their offices with the
Fund, except if it is determined in the manner specified in the
Agreement and Declaration of Trust that they have not acted in
good faith in the reasonable belief that their actions were in
the best interests of the Fund or that such indemnification would
relieve any officer or Trustee of any liability to the Fund or
its shareholders by reason of willful misfeasance, bad faith,
gross negligence or reckless disregard of his or her duties.
Trustees and officers of the Fund who are also officers or
shareholders of the Adviser will benefit from the advisory fees
paid by the Fund.
Potential Conflicts of Interest. Principals of the Adviser as
individuals own approximately 67% of the common stock of
Harrington Financial Group, the holding company for Harrington
Bank, FSB of Richmond, Indiana (the "Association"). As of May
31, 1996, the Association had total assets of $356 million. The
Association invests in assets of the same types as those to be
held by the Fund
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. The Fund will transact no business directly or
indirectly with either CFFG or the banks and thrifts which it
owns. CFFG and its subsidiaries invest in assets of the same
types as those to be held by the Fund.
The Adviser may also manage advisory accounts with investment
objectives similar to or the same as those of the Fund, or
different from the Fund but trading in the same type of
securities and instruments as the Fund. Portfolio decisions and
results of the Fund's investments may differ from those of such
accounts managed by the Adviser. When two or more accounts
managed by the Adviser seek to purchase or sell the same assets,
the assets actually purchased or sold may be allocated among the
accounts on a basis determined by the Adviser in its good faith
- -8-
<PAGE>
discretion to be equitable. In some cases, this system may
adversely affect the size or the price of the position obtainable
for the Fund.
THE INVESTMENT ADVISORY AGREEMENT AND OTHER SERVICES
The investment manager of the Fund is Smith Breeden Associates,
Inc. (the "Adviser"). The table in the Prospectus indicates
which officers and trustees are affiliated persons of the
Adviser.
Under the Investment Advisory Agreement between the Fund and the
Adviser, subject to such policies as the Trustees may determine,
the Adviser, at its expense, furnishes continuously an investment
program for the Fund and makes investment decisions on behalf of
the Fund. Subject to the control of the Trustees, the Adviser
also manages, supervises and conducts the other affairs and
business of the Fund, furnishes office space and equipment,
provides bookkeeping and clerical services and places all orders
for the purchase and sale of the Fund's portfolio securities.
For details of the Adviser's compensation under the Investment
Advisory Agreement, see "Fund Charges and Expenses" in this
Statement. The Adviser's compensation under the Investment
Advisory Agreement may be reduced in any year if the Fund's
expenses exceed the limits on investment company expenses imposed
by any statute or regulatory authority of any jurisdiction in
which shares of the Fund are qualified for offer or sale. The
term "expenses" is defined in the statutes or regulations of such
jurisdictions, and, generally speaking, excludes brokerage
commissions, taxes, interest and extraordinary expenses. The
only such limitation as of the date of this Statement (imposed by
the State of California) was 2.5% of the first $30 million of
average net assets, 2% of the next $70 million and 1.5% of any
excess over $100 million.
Under the Investment Advisory Agreement, the Adviser may reduce
its compensation to the extent that the Fund's expenses exceed
such lower expense limitation as the Adviser may, by notice to
the Fund, voluntarily declare to be effective. The expenses
subject to this limitation are exclusive of brokerage
commissions, interest, taxes, and extraordinary expenses. The
terms of the expense limitation currently in effect are described
in the Prospectus and on the following page. The Fund pays all
expenses not assumed by the Adviser including, without
limitation, auditing, legal, tax preparation and consulting,
custodial, investor servicing and shareholder reporting expenses.
The Investment Advisory Agreement provides that the Adviser shall
not be subject to any liability to the Fund or to any shareholder
of the Fund for any act or omission in the course of or connected
with rendering services to the Fund in the absence of willful
misfeasance, bad faith, gross negligence or reckless disregard of
its duties on the part of the Adviser.
The Investment Advisory Agreement may be terminated without
penalty by vote of the Trustees or the shareholders of the Fund,
or by the Adviser, on 60 days written notice. It may be amended
- -9-
<PAGE>
only by a vote of the shareholders of the Fund. The Investment
Advisory Agreement also terminates without payment of any penalty
in the event of its assignment as defined in the Investment
Company Act. The Investment Advisory Agreement provides that it
will continue in effect after its initial term of two years only
so long as such continuance is approved at least annually by vote
of either the Trustees or the shareholders, and, in either case,
by a majority of the Trustees who are not "interested persons" of
the Adviser or the Fund. In each of the foregoing cases, the
vote of the shareholders is the affirmative vote of a "majority
of the outstanding voting securities".
Under the terms of the Investment Advisory Agreement, the Adviser
performs certain administrative services as follows: (1)
coordinates with the Fund's custodian and transfer agent and
monitors the services they provide to the Fund; (2) coordinates
with and monitors other third parties furnishing services to the
Fund; (3) provides the Fund with necessary office space,
telephones and other communications facilities and personnel
competent to perform administrative and clerical functions for
the Fund; (4) supervises the preparation by third parties of all
Federal, state and local tax returns and reports of the Fund
required by applicable law; (5) prepares and, after approval by
the Fund, files and arranges for the distribution of proxy
materials and periodic reports to shareholders of the Fund as
required by applicable law; (6) prepares and, after approval by
the Fund, arranges for the filing of such registration statements
and other documents with the Securities and Exchange Commission
and other Federal and state regulatory authorities as may be
required by applicable law; (7) reviews and submits to the
officers of the Fund for their approval invoices or other
requests for payment of Fund expenses; and (8) takes such other
actions with respect to the Fund as may be necessary in the
opinion of the Advisor to perform its duties under the agreement.
The Adviser has voluntarily agreed to bear normal operating
expenses (excluding litigation, indemnification and other
extraordinary expenses) of the Fund, and, if necessary, to waive
its advisory fee, for the period ending March 31, 1997 such that
total operating expenses would not exceed 0.88% of the average
net assets of the Fund. Such expense limitations, if any, are
calculated daily based on average net assets and may be continued
or modified by the Adviser at any time in its sole discretion.
Portfolio Transactions
Investment decisions. Investment decisions for the Fund and for
the other investment advisory clients of the Adviser are made
with a view to achieving their respective investment objectives.
Investment decisions are the product of many factors in addition
to basic suitability for the particular client involved. Thus, a
particular security may be bought or sold for certain clients
even though it could have been bought or sold for other clients
at the same time. Likewise, a particular security may be bought
for one or more clients when one or more other clients are
selling the security. In some instances, one client may sell a
particular security to another client. It also sometimes happens
that two or more clients simultaneously purchase or sell the same
- -10-
<PAGE>
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 Fund of negotiated
brokerage commissions. Such commissions vary among different
brokers. In addition, a particular broker may charge different
commissions according to such factors as the difficulty and size
of the transaction. There is generally no stated commission in
the case of securities traded in the over-the-counter markets,
but the price paid by the Fund usually includes an undisclosed
dealer commission or mark-up. In underwritten offerings, the
price paid by the Fund includes a disclosed, fixed commission or
discount retained by the underwriter or dealer. The Fund paid
approximately $1000 in brokerage commissions on futures and
options transactions for each of its three fiscal years ended
March 31.
The Adviser places all orders for the purchase and sale of
portfolio investments for the Fund and may buy and sell
investments for the Fund through a substantial number of brokers
and dealers. In so doing, the Adviser uses its best efforts to
obtain for the Fund the most favorable price and execution
available. In seeking the most favorable price and execution,
the Adviser, having in mind the Fund's best interests, considers
all factors it deems relevant, including, by way of illustration,
price, the size of the transaction, the nature of the market for
the security or other investment, the amount of the commission,
the timing of the transaction taking into account market prices
and trends, the reputation, experience and financial stability of
the broker-dealer involved and the quality of service rendered by
the broker-dealer in other transactions.
When it is determined that several brokers or dealers are equally
able to provide the best net price and execution, the Adviser may
execute transactions through brokers or dealers who provide
quotations and other services to its advisory clients, including
the quotations necessary to determine these clients' net assets,
in such amount of total brokerage as may reasonably be required
in light of such services, and through brokers and dealers who
supply statistical and other data to the Adviser and its clients
in such amount of total brokerage as may reasonably be required.
Consistent with the Rules of Fair Practice of the National
Association of Securities Dealers, Inc. and subject to seeking
the most favorable price and execution available and such other
policies as the Trustees may determine, the Adviser may consider
sales of shares of the Fund (and, if permitted by law, of the
other funds managed by the Adviser) as a factor in the selection
of broker-dealers to execute portfolio transactions for the Fund.
- -11-
<PAGE>
The Adviser conducts extensive proprietary fixed income research
with emphasis on mortgage-backed securities. The Adviser is not
dependent on any broker for such research and analysis and, thus
is able to transact business with brokers regardless of the
brokers' research capabilities or provision of such research to
brokerage customers. The Adviser uses multiple electronic
quotation services for trading and pricing purposes. The Adviser
pays for these services directly out of its advisory fees. The
Adviser is not involved in any soft dollar arrangements. The
Adviser does utilize broker pricing guidance for certain assets
not consistently available through electronic quotation services.
Investor Servicing Agent and Underwriter
FPS Services is the Fund's investor servicing agent (transfer,
plan and dividend disbursing agent), for which it receives fees
which are paid monthly by the Fund as an expense of all its
shareholders. See "Fund Charges and Expenses" in this Statement
for information on fees and reimbursements received by FPS
Services. FPS Services is also investor servicing agent for the
other funds managed by the Adviser and receives fees from each of
those funds for its services.
Custodian
The Bank of New York ("Custodian") acts as custodian of the
Fund's assets. In carrying out its duties under its custodian
contract, the Custodian may employ one or more subcustodians
whose responsibilities will include safeguarding and controlling
the Fund's cash and securities, handling the receipt and delivery
of securities and collecting interest and dividends on the Fund's
investments. The Fund pays the Custodian an annual fee based on
the assets of the Fund and the Fund's securities transactions.
The Fund also pays the Custodian an annual fee based on the
Fund's securities holdings for the year and reimburses the
Custodian for certain out-of-pocket expenses incurred by it or
any subcustodian employed by it in performing custodial services.
The Custodian pays the fees and other charges of any subcustodian
employed by it.
PRINCIPAL HOLDERS OF SECURITIES AND CONTROLLING PERSONS
Listed below are the names and addresses of those shareholders
who, as of February 28, 1997, owned 5% or more of the shares of the
Fund.
Shareholder Percentage
Owned
Charles Schwab & Company 44.77%
Attn: Mutual Funds
101 Montgomery Street
San Francisco, CA 94104
Sammie C. Bledsoe 7.79%
Sammie C. Bledsoe Trust
1737 East 30th Place
Tulsa, OK 74114
- -12-
<PAGE>
A Fund Trustee owns less than 1% of the shares of the Fund as of
February 28, 1997.
DETERMINATION OF NET ASSET VALUE
The Fund determines net asset value as of the close of regular
trading on the New York Stock Exchange at 4 p.m.
If any securities held by the Fund are restricted as to resale,
the Adviser determines their fair value following procedures
approved by the Trustees. The Trustees periodically review such
valuation procedures. The fair value of such securities is
generally determined as the amount which the Fund could
reasonably expect to realize from an orderly disposition of such
securities over a reasonable period of time. The valuation
procedures applied in any specific instance are likely to vary
from case to case. However, consideration is generally given to
the financial position of the issuer and other fundamental
analytical data relating to the investment and to the nature of
the restrictions on disposition of the securities (including any
registration expenses that might be borne by the Fund in
connection with such disposition). In addition, specific factors
are also generally considered, such as the cost of the
investment, the market value of any unrestricted securities of
the same class (both at the time of purchase and at the time of
valuation), the size of the holding, the prices of any recent
transactions or offers with respect to such securities and any
available analysts' reports regarding the issuer.
Generally, trading in certain securities is substantially
completed each day at various times prior to the close of regular
trading on the Exchange. The values of these securities used in
determining the net asset value of the Fund's shares are computed
as of such times. Also, because of the amount of time required
to collect and process trading information as to large numbers of
securities issues, the values of certain securities (such as
convertible bonds and U.S. Government securities) are determined
based on market quotations collected earlier in the day at the
latest practicable time prior to the close of the Exchange.
Occasionally, events affecting the value of such securities may
occur between such times and the close of the Exchange which will
not be reflected in the computation of the Fund's net asset
value. If events materially affecting the value of such
securities occur during such period, then these securities will
be valued at their fair market value following procedures
approved by the Trustees.
ADDITIONAL INFORMATION REGARDING PURCHASES AND
REDEMPTIONS OF FUND SHARES
All checks, drafts, wires and other payment mediums used for
purchasing or redeeming shares of the Fund must be denominated in
U.S. Dollars. The Fund reserves the right, in its sole
discretion, to either (a) reject any order for the purchase or
sale of shares denominated in any other currency, or (b) to honor
the transaction or make adjustments to shareholder's account for
the transaction as of a date and with a foreign currency exchange
factor determined by the drawee bank.
- -13-
<PAGE>
Dividend checks which are returned to the Fund marked "unable to
forward" by the postal service will be deemed to be a request to
change the dividend option and the proceeds will be reinvested in
additional shares at the current net asset value until new
instructions are received.
Redemptions in Kind. The Fund has committed itself to pay in
cash all requests for redemption by any shareholder of record,
limited in amount, however, during any 90-day period to the
lesser of $250,000 or 1% of the value of the Fund's net assets at
the beginning of such period. Such commitment is irrevocable
without the prior approval of the Securities and Exchange
Commission. In the case of requests for redemption in excess of
such amounts, the Trustees reserve the right to make payments in
whole or in part in securities or other assets of the Fund in
case of any emergency, or if the payment of such redemption in
cash would be detrimental to the existing shareholders of the
Fund. In such circumstances, the securities distributed would be
valued at the price used to compute the Fund's net assets.
Should the Fund do so, a shareholder may incur brokerage fees or
other transaction costs in converting the securities to cash.
Principal Underwriter. FPS Broker Services, Inc. (the "Principal
Underwriter"), 3200 Horizon Drive, P.O. Box 61503, King of
Prussia, PA 19406-0903, is the principal underwriter for the Fund
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 Fund's shares is
continuous.
The Fund's underwriting agreement with the Principal Underwriter
provides that the Fund will pay all fees and expenses in
connection with: registering and qualifying its shares under the
various state "blue sky" laws; preparing, setting in type,
printing, and mailing its prospectuses and reports to
shareholders; and issuing its shares, including expenses of
confirming purchase orders.
The Principal Underwriter acts as the agent of the Fund in
connection with the sale of its shares in all states in which the
shares are qualified and in which the Principal Underwriter is
qualified as a broker-dealer. Under the underwriting
agreement,the Principal Underwriter may accept orders for Fund
shares at the offering price. For these services, the Adviser
pays the Principal Underwriter approximately $8000. The
Principal Underwriter may enter into agreements with other
broker-dealers for the sale of Fund shares by them.
Reinvestment Date. The dividend reinvestment date is the date on
which the additional shares are purchased for the investor who
has its dividends reinvested. This date will vary and is not
necessarily the same date as the record date or the payable date
for cash dividends.
Special Services. The Fund may pay certain financial
institutions which maintain omnibus accounts with the Fund on
behalf of numerous beneficial owners for recordkeeping operations
- -14-
<PAGE>
performed with respect to such beneficial owners. Such financial
institutions may also charge a fee for their services directly to
their clients.
SHAREHOLDER INFORMATION
Each time shareholders buy, redeem or exchange shares or receive
a distribution, they will receive a statement confirming the
transaction and listing their current share balance. The Fund
also sends annual and semiannual reports that keep shareholders
informed about its portfolio and performance, and year-end tax
information to simplify their recordkeeping. Shareholders may
call FPS Services toll-free at 1-800-221-3137 between 9:00 a.m.
and 7:00 p.m. (Eastern Time) for more information, including
account balances.
SUSPENSION OF REDEMPTIONS
The Fund may not suspend shareholders' right of redemption, or
postpone payment for more than seven days, unless the New York
Stock Exchange (the "Exchange") is closed for other than
customary weekends or holidays, or if permitted by the rules of
the Securities and Exchange Commission during periods when
trading on the Exchange is restricted or during any emergency
which makes it impracticable for the Fund to dispose of its
securities or to determine fairly the value of its net assets, or
during any other period permitted by order of the Commission for
protection of investors.
SHAREHOLDER LIABILITY
Under Massachusetts law, shareholders could, under certain
circumstances, be held personally liable for the obligations of
the Fund. However, the Agreement and Declaration of Trust
disclaims shareholder liability for acts or obligations of the
Fund and requires that notice of such disclaimer be given in each
agreement, obligation, or instrument entered into or executed by
the Fund or the Trustees. The Agreement and Declaration of Trust
provides for indemnification out of Fund property for all loss
and expense of any shareholder held personally liable for the
obligations of the Fund. Thus, the risk of a shareholder
incurring financial loss on account of shareholder liability is
limited to circumstances in which the Fund would be unable to
meet its obligations. The likelihood of such circumstances is
remote.
STANDARD PERFORMANCE MEASURES
Total return data for the Fund may from time to time be presented
in this Statement and in advertisements. Total return for the
one-year period and for the life of the Fund is determined by
calculating the actual dollar amount of investment return on a
$250 investment in the Fund made at the net asset value at the
beginning of the period, and then calculating the annual
compounded rate of return which would produce that amount. Total
return for a period of one year is equal to the actual return of
the Fund during that period. Total return calculations assume
reinvestment of all Fund distributions at net asset value on
- -15-
<PAGE>
their respective reinvestment dates. As of March 31, 1996, the
average annual total return for the Fund since inception is
17.74% and the average annual total return for the one year
period ended March 31, 1996 is 32.30%.
At times, the Adviser may reduce its compensation or assume
expenses of the Fund in order to reduce the Fund's expenses. The
per share amount of any such fee reduction or assumption of
expenses for the life of the Fund, will be reflected in the
Prospectus as updated. Any such fee reduction or assumption of
expenses would increase the Fund's total return during the period
of the fee reduction or assumption of expenses.
Independent statistical agencies measure the Fund's investment
performance and publish comparative information showing how the
Fund, and similar investment companies, performed in specified
time periods. The agencies whose reports are commonly used for
Morningstar comparisons are Lipper Analytical Services and
Wiesenberger Investment Companies Service. From time to time,
the Fund may distribute these comparisons to its shareholders or
to potential investors.
The Fund's performance may also from time to time be compared to
Standard & Poor's 500 Composite Stock Price Index (the "S&P 500
Index"). The S&P 500 Index is an unmanaged list of common stocks
frequently used as a general measure of stock market performance.
Standard & Poor's performance figures reflect changes of market
prices and reinvestment of all regular cash dividends and are not
adjusted for commissions or other costs. Because the Fund is a
managed portfolio investing in a variety of securities and
derivative instruments, the securities it owns will not match
those in the Index.
Other publications, indices, and averages which may be used are
as follows:
a) CDA Mutual Fund Report, published by CDA Investment
Technologies, Inc. - analyzes price, current yield, risk,
total return and average rate of return (average annual
compounded growth rate) over specified time periods for the
mutual fund industry.
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.
- -16-
<PAGE>
e) Stocks, Bonds, Bills, and Inflation, published by Ibbotson
Associates - historical measure of yield, price and total
return for common and small company stock, long-term
government bonds, treasury bills, and inflation.
f) Savings and Loan Historical Interest Rates - as published in
the U.S. Savings & Loan League Fact Book.
g) Salomon Brothers Broad Bond Index or its component indices -
The Broad Index measures yield, price and total return for
Treasury, Agency, Corporate, and Mortgage bonds.
h) Salomon Brothers Composite High Yield Index or its component
indices - The High Yield Index measures yield, price and
total return for Long-Term High-Yield Index,
Intermediate-Term High-Yield Index and Long-Term Utility
High-Yield Index.
i) Lehman Brothers Aggregate Bond Index or its component
indices - The Aggregate Bond Index measures yield, price and
total return for Treasury, Agency, Corporate, Mortgage, and
Yankee bonds.
j) Lehman Brothers Government/Corporate Bond Index.
k) Other taxable investments including certificates of deposit
(CD's), money market deposit accounts (MMDA's), checking
accounts, savings accounts, money market mutual funds,
repurchase agreements, and government securities.
l) Historical data supplied by the research departments of
Lehman Brothers, First Boston Corporation, Morgan Stanley,
Salomon Brothers, Merrill Lynch, Goldman Sachs, Prudential
Securities and Donaldson Lufkin and Jenrette.
m) Donoghues's Money Fund Report - industry averages for
seven-day annualized and compounded yields of taxable,
tax-free and government money funds.
n) Total returns and yields for Treasury Securities and fixed
income indices as published by Ryan Laboratories or other
suppliers.
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.
- -17-
<PAGE>
A statistic often used by sophisticated institutional investors
when comparing the relative performance of portfolios is the
Sharpe Ratio. This statistic is the portfolio's excess return
(relative to T-Bills) divided by the standard deviation of its
returns.
All data are based on past performance and do not predict future
results.
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey
08540, are the Fund's independent auditors, providing audit
services, tax return review and preparation services and
assistance and consultation in connection with the review of
various Securities and Exchange Commission filings.
EXPERTS
The audited financial statements of the Fund and related notes thereto
included in this Statement of Additional Information have been so
included in reliance upon the report of Deloitte & Touche LLP,
independent auditors, given on the authority of said firm as
experts in auditing and accounting.
REPORT OF INDEPENDENT AUDITORS AND FINANCIAL STATEMENTS
The unaudited financial statements for the six months ended September 30, 1996
are attached. In addition, the audited financial statements for the Fund's
fiscal year ended March 31, 1996 are also attached. Prior to August 1, 1996,
the Fund was known as the Smith Breeden Market Tracking Fund.
See attached reports.
- -18-
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
FINANCIAL STATEMENTS:SIX MONTHS ENDED SEPTEMBER 30, 1996
SCHEDULE OF INVESTMENTS (Unaudited) SEPTEMBER 30, 1996
Face Amount Security Market Value
U.S. GOVERNMENT & AGENCY OBLIGATIONS - 102.30%
FEDERAL HOME LOAN MORTGAGE CORPORATION -
1.75% *
FHLMC:
$123,880 9.50%, due 7/1/02 ......................... $128,102
TOTAL FEDERAL HOME LOAN MORTGAGE CORPORATION
(Cost $128,393) ........................... 128,102
FEDERAL NATIONAL MORTGAGE ASSOCIATION -
13.43% *
FNMA:
125,927 12.50%, due 9/1/12 ........................ 144,608
107,397 13.50%, due 11/1/14 to 1/1/15 ............. 124,998
FNMA ARM:
690,824 7.756%, due 9/1/18......................... 713,148
TOTAL FEDERAL NATIONAL MORTGAGE ASSOCIATION
(Cost $969,055) ........................... 982,754
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION -
68.00%
GNMA ARM:
1,879,739 6.00%, due 7/20/26 to 8/20/26 ............. 1,869,847
948,469 6.50%, due 2/20/16 to 7/20/26 ............. 959,102
117,113 6.875%, due 9/20/22 ....................... 118,691
1,718,773 7.125%, due 4/20/16 to 5/20/22 ............ 1,749,456
272,131 7.250%, due 8/20/22 ....................... 276,893
TOTAL GOVERNMENT NATIONAL MORTGAGE
ASSOCIATION (Cost $4,935,694) ............. 4,973,989
U.S. GOVERNMENT OBLIGATIONS - 19.12%
U.S. TREASURY BILL **
750,000 5.09%, due 12/19/96 ....................... 741,985
400,000 4.85%, due 12/19/96 ....................... 395,725
270,000 5.38%, due 5/29/97 ........................ 260,550
TOTAL U.S. GOVERNMENT OBLIGATIONS
(Cost $1,397,673) ......................... 1,398,260
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(Cost $7,430,815) ......................... 7,483,105
<PAGE>
Contracts THREE MONTH EURODOLLAR FUTURES OPTIONS- 0.03%
20 Put on Eurodollar futures, expires 3/97,
strike price $92.50 ....................... 750
25 Put on Eurodollar futures, expires 3/97,
strike price $92.75........................ 1,250
TOTAL EURODOLLAR FUTURES OPTIONS
(Cost $8,722) ............................. 2,000
5 YEAR TREASURY NOTE FUTURES OPTIONS - 0.04%
5 Put on five year Treasury note futures,
expires 11/96, strike price $105........... 2,656
5 YEAR TREASURY NOTE FUTURES OPTIONS
(Cost $5,988) ............................. 2,656
TOTAL INVESTMENTS (Cost $7,445,525) -
102.36%.................................... 7,487,761
CASH AND OTHER ASSETS LESS LIABILITIES -
(2.36%).................................... (172,856)
NET ASSETS - 100.00% ...................... $7,314,905
* 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, 1996. ARMs have coupon rates which adjust periodically.
The adjusted rate is determined by adding a spread to a specified index.
** The interest rate shown is the discount rate paid at the time
of purchase by the Fund.
Portfolio Abbreviations:
ARM - Adjustable-Rate Mortgage
FHLMC - Federal Home Loan Mortgage Corporation
FNMA - Federal National Mortgage Association
GNMA - Government National Mortgage Association
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
STATEMENT OF ASSETS AND LIABILITIES
SEPTEMBER 30, 1996
(Unaudited)
ASSETS:
Investments at market value (identified
cost $7,445,525)(Note 1)................... $7,487,761
Cash....................................... 133,707
Receivables:
Interest................................ 36,009
Maturities.............................. 2,067
Subscriptions........................... 1,100
Prepaid expenses........................... 3,284
Deferred organization expenses (Note 1).... 20,653
TOTAL ASSETS.......................... 7,684,581
LIABILITIES:
Variation margin on futures contracts (Note 2) 1,000
Redemptions payable........................ 17,902
Payable for securities purchased........... 318,747
Due to adviser (Note 3).................... 24,464
Accrued expenses........................... 7,563
TOTAL LIABILITIES..................... 369,676
NET ASSETS:
(Applicable to outstanding shares of 603,141;
unlimited number of shares of beneficial
interest authorized; no stated par)....... $7,314,905
Net asset value, offering price and
redemption price per share
($7,314,905 / 603,141)..................... $12.13
SOURCE OF NET ASSETS:
Paid in capital............................ 6,977,379
Undistributed net investment income........ 51,935
Accumulated net realized gain on investments 181,678
Net unrealized appreciation of investments. 103,913
NET ASSETS............................ $7,314,905
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED SEPTEMBER 30, 1996
(Unaudited)
INVESTMENT INCOME:
Interest and discount earned, net of premium
amortization (Note 1)........................ $179,234
EXPENSES:
Advisory fees (Note 3)....................... 19,368
Accounting and pricing services fees......... 12,500
Custodian fees............................... 5,595
Audit and tax preparation fees............... 6,500
Legal fees................................... 600
Amortization of organization expenses (Note 1) 13,934
Transfer agent fees.......................... 14,012
Registration fees............................ 10,167
Trustees fees and expenses................... 1,875
Insurance expense............................ 3,266
Other........................................ 1,773
TOTAL EXPENSES BEFORE REIMBURSEMENT...... 89,590
Expenses reimbursed by Adviser (Note 3).. (64,897)
NET EXPENSES............................. 24,693
NET INVESTMENT INCOME.................... 154,541
REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gain on investments............. 228,555
Change in unrealized appreciation of investments 65,639
Net realized and unrealized gain on investments 294,194
Net increase in net assets resulting from
operations................................... $448,735
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
Six Months
Ended
September 30,
1996 Year Ended
(Unaudited) March 31, 1996
OPERATIONS:
Net investment income.............. $154,541 $171,628
Net realized gain on investments... 228,555 709,594
Change in unrealized appreciation
(depreciation) of investments...... 65,639 (66,654)
Net increase in net assets
resulting from operations.......... 448,735 814,568
DISTRIBUTIONS TO SHAREHOLDERS:
Dividends from net investment income (115,200) (159,034)
Distributions from net realized
gains on investments............... (346,002) (371,974)
Total distributions................ (461,202) (531,008)
CAPITAL SHARE TRANSACTIONS:
Shares sold........................ 2,454,310 2,256,010
Shares issued on reinvestment
of distributions................... 428,081 502,798
Shares redeemed.................... (321,553) (383,180)
Increase in net assets resulting from
capital share transactions (a)..... 2,560,838 2,375,628
TOTAL INCREASE IN NET ASSETS... 2,548,371 2,659,188
NET ASSETS:
Beginning of period................ 4,766,534 2,107,346
End of period...................... $7,314,905 $4,766,534
(a) Transactions in capital shares
were as follows:
Shares sold................... 204,835 183,531
Shares issued on reinvestment
of distributions.............. 36,227 42,520
Shares redeemed............... (26,450) (32,004)
Net increase.................. 214,612 194,047
Beginning balance ............ 388,529 194,482
Ending balance................ 603,141 388,529
The accompanying notes are an integral part of these financial statements.
<PAGE>
<TABLE>
SMITH BREEDEN EQUITY PLUS FUND
FINANCIAL HIGHLIGHTS <F5>
The following average per share data, ratios and supplemental information has been derived
from information provided in the financial statements.
<CAPTION>
Six Months
Ended Year Year Year Period
September 30, Ended Ended Ended Ended
1996 March 31, March 31, March 31, March 31,
(Unaudited) 1996 1995 1994 1993 <F3>
<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 0.294 0.615 0.568 0.476 0.355
Net realized and
unrealized gain
(loss) on
investments......... 0.627 2.768 1.081 (0.216) 1.281
Total from
investment
operations........ 0.921 3.383 1.649 0.260 1.636
Less Distributions
Dividends from net
investment income... (0.240) (0.583) (0.568) (0.472) (0.311)
Dividends in excess
of net investment
income.............. - - (0.001) - -
Distributions from net
realized gains on
investments......... (0.821) (1.370) (0.047) (0.701) (0.420)
Distributions in
excess of net realized
gains on investments. - - (0.073) (0.057) (0.055)
Total distributions.. (1.061) (1.953) (0.689) (1.230) (0.786)
Net Asset Value,
End of Period......... $12.13 $12.27 $10.84 $9.88 $10.85
Total Return.......... 16.26% <F4> 32.30% 17.18% 2.19% 22.59% <F4>
Ratios/Supplemental Data
Net assets, end of
period.............$7,314,905 $4,766,534 $2,107,346 $1,760,519 $903,846
Ratio of expenses to
average net assets<F1>0.89% <F4> 0.90% 0.90% 0.90% 0.57% <F4>
Ratio of net
investment income to
average net assets<F2>5.65% <F4> 5.53% 7.44% 8.02% 5.28% <F4>
Portfolio turnover
rate............... 88% 107% 120% 119% 271%
<FN>
<F1>
The annualized ratio of expenses to average net assets prior to reimbursement of expenses
by the Adviser was 3.25%, 4.58%, 7.75%, 7.08%, and 28.48% for the six months ended
September 30, 1996, and the years ended March 31, 1996, March 31, 1995, March 31, 1994,
and the period ended March 31, 1993, respectively.
<F2>
The annualized ratio of net investment income to average net assets prior to reimbursement
of expenses by the Adviser was 3.29%, 1.85%, 0.59%, 1.84%, and (22.63%) for
the six months ended September 30, 1996, and the years ended March 31, 1996,
March 31, 1995, March 31, 1994, and the period ended March 31, 1993, respectively.
<F3>
Commenced operations June 30, 1992.
<F4>
Annualized
<F5>
The accompanying notes are an integral part of these financial statements.
</FN>
</TABLE>
<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: The Fund intends to continue to qualify
for and elect the special tax treatment afforded regulated investment
companies under Subchapter M of the Internal Revenue Code, thereby relieving
the Fund of federal income taxes. To so qualify, the Fund intends to
distribute substantially all of its net investment income and net realized
capital gains, if any, less any available capital loss carryforward. As of
March 31, 1996, the Fund had no net capital loss carryforward.
C. Repurchase Agreements: The Fund may enter into repurchase agreements
with member banks of the Federal Reserve System having total assets in excess
of $500 million and securities dealers, provided that such banks or dealers
meet the credit guidelines of the Fund's Board of Trustees. In a repurchase
agreement, the Fund acquires securities from a third party with the
commitment that they will be repurchased by the seller at a fixed price on an
agreed upon date. The Fund's custodian maintains control or custody of these
securities which collateralize the repurchase agreements until maturity of the
repurchase agreements. The value of the collateral is monitored daily, and if
necessary, additional collateral is received to ensure that the market value
of the underlying assets remains sufficient to protect the Fund in the event
of the seller's default. However, in the event of default or bankruptcy of
the seller, the Fund's right to the collateral may be subject to legal
proceedings.
D. Reverse Repurchase Agreements: A reverse repurchase agreement
involves the sale by the Fund of portfolio assets concurrently with an
agreement by the Fund to repurchase the same assets at a later date at a
fixed price. The Fund will maintain a segregated account with its custodian,
which will be marked to market daily, consisting of cash, U.S. Government
securities or other liquid high-grade debt obligations equal in value to its
obligations under reverse repurchase agreements. In the event the buyer of
securities under a reverse repurchase agreement files for bankruptcy or
becomes insolvent, the Fund's use of the proceeds of the agreement may be
restricted pending a determination by the other party, or its trustee or
receiver whether to enforce the Fund's obligation to repurchase the
securities.
<PAGE>
NOTES TO FINANCIAL STATEMENTS (cont.) (Unaudited)
E. Determination Of Gains Or Losses On Sales Of Securities: Gains or
losses on the sale of securities are calculated for accounting and tax
purposes on the identified cost basis.
F. Deferred Organization Expenses: Deferred organization expenses are
being amortized on a straight-line basis over five years.
G. Securities Transactions and Investment Income: Interest income is
accrued daily on both long-term bonds and short-term investments. Interest
income also includes net amortization from the purchase of fixed-income
securities. Transactions are recorded on the first business day following
the trade date. Realized gains and losses from security transactions are
determined and accounted for on the basis of identified cost.
2. FINANCIAL INSTRUMENTS
A. Derivative Financial Instruments Held or Issued for Purposes other
than Trading: The Fund uses interest rate futures contracts for risk
management purposes in order to manage the Fund's interest-rate risk relative
to its benchmark. Upon entering into a futures contract, the Fund is required
to deposit either cash or securities in an amount (initial margin) equal to a
certain percentage of the contract value. Subsequent payments (variation
margin) are made or received by the Fund each day. The variation margin
payments are equal to the daily changes in the contract value and are recorded
as unrealized gains or losses. The Fund recognizes a realized gain or loss
when the contract is closed or expires equal to the difference between the
value of the contract at the time it was opened and the value at the time
it was closed.
Futures contracts involve costs and may result in losses. The effective use
of futures strategies depends on the Fund's ability to terminate futures
positions at times when the Fund's investment adviser deems it desirable to
do so. The use of futures also involves the risk of imperfect correlation
among movements in the values of the securities underlying the futures
purchased and sold by the Fund, of the futures contract itself, and of the
securities which are the subject of a hedge.
The Fund had the following open futures contracts as of September 30, 1996:
Type Notional Amount Position Expiration Month Unrealized
Gain/(Loss)
3 Month
Eurodollar 10,000,000 Long December, 1996 $3,155
3 Month
Eurodollar 6,000,000 Long March, 1997 7,323
3 Month
Eurodollar 7,000,000 Short September, 1997 (5,707)
3 Month
Eurodollar 8,000,000 Short March, 1998 (5,011)
3 Month
Eurodollar 6,000,000 Short September, 1998 (8,976)
3 Month
Eurodollar 5,000,000 Short March, 1999 (3,148)
3 Month
Eurodollar 8,000,000 Short September, 1999 (7,261)
3 Month
Eurodollar 3,000,000 Short March, 2000 (1,888)
Total ($21,513)
<PAGE>
NOTES TO FINANCIAL STATEMENTS (cont.) (Unaudited)
The aggregate market value of investments pledged to cover margin requirements
for the open positions at September 30, 1996 was $310,016.
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 return is expected to track movements in the S&P 500
Index.
The Fund had the following open futures contracts on the S&P 500 and New York
Stock Exchange Indexes as of September 30, 1996:
Type Notional Amount Position Expiration Month Unrealized Gain
S&P 500 $ 3,456,000 Long December, 1996 $ 22,145
S&P 500 3,835,700 Long March, 1997 60,700
NYSE 184,475 Long December, 1996 343
Total $ 83,188
3. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES
Smith Breeden Associates, Inc. (the "Adviser"), a registered investment
adviser, provides the Fund with investment management services. As
compensation for these services, the Fund pays the Adviser a fee computed
daily and payable monthly, at an annual rate equal to 0.70% of the Fund's
average daily net asset value.
The Adviser has voluntarily agreed to limit the expenses of the Fund to
0.88% 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 six months ended September 30, 1996, the
Adviser received fees of $19,368 and reimbursed the Fund $64,897.
Effective August 1, 1994, the Fund adopted a Distribution and Services Plan
(the "Plan") pursuant to Rule 12b-1 under the Investment Company Act of 1940.
The purpose of the Plan is to permit the Adviser to compensate investment
dealers and other persons involved in servicing shareholder accounts for
services provided and expenses incurred in promoting the sale of shares of
the Fund, reducing redemptions, or otherwise maintaining or improving services
provided to shareholders by such dealers or other persons.
The Plan provides for payments by the Adviser, out of its advisory fee paid
to it by the Fund, to dealers and other persons at the annual rate of up to
0.25% of the Fund's average net assets subject to the authority the Trustees
of the Fund to reduce the amount of payments permitted under the Plan or to
suspend the Plan for such periods as they may determine. Subject to these
limitations, the amount of such payments and the purposes for which they are
made shall be determined by the Adviser.
Certain officers and trustees of the Fund are also officers and directors of
the Adviser.
<PAGE>
NOTES TO FINANCIAL STATEMENTS (cont.) (Unaudited)
4. INVESTMENT TRANSACTIONS
During the six months ended September 30, 1996, purchases and proceeds from
sales of securities, other than short-term investments, aggregated
$6,572,454 and $4,439,545, respectively. The cost of securities for federal
income tax purposes is $7,445,525. Net unrealized appreciation of
investments and futures contracts consists of:
Gross unrealized appreciation.......... $114,274
Gross unrealized depreciation.......... (10,361)
Net unrealized appreciation............ $103,913
<PAGE>
MARKET TRACKING FUND
ANNUAL REPORT
FISCAL YEAR ENDED MARCH 31, 1996
PERFORMANCE REVIEW
The Smith Breeden Market Tracking Fund provided at total return
of 32.30% for the year ended March 31, 1996, while the S&P 500
index return was 32.10%. The annualized total return of the
Market Tracking Fund from its inception on June 30, 1992 through
March 31, 1996 was 17.74%, while the annualized return of the
S&P 500 index was 16.10% over the same period.
The S&P 500 index, with dividends reinvested, has posted
positive returns every month from December 1994 through March
1996, with the one exception of a -0.36% return in October of
1995. This excellent performance was supported by strong
corporate earnings combined with low inflation and generally
falling long term interest rates. Long term interest rates, as
measured by the yield on the benchmark thirty year U.S. Treasury
Bond, fell from 7.43% in March 1995 to 5.96% in December 1995.
Falling long term interest rates benefit stocks in two ways.
Firstly, as bond yields fall, the price of bond investments
increases, and stocks become more attractive as an alternative
to bonds. Secondly, lower interest rates directly help raise
corporate earnings by lowering interest expense, which in turn
supports higher stock prices.
IN ACCORDANCE WITH REG. 232.304 OF REGULATION S-T, THE FOLLOWING
IS A DESCRIPTION OF THE GRAPH PRESENTED HERE IN THE TEXT IN
COMPLIANCE WITH ITEM 5a. OF FORM N-1A:
THE GRAPH DEPICTS THE CHANGE IN VALUE OF A $10,000 INVESTMENT IN
THE MARKET TRACKING FUND VERSUS THAT OF ITS BENCHMARK, THE S&P
500 INDEX. FROM INCEPTION OF JUNE 30, 1992 THROUGH MARCH 31,
1996, AN INVESTMENT OF $10,000 IN THE MARKET TRACKING FUND WOULD
HAVE GROWN TO $18,459, VERSUS $17,514, IF INVESTED IN THE S&P
500 INDEX. THE AVERAGE ANNUAL TOTAL RETURN IN THE MARKET
TRACKING FUND WAS 32.30% FOR THE ONE YEAR PERIOD, 16.57% FOR THE
THREE YEAR PERIOD, AND 17.74% FOR THE PERIOD SINCE INCEPTION.
In the first quarter of 1996, the stock market rally continued
unabated, with the S&P 500 index returning 5.37%, and the Market
Tracking Fund returning 5.90%. Interest rates however began
climbing during the first quarter fueled by investors' fears of
higher inflation in the future. The thirty year benchmark U.S.
Treasury yield rose from 5.96% in December 1995 to 6.66% on
March 31, 1996. Despite the climb in interest rates, investors
continued to expect strong earnings growth and accordingly were
willing to buy stocks at higher prices over the quarter.
The Market Tracking Fund can be viewed as comprising income and
equity segments: the income segment invests in a combination of
U.S. Government Agency mortgage securities, hedged to a low
level of interest rate risk, along with U.S. Treasury Bills,
while the equity segment invests in S&P 500 index futures
contracts with a notional value approximately the same as the
Fund's net assets. When the return on the income segment of the
portfolio exceeds the funding cost implicit in the price of the
S&P 500 futures contracts plus the operating expenses incurred
<PAGE>
by the Fund, the Fund is able to outperform the S&P 500 index.
This strategy was successful in the year to March 31, 1996, with
the Fund providing a total return 0.20% in excess of the total
return of the S&P 500 index.
Mortgage securities held in the income segment of the portfolio
varied from 95% of net assets in March 1995 to a low of 80% in
November 1995, and stood at 89% in March 1996. The balance of
the income segment was invested in U.S. Treasury Bills. During
the year, the Fund's holdings of 9.5% to 13.5% coupon FNMA and
FHLMC fixed-rate mortgages were reduced, dropping from 38% of
net assets in March 1995 to 10% in March 1996. In their place
GNMA and FNMA adjustable-rate mortgage securities were
purchased, and holdings of these securities rose from 52% of net
assets to 78% of assets over the year. The change in portfolio
composition resulted from opportunities to sell securities at a
relatively low risk-adjusted yield and to purchase securities at
a higher risk-adjusted yield. Portfolio turnover, which is
calculated by dividing the lesser of purchases and sales by
average assets, was 107% for the year.
<PAGE>
SMITH BREEDEN MARKET TRACKING FUND
SCHEDULE OF INVESTMENTS MARCH 31, 1996
Face Amount Security Market Value
U.S. GOVERNMENT & AGENCY OBLIGATIONS - 99.61%
FEDERAL HOME LOAN MORTGAGE CORPORATION - 4.49% *
FHLMC:
$146,653 9.50%, due 7/1/02 ....................... $153,163
53,465 12.50%, due 2/1/14 ...................... 60,699
TOTAL FEDERAL HOME LOAN MORTGAGE CORPORATION
(Cost $212,374)......................... 213,862
FEDERAL NATIONAL MORTGAGE ASSOCIATION - 30.92% *
FNMA:
139,126 12.50%, due 9/1/12 ...................... 159,548
109,513 13.50%, due 11/1/14 to 1/1/15 ........... 125,483
FNMA ARM:
342,269 5.98%, due 9/1/25 ....................... 350,845
758,504 7.687%, due 9/1/18 ...................... 780,943
54,881 7.839%, due 12/1/26 ..................... 56,916
TOTAL FEDERAL NATIONAL MORTGAGE ASSOCIATION
(Cost $1,460,675)....................... 1,473,735
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION - 53.22% *
GNMA ARM:
1,010,000 5.50%, due 3/20/26 ...................... 998,082
325,955 6.75%, due 2/20/16 ...................... 330,601
136,926 7.00%, due 5/20/25 ...................... 139,611
1,047,808 7.375%, due 4/20/16 to 6/20/21 .......... 1,068,366
TOTAL GOVERNMENT NATIONAL MORTGAGE ASSOCIATION
(Cost $2,536,598)....................... 2,536,660
U.S. GOVERNMENT OBLIGATIONS - 10.98%
U.S. TREASURY BILL **
300,000 5.00%, due 6/27/96 ...................... 296,375
230,000 5.02%, due 6/27/96 ...................... 227,221
TOTAL U.S. GOVERNMENT OBLIGATIONS
(Cost $523,585) ........................ 523,596
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(Cost $4,733,232)....................... 4,747,853
THREE MONTH EURODOLLAR FUTURES PUT OPTIONS - 0.01%
Contracts
20 Expires 6/96, Strike Price $93.75 ....... 500
TOTAL EURODOLLAR PUT OPTIONS (Cost $1,590) 500
TOTAL INVESTMENTS (Cost $4,734,822) -
99.62% ................................. 4,748,353
<PAGE>
CASH AND OTHER ASSETS LESS LIABILITIES -
0.38% .................................. 18,181
NET ASSETS - 100.00% .................... $4,766,534
* Mortgage-backed obligations are subject to principal paydowns
as a result of prepayments or refinancings of the underlying
mortgage loans. As a result, the average life may be
substantially less than the original maturity. The interest
rate shown is the rate in effect at March 31, 1996. ARMs have
coupon rates which adjust periodically. The adjusted rate is
determined by adding a spread to a specified index.
** The interest rate shown is the discount rate paid at the time
of purchase by the Fund.
Portfolio Abbreviations:
ARM - Adjustable-Rate Mortgage
FHLMC - Federal Home Loan Mortgage Corporation
FNMA - Federal National Mortgage Association
GNMA - Government National Mortgage Association
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN MARKET TRACKING FUND
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 1996
ASSETS:
Investments at market value
(identified cost $4,734,822)(Note 1).............. $4,748,353
Cash................................................. 35,919
Receivables:
Interest.......................................... 26,778
Maturities........................................ 4,329
Subscriptions..................................... 4,760
Other............................................. 848
Prepaid expenses..................................... 27
Deferred organization expenses (Note 1).............. 34,587
TOTAL ASSETS.................................... 4,855,601
LIABILITIES:
Variation margin on futures contracts................ 48,342
Due to adviser (Note 3).............................. 29,004
Accrued expenses..................................... 11,721
TOTAL LIABILITIES............................... 89,067
NET ASSETS:
(Applicable to outstanding shares of 388,529;
unlimited number of shares of beneficial
interest authorized; no stated par)................. $4,766,534
Net asset value, offering price and redemption
price per share ($4,766,534 / 388,529)............ $12.27
SOURCE OF NET ASSETS:
Paid in capital...................................... $4,416,541
Undistributed net investment income.................. 12,594
Accumulated net realized gain on investments......... 299,125
Net unrealized appreciation of investments........... 38,274
NET ASSETS...................................... $4,766,534
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN MARKET TRACKING FUND
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1996
INVESTMENT INCOME:
Interest and discount earned, net of
premium amortization (Note 1).................. $199,564
EXPENSES:
Advisory fees (Note 3)......................... 21,727
Accounting and pricing services fees........... 25,000
Custodian fees................................. 8,455
Audit and tax preparation fees................. 4,800
Legal fees..................................... 2,250
Amortization of organization expenses (Note 1). 27,943
Transfer agent fees............................ 25,284
Registration fees.............................. 20,004
Trustees fees and expenses..................... 3,630
Insurance expense.............................. 2,793
Other.......................................... 150
TOTAL EXPENSES BEFORE REIMBURSEMENT........ 142,036
Expenses reimbursed by Adviser (Note 3).... (114,100)
NET EXPENSES............................... 27,936
NET INVESTMENT INCOME...................... 171,628
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized gain on investments............... 709,594
Change in unrealized appreciation of
investments.................................... (66,654)
Net realized and unrealized gain on
investments.................................... 642,940
Net increase in net assets resulting
from operations................................ $814,568
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN MARKET TRACKING FUND
STATEMENTS OF CHANGES IN NET ASSETS
FOR THE YEARS ENDED MARCH 31, 1996 AND 1995
Year Ended Year Ended
March 31, 1996 March 31, 1995
OPERATIONS:
Net investment income............ $171,628 $140,115
Net realized gain (loss) on
investments...................... 709,594 (64,050)
Change in unrealized appreciation
(depreciation) of investments.... (66,654) 229,458
Net increase in net assets
resulting from operations........ 814,568 305,523
DISTRIBUTIONS TO SHAREHOLDERS:
Dividends from net investment
income........................... (159,034) (104,085)
Dividends in excess of net
investment income................ - (251)
Distributions from net realized
gains on investments............. (371,974) (9,133)
Distributions in excess of
net realized gains on investments - (13,962)
Total distributions.............. (531,008) (127,431)
CAPITAL SHARE TRANSACTIONS:
Shares sold...................... 2,256,010 200,709
Shares issued on reinvestment of
distributions.................... 502,798 120,434
Shares redeemed.................. (383,180) (152,408)
Increase in net assets resulting
from capital share transactions
(a).............................. 2,375,628 168,735
TOTAL INCREASE IN NET ASSETS. 2,659,188 346,827
NET ASSETS:
Beginning of year................ 2,107,346 1,760,519
End of year...................... $4,766,534 $2,107,346
(a) Transactions in capital shares
were as follows:
Shares sold................. 183,531 19,300
Shares issued on reinvestment
of distributions............ 42,520 11,593
Shares redeemed............. (32,004) (14,689)
Net increase................ 194,047 16,204
Beginning balance .......... 194,482 178,278
Ending balance.............. 388,529 194,482
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN MARKET TRACKING FUND
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED MARCH 31, 1996
Year Ended
March 31, 1996
Cash Flows from Operating Activities:
Net increase in net assets resulting
from operations................................ $814,568
Net realized and unrealized gain on investments (642,940)
Net investment income........................ 171,628
Adjustments to reconcile net investment income
to net cash provided by operating activities:
Net paydown gains and losses................... 16,109
Increase in interest receivable................ (11,919)
Decrease in other assets....................... 31,562
Decrease in other liabilities.................. (19,935)
Net cash provided by operating activities.... 187,445
Cash Flows from Investing Activities:
Settlement payment on S&P 500 equity
swap contract.................................. 168,247
Proceeds from futures variations............... 554,718
Proceeds from sales of long-term investments... 2,826,874
Proceeds from maturities of short-term
investments.................................... 2,365,000
Proceeds from sales of short-term investments.. 2,627,509
Proceeds from paydowns of long-term investments 449,569
Purchases of long-term investments............. (5,625,270)
Purchases of short-term investments............ (5,439,093)
Net cash used in investing activities........ (2,072,446)
Cash Flows from Financing Activities:
Purchase of shares tendered.................... 1,868,070
Dividends from net investment income and
realized gains................................. (28,210)
Net cash provided by financing activities.... 1,839,860
Net decrease in cash......................... (45,141)
Cash at beginning of year......................... 81,060
Cash at end of year............................... $35,919
Noncash Financing Activities:
Market value of shares issued to stockholders
through reinvestment of dividends............ $502,798
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN MARKET TRACKING FUND
FINANCIAL HIGHLIGHTS
The following average per share data, ratios and supplemental information
has been derived from information provided in the financial statements.
Year Year Year Period
Ended Ended Ended Ended
March 31, 1996 March 31, 1995 March 31, 1994 March 31,1993*
Net Asset Value,
Beginning of Period $10.84 $9.88 $10.85 $10.00
Income From Investment
Operations
Net investment
income.......... 0.615 0.568 0.476 0.355
Net realized and
unrealized gain
(loss) on
investments..... 2.768 1.081 (0.216) 1.281
Total from
investment
operations.. 3.383 1.649 0.260 1.636
Less Distributions
Dividends from
net investment
income.......... (0.583) (0.568) (0.472) (0.311)
Dividends in excess
of net investment
income.......... - (0.001) - -
Distributions from
net realized gains
on investments.. (1.370) (0.047) (0.701) (0.420)
Distributions in
excess of net
realized gains on
investments..... - (0.073) (0.057) (0.055)
Total
distributions (1.953) (0.689) (1.230) (0.786)
Net Asset Value,
End of Period.... $12.27 $10.84 $9.88 $10.85
Total Return..... 32.30% 17.18% 2.19% 22.59%**
Ratios/Supplemental Data
Net assets, end
of period....... $4,766,534 $2,107,346 $1,760,519 $903,846
Ratio of expenses
to average net
assets (1)...... 0.90% 0.90% 0.90% 0.57%**
Ratio of net
investment income
to average net
assets (2)...... 5.53% 7.44% 8.02% 5.28%**
Portfolio
turnover rate... 107% 120% 119% 271%
______________________
(1) The annualized ratio of expenses to average net assets prior to
reimbursement of expenses by the Adviser was 4.58%, 7.75%, 7.08%,
and 28.48% for the years ended March 31, 1996, March 31,1995, March
31, 1994, and the period ended March 31, 1993, respectively.
(2) The annualized ratio of net investment income to average net assets
prior to reimbursement of expenses by the Adviser was 1.85%, 0.59%,
1.84%, and (22.63%) for the years ended March 31, 1996, March 31, 1995,
March 31, 1994, and the period ended March 31, 1993, respectively.
* The Smith Breeden Market Tracking Fund commenced operations June 30,1992.
** Annualized
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN MARKET TRACKING FUND
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Breeden Market Tracking Fund (the "Fund") is a series
of the Smith Breeden Trust (the "Trust"), an open-end,
diversified management investment company registered under the
Investment Company Act of 1940, as amended. The following is a
summary of significant accounting policies consistently followed
by the Fund.
A. Security Valuation: Portfolio securities are valued at
current market value provided by a pricing service or by a bank
or broker/dealer experienced in such matters, when over-
the-counter market quotations are readily available. Securities
and other assets for which market prices are not readily
available are valued at fair market value as determined in
accordance with procedures approved by the Board of Trustees.
B. Distributions and Taxes: The Fund intends to continue to
qualify for and elect the special tax treatment afforded
regulated investment companies under Subchapter M of the
Internal Revenue Code, thereby relieving the Fund of federal
income taxes. To so qualify, the Fund intends to distribute
substantially all of its net investment income and net realized
capital gains, if any, less any available capital loss
carryforward. As of March 31, 1996, the Fund had no net capital
loss carryforward.
C. Repurchase Agreements: The Fund may enter into repurchase
agreements with member banks of the Federal Reserve System
having total assets in excess of $500 million and securities
dealers, provided that such banks or dealers meet the credit
guidelines of the Fund's Board of Trustees. In a repurchase
agreement, the Fund acquires securities from a third party with
the commitment that they will be repurchased by the seller at a
fixed price on an agreed upon date. The Fund's custodian
maintains control or custody of these securities which
collateralize the repurchase agreements until maturity of the
repurchase agreements. The value of the collateral is monitored
daily, and if necessary, additional collateral is received to
ensure that the market value of the underlying assets remains
sufficient to protect the Fund in the event of the seller's
default. However, in the event of default or bankruptcy of the
seller, the Fund's right to the collateral may be subject to
legal proceedings.
D. Reverse Repurchase Agreements: A reverse repurchase
agreement involves the sale by the Fund of portfolio assets
concurrently with an agreement by the Fund to repurchase the
same assets at a later date at a fixed price. The Fund will
maintain a segregated account with its custodian, which will be
marked to market daily, consisting of cash, U.S. Government
securities or other liquid high-grade debt obligations equal in
value to its obligations under reverse repurchase agreements.
In the event the buyer of securities under a reverse repurchase
agreement files for bankruptcy or becomes insolvent, the Fund's
use of the proceeds of the agreement may be restricted pending
a determination by the other party, or its trustee or receiver
<PAGE>
whether to enforce the Fund's obligation to repurchase the
securities.
E. Determination Of Gains Or Losses On Sales Of Securities:
Gains or losses on the sale of securities are calculated for
accounting and tax purposes on the identified cost basis.
F. Deferred Organization Expenses: Deferred organization
expenses are being amortized on a straight-line basis over five
years.
G. Securities Transactions and Investment Income: Interest
income is accrued daily on both long-term bonds and short-term
investments. Interest income also includes net amortization
from the purchase of fixed-income securities. Transactions are
recorded on the first business day following the trade date.
Realized gains and losses from security transactions are
determined and accounted for on the basis of identified cost.
2. FINANCIAL INSTRUMENTS
A. Derivative Financial Instruments Held or Issued for Purposes
other than Trading: The Fund uses interest rate futures
contracts for risk management purposes in order to manage the
Fund's interest-rate risk relative to its benchmark. Upon
entering into a futures contract, the Fund is required to
deposit either cash or securities in an amount (initial margin)
equal to a certain percentage of the contract value. Subsequent
payments (variation margin) are made or received by the Fund
each day. The variation margin payments are equal to the daily
changes in the contract value and are recorded as unrealized
gains or losses. The Fund recognizes a realized gain or loss
when the contract is closed or expires equal to the difference
between the value of the contract at the time it was opened and
the value at the time it was closed.
Futures contracts involve costs and may result in losses. The
effective use of futures strategies depends on the Fund's
ability to terminate futures positions at times when the Fund's
investment adviser deems it desirable to do so. The use of
futures also involves the risk of imperfect correlation among
movements in the values of the securities underlying the futures
purchased and sold by the Fund, of the futures contract itself,
and of the securities which are the subject of a hedge.
The Fund had the following open futures contracts, held for
purposes other than trading, as of March 31, 1996:
Notional Expiration Unrealized
Type Amount Position Month Gain/(Loss)
Eurodollar $3,000,000 Short June, 1996 $ (88)
Eurodollar 5,000,000 Short September, 1996 (1,473)
Eurodollar 6,000,000 Short September, 1997 3,973
Eurodollar 6,000,000 Short September, 1998 (601)
Eurodollar 4,000,000 Short September, 1999 (418)
<PAGE>
$ 1,393
The aggregate market value of investments pledged to cover
margin requirements for the open positions at March 31, 1996 was
$227,221.
B. Derivative Financial Instruments Held or Issued for Trading
Purposes: The Fund invests in Futures Contracts on the S&P 500
Index whose return is expected to track movements in the S&P 500
Index.
The Fund had fifteen open futures contracts on the S&P 500 Index
as of March 31, 1996:
Notional Expiration Unrealized
Type Amount Position Month Gain
S&P 500 $4,841,250 Long June, 1996 $23,350
3. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH
AFFILIATES
Smith Breeden Associates, Inc. (the "Adviser"), a registered
investment adviser, provides the Fund with investment management
services. As compensation for these services, the Fund pays the
Adviser a fee computed daily and payable monthly, at an annual
rate equal to 0.70% of the Fund's average daily net asset value.
The Adviser has voluntarily agreed to limit the expenses of the
Fund to 0.90% of the Fund's average daily net assets. This
voluntary agreement may be terminated or modified at any time by
the Adviser in its sole discretion, except that the Adviser has
agreed to limit expenses of the Fund to 0.90% through March 31,
1996. For the year ended March 31, 1996, the Adviser received
fees of $21,727 and reimbursed the Fund $114,100.
Effective August 1, 1994, the Fund adopted a Distribution and
Services Plan (the "Plan") pursuant to Rule 12b-1 under the
Investment Company Act of 1940. The purpose of the Plan is to
permit the Adviser to compensate investment dealers and other
persons involved in servicing shareholder accounts for services
provided and expenses incurred in promoting the sale of shares
of the Fund, reducing redemptions, or otherwise maintaining or
improving services provided to shareholders by such dealers or
other persons.
The Plan provides for payments by the Adviser, out of its
advisory fee paid to it by the Fund, to dealers and other
persons at the annual rate of up to 0.25% of the Fund's average
net assets subject to the authority the Trustees of the Fund to
reduce the amount of payments permitted under the Plan or to
suspend the Plan for such periods as they may determine.
Subject to these limitations, the amount of such payments and
the purposes for which they are made shall be determined by the
Adviser.
<PAGE>
Certain officers and trustees of the Fund are also officers and
directors of the Adviser.
4. INVESTMENT TRANSACTIONS
During the year ended March 31, 1996, purchases and proceeds
from sales of securities, other than short-term investments,
aggregated $5,597,637 and $2,831,265, respectively. The cost of
securities for federal income tax purposes is $4,734,822. Net
unrealized appreciation of investments and futures contracts
consists of:
Gross unrealized appreciation....... $47,183
Gross unrealized depreciation....... (8,909)
Net unrealized appreciation......... $38,274
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders,
Smith Breeden Market Tracking Fund of the Smith Breeden Trust:
We have audited the accompanying statement of assets and
liabilities, including the schedule of investments, of the Smith
Breeden Market Tracking Fund of the Smith Breeden Trust as of
March 31, 1996, and the related statements of operations and
cash flows for the year then ended, the statements of changes in
net assets for each of the years in the two-year period then
ended and the financial highlights for each of the years in the
three year period then ended and the period June 30, 1992
(commencement of operations) to March 31, 1993. These financial
statements and the financial highlights are the responsibility
of the Fund's management. Our responsibility is to express an
opinion on these financial statements and the financial
highlights based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements and the financial highlights are free
of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements. Our procedures included confirmation
of securities owned at March 31, 1996 by correspondence with the
custodian. An audit also includes assessing the accounting
principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements and financial
highlights referred to above present fairly, in all material
respects, the financial position of the Smith Breeden Market
Tracking Fund of the Smith Breeden Trust as of March 31, 1996,
the results of its operations and its cash flows, the changes in
its net assets, and the financial highlights for the respective
stated periods in conformity with generally accepted accounting
principles.
Deloitte & Touche LLP
Princeton, New Jersey
May 10, 1996
<PAGE>
FORM N-1A
PART C. OTHER INFORMATION
Item 24. Financial Statements and Exhibits.
(a) Financial Statement filed with Part B
(b) Exhibits:
(1) Declaration of Trust:Incorporated by Reference
(2) By-Laws:Incorporated by Reference
(3) Voting Trust Agreement--Not Applicable
(4) Specimen Share Certificate--Incorporated by Reference
(5) Form of Investment Advisory Agreement
for Smith Breeden Trust: Incorporated by Reference
(6) Form of Underwriting or Distribution
Agreement: Incorporated by Reference
(7) Bonus, Profit Sharing, Pension and Other
Similar Arrangements -- Not Applicable
(8) Custodian Agreement: Incorporated by Reference
(9)(a) Shareholder Services Agreement: Incorporated by Reference
(9)(b) Accounting Services Agreement: Incorporated by Reference
(9)(c) Sub-Administration Agreement- Not Applicable
(10) Opinion and Consent of Counsel: Incorporated by Reference
to Pre-Effective Amendment Number 2 filed April 14, 1992
(11) Independent Auditor's Consent
(12) Financial Statements Omitted from Item 23 --
Not Applicable
(13) Letter of Understanding relating to
initial capital--Incorporated by Reference
(14) Model Retirement Plan -- Not Applicable
(15) Form of Rule 12b-1 Plan for Smith
Breeden Trust: Incorporated by Reference
(16) Performance Calculation --
Not Applicable
(17) Powers of Attorney--Incorporated by Reference
(18) Financial Data Schedule
<PAGE>
Item 25. Persons Controlled by or under Common Control with Registrant.
There were no persons directly or indirectly controlled by or under common
control with the Registrant as of March 31, 1997.
Item 26. Number of Holders of Securities.
NUMBER OF RECORD HOLDERS
TITLE OF CLASS AS OF MARCH 31, 1997
Smith Breeden Equity Index Plus Fund 434
Shares of Beneficial Interest
Item 27. Indemnification.
Reference is made to Article IV,Sections 4.2 and 4.3 of Registrant's
Declaration of Trust with respect to indemnification of the Trustees and
officers of Registrant against liabilities which may be incurred by them
in such capacities.
Insofar as indemnification for liability arising under the Securities Act
of 1933, as amended (the "Act"), may be permitted to directors, officers and
controlling persons of the Registrant pursuant to the foregoing provisions,
or otherwise, the Registrant has been advised that, in the opinion of the
Securities and Exchange Commission ("SEC"), such indemnification is against
public policy as expressed in the Act, and is therefore, unenforceable.
In the event that a claim for indeminfication against such liabilities
(other than the payment by the Registrant of expenses incurred or paid by
a trustee, an officer or a controlling person of the Registrant in
the successful defense of any action, suit or proceeding) is asserted by
such trustee, officer or controlling person in connection with the
securities being registered, the Registrant will, unless in the opinion
of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed
in the Act and will be governed by the final adjudication of such
issue.
Each disinterested Trustee has entered into an indemnity agreement with
the Adviser whereby the Adviser indemnifies each disinterested Trustee
against defense costs in connection with a civil claim which involves
the Trustee by virtue of his position with the Fund.
Item 28. Business and Other Connections of Adviser.
Smith Breeden Associates, Inc. (the "Adviser") acts as
investment adviser to financial institution, insurance, pension,
charitable foundation clients and other registered investment
companies. For a description of the officers and directors of
the Adviser and their business affiliations, see "Management of
the Fund" in the Prospectus contained within this Registration
Statement.
Item 29. Principal Underwriters
(a) FPS Broker Services, Inc., located at 3200 Horizon Drive,
P.O. Box 61503, King of Prussia, Pennsylvania 19406-0903, is
the principal underwriter. FPS Broker Services also serves
<PAGE>
as the Principal Underwriter for The Brinson Funds, Inc., Chicago
Trust Funds, Fairport Funds, First Mutual Funds, Focus Trust, Inc.,
IAA Trust Mutual Funds, Matthews International Funds, MCM Funds,
Polynous Trust, Sage/TSO Trust, Smith Breeden Series Fund,
Smith Breeden Trust, The Stratton Funds, Inc.,
Stratton Growth Fund, Inc., Stratton Monthly Dividend Shares,
Inc., The Japan Alpha Fund, and The Timothy Plan.
(b) The table below sets forth certain information as to
the Underwriter's Directors, Officers and Control Persons:
NAME AND PRINCIPAL POSITION AND OFFICES POSITION
BUSINESS ADDRESS WITH UNDERWRITER AND OFFICES
WITH REGISTRANT
Kenneth J. Kempf Director and President None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA
19406-0903
Lynne M. Cannon Vice President and Principal None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA
19406-0903
Rocco C. Cavalieri Director and Vice President None
3200 Horizon Drive
P.O Box 61503
King of Prussia, PA
19406-0903
Gerald J. Holland Director, Senior Vice None
3200 Horizon Drive President and Principal
P.O. Box 61503
King of Prussia, PA
19406-0903
Joseph M. O'Donnell Director and Vice President None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA
19406-0903
Sandra L. Adams Assistant Vice President None
3200 Horizon Drive and Principal
P.O. Box 61503
King of Prussia, PA
19406-0903
John H. Leven Treasurer None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA
19406-0903
<PAGE>
Mary P. Efstration Secretary None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA
19406-0903
James W. Stratton may be considered a control person of the
Underwriter due to his direct or indirect ownership of FPS
Services, Inc., the parent of the Underwriter.
c) Not Applicable.
Item 30. Locations of Accounts and Records.
The accounts, books or other documents required to be
maintained by Section 31(a) of the Investment Company Act of 1940
and the Rules thereunder will be kept by the Registrant at the
following offices:
(1) FPS Services, Inc., 3200 Horizon Drive, P. O. Box
61503, King of Prussia, Pennsylvania 19406-0903
(2) Smith Breeden Associates, Inc., 100 Europa Drive,
Suite 200, Chapel Hill, NC 27514
Item 31. Management Services.
There are no management-related service contracts not
discussed in Part A or Part B.
Item 32. Undertakings.
(a) The Registrant previously has undertaken to promptly
call a meeting of shareholders for the purpose of voting upon the
question of removal of any trustee or trustees when requested in
writing to do so by the record holders of not less than 10
percent of the Registrant's outstanding shares and to assist its
shareholders in accordance with the requirements of Section 16(c)
of the Investment Company Act of 1940 relating to shareholder
communications.
(b) The registrant hereby undertakes to furnish to each
person to whom a prospectus is delivered a copy of the
Registrant's latest annual report to shareholders upon request
and without charge.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933,
as amended, and the Investment Company Act of 1940, as amended,
the Registrant has duly caused this Amendment
to the Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Chapel Hill,
the State of North Carolina, on the 25th day of April, 1997.
SMITH BREEDEN TRUST
By
Michael J. Giarla
President
Pursuant to the requirements of the Securities Act of 1933,
this Amendment to the Registration Statement has been signed
below by the following persons in the capacities and on the dates
indicated.
SIGNATURE TITLE DATE
Michael J. Giarla President, April 25, 1997
Trustee
Douglas T. Breeden* Trustee April 25, 1997
Stephen M. Schaefer* Trustee April 25, 1997
Myron S. Scholes* Trustee April 25, 1997
William F. Sharpe* Trustee April 25, 1997
Marianthe S. Mewkill Principal Financial April 25, 1997
and Accounting Officer
* By:
Marianthe S. Mewkill
*Attorney-in-Fact pursuant to power-of-attorney filed previously.
<PAGE>
CONSENT OF INDEPENDENT AUDITORS
Smith Breeden Trust:
We consent to the use in Post-Effective Amendment No. 9 to Registration
Statement No. 33-44909 of our report dated May 10, 1996 relating to the
Smith Breeden Market Tracking Fund of Smith Breeden Trust (now known as Smith
Breeden Equity Index Plus Fund) appearing in the Statement of Additional
Information, which is a part of such Registration Statement, and to the
references to us under the captions "Experts" appearing in the Statement of
Additional Information and "Financial Highlights" appearing in the Prospectus,
which also is a part of such Registration Statement.
DELOITTE & TOUCHE LLP
Princeton, New Jersey
April 15, 1997
<TABLE> <S> <C>
<ARTICLE> 6
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<NAME> SMITH BREEDEN EQUITY INDEX PLUS FUND
<S> <C>
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