FEBRUARY 18, 1997
SMITH BREEDEN MUTUAL FUNDS
The Smith Breeden Mutual Funds consists of three no-load,
registered investment companies (the "Funds" or a
"Fund"). Smith Breeden Associates, Inc. (the "Adviser")
serves as the investment adviser to the Funds.
Smith Breeden Equity Plus Fund (the "Equity Plus Fund")
seeks to provide a total return exceeding the Standard &
Poor's 500 Composite Stock Price Index without additional
equity market risk. The previous name of the Equity Plus
Fund was the Smith Breeden Market Tracking Fund.
Smith Breeden Short Duration U.S. Government Series (the
"Short Series") seeks a high level of current income,
consistent with low volatility of net asset value. The
Short Series seeks to match the interest-rate risk of a
portfolio that invests exclusively in six month U.S.
Treasury securities on a constant maturity basis. The
dollar weighted average maturity of the Fund's securities
may significantly exceed six months at times.
Smith Breeden Intermediate Duration U.S. Government
Series (the "Intermediate Series") seeks a total return
in excess of the total return of the major market indices
for mortgage-backed securities. The major market indices
for mortgage-backed securities include, but are not
limited to, the Salomon Brothers Mortgage Index and the
Lehman Brothers Mortgage Index. These indices include
all outstanding government sponsored fixed-rate
mortgage-backed securities, weighted in proportion to their
current market capitalization. The duration, or
interest-rate risk, of these indices is similar to that
of intermediate-term U.S. Treasury Notes, and typically
will range between three and five years. The
Intermediate Series consistently seeks to achieve a
volatility of net asset value similar to that of a
portfolio that invests exclusively in mortgage-backed
securities, as weighted in the major mortgage market
indices.
An investment in any of the Funds is neither insured nor
guaranteed by the U.S. Government. There can be no
assurance that any of the Funds will meet their
investment objectives. This Prospectus sets forth
concisely the information about the Funds that you should
know before investing. You are advised to read this
Prospectus carefully and keep it for future reference.
A Statement of Additional Information, dated February 18,
1997 which is incorporated herein by reference, has been
filed with the Securities and Exchange Commission with
respect to each Fund. The Statements of Additional
Information, which may be revised from time to time,
contain further information about the Funds, and are
available without charge by writing to the Funds at 100
Europa Drive, Chapel Hill, North Carolina 27514 or by
calling 1-800-221-3138.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE
SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
TABLE OF CONTENTS
Expense Table. . . . . . . . . . . . . . . . . . . . .3
Financial Highlights--Equity Plus Fund . . . . . . . .5
Financial Highlights--Short Series . . . . . . . . . .6
Financial Highlights--Intermediate Series. . . . . . .7
Smith Breeden Mutual Funds . . . . . . . . . . . . . .8
Investment Objectives, Policies and Risk
Considerations. . . . . . . . . . . . . . . . . . . .8
Other Investment Practices and Risk Considerations . 22
Management of the Funds. . . . . . . . . . . . . . . 25
Pricing of Fund Shares . . . . . . . . . . . . . . . 30
How to Purchase Shares . . . . . . . . . . . . . . . 31
How to Exchange Shares . . . . . . . . . . . . . . . 34
How to Redeem Shares . . . . . . . . . . . . . . . . 35
Dividends and Distributions. . . . . . . . . . . . . 38
Shareholder Reports and Information. . . . . . . . . 39
Retirement Plans . . . . . . . . . . . . . . . . . . 40
Service and Distribution Plans . . . . . . . . . . . 40
Taxes. . . . . . . . . . . . . . . . . . . . . . . . 41
Capital Structure. . . . . . . . . . . . . . . . . . 42
Transfer, Dividend Disbursing Agent, Custodian and
Independent Auditors. . . . . . . . . . . . . . . 43
Fund Performance . . . . . . . . . . . . . . . . . . 43
No person has been authorized to give any information or
to make any representations not contained in this
Prospectus and, if given or made, such information or
representations must not be relied upon as having been
authorized by the Funds. The Prospectus does not
constitute an offering by the Funds in any jurisdiction
in which such offering may not be lawfully made.
<PAGE>
EXPENSE TABLE
The following table is designed to assist you in
understanding the expenses you will bear as a shareholder
in the Funds. Shareholder Transaction Expenses are
charges that you pay when buying or selling shares of a
Fund. Annual Fund Operating Expenses are paid out of a
Fund's assets and include fees for portfolio management,
maintenance of shareholder accounts, shareholder
servicing, accounting and other services. The expenses
shown below are based on each Fund's expenses for the
past fiscal year.
Equity Plus Short Intermediate
Fund Series Series
Shareholder Transaction
Expenses
Maximum Sales Load Imposed
on Purchases None None None
Maximum Sales Load Imposed on
Reinvested Dividends None None None
Deferred Sales Load Imposed on
Redemptions None None None
Redemption Fees1 None None None
Exchange Fees None None None
Annual Fund Operating Expenses
(as a percentage of average
net assets)
Management Fees2 0.70% 0.70% 0.70%
Other Expenses (net of
reimbursement) 0.18% 0.08% 0.18%
Total Fund Operating Expenses
(net of reimbursement)3 0.88% 0.78% 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 each
Fund, the Adviser may pay annual distribution and servicing fees
of up to 0.25% of each of the Funds' 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
each of the Funds and/or waive its fees to the extent necessary
to limit Total Fund Operating Expenses to 0.78% for the Short
Series and 0.88% for each of the Equity Plus Fund and
Intermediate Series through March 31, 1997 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 0.23% and 0.93% for the Short Series, 0.44% and 1.14%
for the Intermediate Series, and 3.88% and 4.58% for the Equity
Plus Fund. Actual Total Fund Operating Expenses for the fiscal
year ended March 31, 1996 were 0.78% for the Short Series and
0.90% for each of the Equity Plus Fund and Intermediate Series.
<PAGE>
The following examples illustrate the expenses that apply
to a $250 investment in each Fund over various time
periods assuming (1) a 5% annual rate of return and (2)
redemption or no redemption at the end of each time
period. Except as noted in the table above, the Funds
charge no redemption fees.
Short Duration Series
1 Year 3 Years 5 Years 10 Years
$ 2 $ 7 $ 11 $ 24
Intermediate Duration Series and Equity Plus Fund
1 Year 3 Years 5 Years 10 Years
$ 3 $ 8 $ 12 $ 27
These examples are based on the annual operating expenses
shown above and should not be considered a representation
of past or future expenses or performance. Actual
expenses may be greater or less than those shown. The
annual rate of return may be more or less than 5%.
The Funds may be recommended to investors by registered
investment advisors. Such advisors customarily impose
fees 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 Funds, nor the Adviser,
exercise any control over such advisory fees and may not
be informed of the level of such fees.
<PAGE>
EQUITY PLUS FUND
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
The following selected per share data and ratios cover the fiscal
periods from June 30, 1992, the date the Fund commenced operations,
through March 31, 1996 and are a part of the Fund's financial statements
which have been audited by Deloitte & Touche LLP, independent auditors.
This data should be read in conjunction with the Fund's most recent
annual audited financial statements and the report of Deloitte & Touch
LLP thereon which appear in the Fund's Statement of Additional
Information. (The Equity Plus Fund was previously named The Market
Tracking Fund.)
Year Ended Year Ended Year Ended Period 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
Before expense
limitation....... 4.58% 7.75% 7.08% 28.48%*
After expense
limitation....... 0.90% 0.90% 0.90% 0.57%*
Ratio of net income to
average net assets
Before expense
limitation....... 1.85% 0.59% 1.84% (22.63%)*
After expense
limitation....... 5.53% 7.44% 8.02% 5.28%*
Portfolio turnover rate. 107% 120% 119% 271%
* Annualized
Additional performance information is presented in the Fund's Annual
Report, which is available without charge upon request.<PAGE>
SHORT DURATION SERIES
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
The following selected per share data and ratios cover the fiscal
periods from March 31, 1992, the date the Fund commenced operations,
through March 31, 1996 and are a part of the Short Series' financial
statements which have been audited by Deloitte & Touche LLP, independent
auditors. This data should be read in conjunction with the Short
Series' most recent annual audited financial statements and the report
of Deloitte & Touche LLP thereon which appear in the Fund's Statement
of Additional Information.
Year Ended Year Ended Year Ended Year Ended
March 31,1996 March 31, 1995 March 31,1994 March 31,1993
Net Asset Value,
Beginning of Period. $9.90 $9.90 $10.00 $10.00
Income From Investment
Operations
Net investment income 0.621 0.628 0.432 0.552
Net gain (loss) on
securities (both
realized and
unrealized)......... (0.148) -- (0.070) 0.002
Total from investment
operations........... 0.473 0.628 0.362 0.554
Less Distributions
Dividends from net
investment income.... (0.621) (0.628) (0.462) (0.554)
Dividends in excess of
investment income.... (0.012) -- -- --
Total distributions. (0.633) (0.628) (0.462) (0.554)
Net Asset Value,
End of Period........ $9.74 $9.90 $9.90 $10.00
Total Return........ 4.95% 6.58% 3.67% 5.67%
Ratios/Supplemental Data
Net assets, end of
period.............. $221,825,136 $218,431,665 $218,167,491 $48,531,206
Ratio of expenses to
average net assets
Before expense
limitation.. 0.93% 0.92% 1.00% 2.58%
After expense
limitation... 0.78% 0.78% 0.78% 0.78%
Ratio of net income to
average net assets
Before expense
limitation 6.13% 6.18% 3.95% 2.73%
After expense
limitation 6.29% 6.33% 4.17% 4.53%
Portfolio turnover
rate................. 225% 47% 112% 3%
Additional performance information is presented in the Short Series'
Annual Report, which is available without charge upon request.
<PAGE>
INTERMEDIATE DURATION SERIES
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
The following selected per share data and ratios cover the fiscal
periods from March 31, 1992, the date the Fund commenced operations,
through March 31, 1996 and are a part of the Intermediate Series'
financial statements which have been audited by Deloitte & Touche LLP,
independent auditors. This data should be read in conjunction with the
Intermediate Series' most recent annual audited financial statements and
the report of Deloitte & Touche LLP thereon which appear in the Fund's
Statement of Additional Information.
Year Ended Year Ended Year Ended Year Ended
March 31, 1996 March 31, 1995 March 31, 1994 March 31, 1993
Net Asset Value,
Beginning of Period. $9.83 $10.01 $10.62 $10.00
Income From Investment
Operations
Net investment income. 0.660 0.664 1.05 0.826
Net gain (loss) on
securities
(both realized and
unrealized)......... 0.277 (0.049) (0.601) 0.621
Total from investment
operations............ 0.937 0.615 0.449 1.447
Less Distributions
Dividends from net
investment income..... (0.656) (0.664) (1.044) (0.826)
Dividends in excess of
net investment income.. -- (0.108) -- --
Distributions from net
realized gains on
investments........ (0.101) -- (0.015) --
Distributions in excess
of net realized gains
on investments...... -- (0.022) -- --
Total distributions. (0.757) (0.794) (1.059) (0.826)
Net asset value,
end of period........ $10.01 $9.83 $10.01 $10.62
Total Return......... 9.69% 6.10% 4.11% 14.93%
Ratios/Supplemental Data
Net assets, end
of period............ $36,446,940 $34,797,496 $6,779,666 $2,923,913
Ratio of expenses to
average net assets
Before expense
limitation........ 1.14% 2.33% 2.34% 17.52%
After expense
limitation........ 0.90% 0.90% 0.90% 0.82%
Ratio of net income to
average net assets
Before expense
limitation........ 6.26% 4.77% 6.30% (8.52)%
After expense
limitation....... 6.49% 6.20% 7.74% 8.18%
Portfolio turnover rate 193% 557% 84% 42%
Additional performance information is presented in the Intermediate Series'
Annual Report, which is available without charge upon request.<PAGE>
SMITH BREEDEN MUTUAL FUNDS
The Short and Intermediate Series are series of the Smith
Breeden Series Fund ( the "Series Fund"), an open-end
diversified management investment company, registered under the
Investment Company Act of 1940 (the "1940 Act"). The Series Fund
currently issues shares in two series, which are the Short and
Intermediate Series. The Equity Plus Fund is currently the only
series of the Smith Breeden Trust (the "Trust"), also an open-end
diversified management investment company registered under the 1940 Act.
Smith Breeden Associates, Inc. ("Smith Breeden" or the
"Adviser") acts as investment adviser to the Funds. Smith
Breeden is a money management and consulting firm founded in
1982 whose clients include pension funds, financial
institutions, corporations, government entities and charitable
foundations. 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
Each of the Funds has a different investment objective and a
different investment policy since each Fund is designed to meet
different investment needs.
The investment objectives and certain investment policies of the
Short and Intermediate Series are fundamental and may not be
changed without a vote of shareholders of the relevant Fund.
The investment objective of the Equity Plus Fund is not
fundamental, and may be changed without a vote of the majority
of the shareholders of the Equity Plus Fund. Shareholders of
the Equity Plus Fund will receive a written notification at
least thirty days prior to any change in the Equity Plus Fund's
investment objective. If such a change in the investment
objective of the Equity Plus 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 Equity Plus Fund.
Because shares of each Fund represent an investment in
securities with fluctuating market prices, you should understand
that the net asset value per share of each Fund will vary as the
aggregate value of a Fund's portfolio securities increases or
decreases. Because of the risks inherent in all investments,
there can be no assurance that the objectives of the Funds will
be met. The descriptions that follow are designed to help you
choose the Fund or combination of Funds that best fits your
investment objectives.
Short Series
The Short Series' investment objective is to provide investors
with a high level of current income, consistent with a
volatility of net asset value similar to that of a portfolio
which invests exclusively in six-month U.S. Treasury securities
on a constant maturity basis. There is no assurance that the
Short Series will be able to maintain a low volatility of net
asset value.
Under normal circumstances the Short Series will seek to achieve
an interest-rate risk or option-adjusted duration similar to
that of a six-month U.S. Treasury security on a constant
maturity basis. Option-adjusted duration is a measure of the
price sensitivity (in percentage) of a portfolio to changes in
interest rates, taking into account the changing nature of
expected cash flows, as influenced by mortgage prepayments and
other factors. The Short Series expects that, under normal
circumstances, the dollar-weighted average life (or period until
the next reset date) of its portfolio securities will be longer
than six months, sometimes significantly. The maturity of a
security measures only the time until final payment is due,
whereas option-adjusted duration takes into account the pattern
of all payments of interest and principal on a security over
time, including how these payments are affected by prepayments
and by changes in interest rates. In computing the duration of
the Short Series' portfolio, the Adviser will estimate the
duration of obligations that are subject to prepayment, or
redemption by the issuer, taking into account the influence of
changes in interest rates on prepayments and coupon flows. The
Adviser will use certain hedging techniques (discussed in more
detail in Appendix A and in "Investment Policies of the Short
and Intermediate Series and Fixed Income Segment of the Equity
Plus Fund") to lengthen or shorten the option-adjusted duration
of the Short Series' portfolio so that it targets the
interest-rate risk of a six-month U.S. Treasury security.
The Adviser believes that by investing in mortgage securities
from a variety of market sectors on a selective basis and
adjusting the overall option-adjusted duration of the portfolio
to approximate that of a six-month U.S. Treasury security, the
Short Series will achieve a more consistent and less volatile
net asset value than is characteristic of mutual funds that
invest primarily in mortgage securities paying a fixed rate of
interest or those that invest exclusively in adjustable-rate
mortgage securities. The securities in which the Short Series
may invest may not yield as high a level of income as other
securities in which other funds may invest. However, such
higher yielding securities may be more volatile and may be
issued by less creditworthy entities.
Intermediate Series
The Intermediate Series' investment objective is to provide
investors with a total return in excess of the total return of
the major market indices for mortgage-backed securities. The
major market indices for mortgage-backed securities include, but
are not limited to, the Salomon Brothers Mortgage Index and the
Lehman Brothers Mortgage Index. These indices include all
outstanding government sponsored fixed-rate mortgage-backed
securities, weighted in proportion to their current market
capitalization. Total return is the change in value of the
investment assuming reinvestment of all distributions. Under
normal circumstances, the Intermediate Series will seek to
achieve an interest-rate risk or option-adjusted duration
similar to that of a portfolio that invests exclusively in
mortgage-backed securities, as weighted in the major market
indices. The duration, or interest-rate risk, of these indices
is similar to the that of intermediate-term U.S. Treasury Notes,
and typically will range between three and five years. When
market interest rates decline, the value of a portfolio invested
in intermediate-term fixed-rate obligations can be expected to
rise. Conversely, when market interest rates rise, the value of
a portfolio invested in intermediate-term fixed-rate obligations
can be expected to fall.
Option-adjusted duration is a measure of the price sensitivity
(in percentage) of a portfolio to changes in interest rates,
taking into account the changing nature of expected cash flows,
as influenced by mortgage prepayments and other factors. The
maturity of a security measures only the time until final
payment is due, whereas option-adjusted duration takes into
account the pattern of all payments of interest and principal on
a security over time, including how these payments are affected
by prepayments and by changes in interest rates. In computing
the duration of the Intermediate Series' portfolio, the Adviser
will estimate the duration of obligations that are subject to
prepayment, or redemption by the issuer, taking into account the
influence of changes in interest rates on prepayments and coupon
flows. The Adviser may use certain hedging techniques (as
described in more detail in Appendix A and in "Investment
Policies of the Short and Intermediate Series and Fixed Income
Segment of the Equity Plus Fund") to lengthen or shorten the
option-adjusted duration of the Intermediate Series so that it
targets the interest-rate risk of a portfolio that invests
exclusively in mortgage-backed securities, as weighted in the
major mortgage indices.
There is no assurance that the Intermediate Series will be able
to maintain a total return in excess of the total return of
major market indices for mortgage-backed securities or that it
will match the interest-rate risk of a portfolio investing
exclusively in these securities.
Equity Plus Fund
The Equity 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 former name
of the Equity Plus Fund was the Smith Breeden Market Tracking
Fund.) Total return is a measure of investment performance
which includes all of the interest, dividends and other income,
net of expenses, paid on the Fund's investments, as well as all
realized and unrealized capital gains and losses. The S&P 500
Index is composed of 500 common stocks, most of which are listed
on the New York Stock Exchange. Standard & Poor's, which is not
a sponsor of or in any other way affiliated with the Fund,
chooses the 500 stocks included in the S&P 500 Index on the
basis of market value and industry diversification. The S&P 500
Index assigns relative values to the stocks included in the
index, weighted according to each stock's total market value
relative to the total market value of the other stocks included
in the index.
The Equity Plus Fund seeks to achieve its objective by dividing
its portfolio into two separate segments, an "Equity Simulation
Segment" and a "Fixed Income Segment." The Equity Plus Fund's
Equity Simulation Segment will invest in a combination of Equity
Swap Contracts (described more fully below), 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 ("S&P
500 and Other Stock Index Futures"), and a combination of common
stocks whose return (before deducting allocated costs) is
expected to track movements in the S&P 500 Index. In the Equity
Simulation Segment, the Equity Plus Fund expects its use of
stock index futures other than S&P 500 Stock Index Futures to be
minimal.
The Equity Plus Fund's Fixed Income Segment will seek a total
return greater than the expenses of the Fund (including the
expenses associated with the Equity Simulation Segment such as
those relating to the Equity Swap Contracts and S&P 500 and
Other Stock Index Futures) by investing in fixed-income
securities and futures, options, floors, caps and swaps related
thereto. Through these investments, the Fixed Income Segment
seeks to generate income (consisting primarily of interest
income) and gains which exceed the expenses of operating the
entire Equity Plus Fund. Thus, whether the Fund outperforms or
underperforms the S&P 500 Index will depend on whether the total
return on the Fixed Income Segment is greater or less than the
Fund's total operating expenses (including transaction costs and
the costs of the equity derivative instruments held in the
Equity Simulation Segment), respectively.
Investment Policies of the Equity Simulation Segment of the
Equity Plus Fund
As stated above, the Equity Plus Fund's Equity Simulation
Segment will invest in a combination of Equity Swap Contracts,
S&P 500 and other Stock Index Futures, and a combination of
common stocks whose return is expected to track movements in the
S&P 500 Index. By employing such a strategy, the Equity Plus
Fund seeks to achieve the same 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.)
Set forth below is an example of a hypothetical portfolio
allocation for the Fund, assuming total assets of $100 million.
The Fund might:
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 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.
The Fixed Income Segment would invest $100 million in various
fixed income assets 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 Fund's return, before Fund 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 Fund'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 6.58%
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 6.58% 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 will tend to be greater than a hypothetical portfolio
invested in the stocks comprising the S&P 500 Index if the
Fund's exposure to the S&P 500 Index is higher or lower than the
Fund's total assets. For example, the total notional amount of
the Fund's Equity Swap Contracts (less the notional amount of
any Reverse Equity Swap Contracts) plus the face amount of the
Fund's 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 from time to time, due to purchases and
redemptions which will frequently affect the Fund's total assets
and because S&P 500 Index Futures can only be purchased in
multiples of 500 times the S&P 500 Index. Under normal market
conditions, the Fund expects that such variations in exposure to
the S&P 500 Index 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 opportunity and risk profile of a hypothetical stock
portfolio may be diminished by imperfect correlations between
price movements of the S&P 500 Index itself 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, if the aggregate face amount of the Fund's S&P 500
and Other Stock Index Futures, the notional amount of the
Fund's Equity Swap Contracts (less the notional amount of any
Reverse Equity Swap Contracts) and the value of the Fund's
common stocks is equal to the Fund's total net assets, and if
there is exact price movement correlation between the Fund's
common stocks and/or S&P 500 Index and Other Stock Index Futures
and the S&P 500 Index, the Fund will outperform the S&P 500
Index only if the total net return on the Fixed Income Segment
of the Fund's portfolio exceeds the sum of (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) all the Fund's operating
expenses as described more fully under "Management of the Fund."
The Equity Plus Fund will not enter into any Equity Swap
Contract or Reverse Equity Swap Contract unless, at the time of
entering into such transaction, the unsecured senior debt of the
counterparty is rated at least A by Moody's Investors Service,
Inc. ("Moody's") or Standard & Poor's ("S&P"). In addition, the
staff of the SEC considers Equity Swap Contracts and Reverse
Equity Swap Contracts to be illiquid securities. Consequently,
while the staff maintains this position, the Fund will not
invest in Equity Swap Contracts or Reverse Equity Swap Contracts
if, as a result of the investment, the total value of such
investments together with that of all other illiquid securities
which the Fund owns would exceed 15% of the Fund's total assets.
The Adviser and the Equity 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 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.
The Equity 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 liquid high quality
debt obligations in a segregated account with its Custodian, in
an amount which, together with the initial margin deposit on the
futures contract, is equal to the current delivery or cash
settlement value of the futures contract.
The Fund will not use Equity Swap Contracts, or S&P 500 or Other
Stock Index Futures for leverage.
Characteristics of the Securities in which the Equity Segment of
the Equity Plus Fund may invest.
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 ("Equity Swap Contracts"). The counterparty to an Equity
Swap Contract will typically be a bank, investment banking firm
or broker/dealer. The counterparty generally agrees to pay the
Fund the amount, if any, by which the notional amount of the
Equity Swap Contract would have increased in value had it been
invested in the 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 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 pursuant to Equity Swap Contracts
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 Equity Swap 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 consistent with the Fund's
objective. These positions are sometimes referred to as
"Reverse Equity Swap Contracts".
S&P 500 Index and Other Stock Index Futures. The Equity
Simulation Segment of the Fund may also invest in S&P 500 and
Other Stock Index Futures to track the return of the S&P 500
Index.
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 price of the S&P 500 or Other Stock Index
Future fluctuates.
Long positions in S&P 500 or Other Stock Index Futures 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 S&P 500 or Other Stock Index Futures could be
adversely affected by "daily price fluctuation limits"
established by an exchange which limit the amount of fluctuation
in the price of an S&P 500 or Other Stock Index 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.
Common Stocks. When S&P 500 or Other Stock Index Futures 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 also invest directly in the common stocks
represented by the S&P 500 Index. The Fund will generally 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.
Investment Policies of the Short and Intermediate Series and the
Fixed Income Segment of the Equity Plus Fund.
The Short and Intermediate Series each seek to achieve their
investment objective by investing, under normal circumstances,
at least 70% of their total assets in fixed-income U.S.
Government securities. The Fixed Income Segment of the Equity
Plus Fund will also invest substantially 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 and
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 Funds will invest substantially in
FNMA, FHLMC, and GNMA mortgage-backed certificates and other
U.S. Government Securities representing ownership interests in
mortgage pools.
With respect to their remaining assets, the Short and
Intermediate Series may invest in fixed-rate and adjustable-rate
mortgage-backed securities issued by private originators of, or
investors in, mortgage loans issued by private entities that are
rated AAA by Standard & Poor's ("S&P") or Aaa by Moody's
Investors Service ("Moody's") or, if unrated, determined by the
Adviser to be of comparable quality. The two Series may also
invest in money market instruments of a comparable short-term
rating or credit quality, as well as in time and savings
deposits (including fixed-rate or adjustable-rate certificates
of deposit) in commercial banks or in institutions whose
accounts are insured by the FDIC, BIF or SAIF. The Short and
Intermediate Series will not pay any additional fees for credit
support and will not invest in private mortgage pass-through
securities unless they are rated AAA by S&P or Aaa by Moody's,
or are unrated but deemed to be of comparable credit quality by
the Adviser. In addition, the Short and Intermediate Series
will only purchase mortgage-backed securities which constitute
"Mortgage Related Securities" for purposes of the Secondary
Mortgage Market Enhancement Act of 1984.
With respect to the remaining assets of the Equity Plus Fund,
its Fixed Income Segment may invest a portion of its assets 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
Fund's Fixed Income Segment's investments will be either of
investment grade (as rated by S&P or Moody's), or, if unrated,
determined by the Adviser to be of comparable quality. Its
investment in mortgage-backed and other asset-backed securities
will be rated 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 Plus
Fund's investments in fixed income securities and will cause the
Equity Plus 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 Funds may
invest are subject to varying degrees of risk of default. These
risk factors include the creditworthiness of the issuer and, in
the case of mortgage-backed and asset-backed securities, the
ability of the mortgagor or other borrower to meet its
obligations. The Short and Intermediate Series will seek to
minimize this credit risk by investing in securities of the
highest credit quality instruments, while the Equity Plus 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 Short and Intermediate Series may employ certain active
management techniques both to hedge the interest rate risks
associated with portfolio securities and to seek to minimize
fluctuation in net asset values in accordance with their
investment objectives and targeted option-adjusted durations.
In addition, the Fixed Income Segment of the Equity Plus Fund
will engage in various hedging strategies so that its volatility
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. In addition, the Short and Intermediate Series may
use stripped mortgage-backed securities to reduce the
option-adjusted duration. Appendix A provides information about
these hedging techniques.
There can be no assurance that the hedging techniques employed
by the Short and Intermediate Series and the Fixed Income
Segment of the Equity Plus Fund will be successful. As a
result, the Funds may not achieve, and may at times exceed,
their targeted option-adjusted duration. The Funds' 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 Funds (as
described in Appendix A).
Both of the Series, as well as the Fixed Income Segment of the
Equity 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.
Characteristics of the Securities in which the Short and
Intermediate Series and Fixed Income Segment of the Equity Plus
Fund Invest.
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 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-backed securities include both interest and a partial payment of
principal. This partial payment of principal may be comprised
of a scheduled principal payment as well as an unscheduled
payment from the voluntary prepayment, refinancing, or
foreclosure of the underlying loans. As a result of these
unscheduled payments of principal, or prepayments on the
underlying securities, the price and yield of mortgage-backed
securities can be adversely affected. For example, during
periods of declining interest rates, prepayments can be expected
to accelerate, and the Funds would be required to reinvest the
proceeds at the lower interest rates then available.
Prepayments of mortgages which underlie securities purchased at
a premium could result in capital losses because the premium may
not have been fully amortized at the time the obligation is
prepaid. In addition, like other interest-bearing securities,
the values of mortgage-backed securities generally fall when
interest rates rise, but when interest rates fall, their
potential for capital appreciation is limited due to the
existence of the prepayment feature. In order to hedge against
possible prepayment, the Funds may purchase certain options and
options on futures contracts as described more fully in 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 Short and Intermediate
Series will only invest in adjustable-rate securities backed by
pools of mortgage loans ("ARMs"). The Fixed Income Segment of
the Equity 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 or series may bear some or all of the risk of
default on the underlying mortgages. CMOs of different classes
are generally retired in sequence as the underlying mortgage
loans in the mortgage pools are repaid. In the event of
sufficient early prepayments on such mortgages, the class or
series of CMO first to mature generally will be retired prior to
its stated maturity. Thus, the early retirement of a particular
class or series of a CMO held by the Funds would have the same
effect as the prepayment of mortgages underlying a
mortgage-backed pass-through security. Another type of CMO is
a real estate mortgage investment conduit ("REMIC") which
qualifies for special tax treatment under the Internal Revenue
Code and invests in certain mortgages principally secured by
interests in real property and other permitted investments.
CMOs also include securities representing the interest in any
excess cash flow and/or the value of any collateral remaining
after the issuer has applied cash flow from the underlying
mortgages or mortgage-backed securities to the payment of
principal of and interest on all other CMOs and the
administrative expenses of the issuer ("Residuals"). Residuals
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. As a non-fundamental policy (meaning it
can be changed without the vote of the shareholders), the Short
and Intermediate Series will not invest in Residuals.
In reliance on an interpretation by the Securities and Exchange
Commission ("SEC"), the Funds' 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 each 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 Funds may invest in
STRIPS. The Short and Intermediate Series may invest only in
stripped mortgage-backed securities ("SMBS") which are STRIPS
represented by derivative multi-class mortgage securities. In
addition to SMBS issued by the U.S. Government, its agencies or
instrumentalities, the Short and Intermediate Series may
purchase SMBS issued by private originators of, or investors in,
mortgage loans, including depository institutions, mortgage
banks, investment banks and special purpose subsidiaries of
these entities. However, the Short and Intermediate Series will
purchase only SMBS that are collateralized by mortgage-backed
securities that are issued or guaranteed by the U.S. Government
or its agencies or instrumentalities. The Equity Plus Fund may
invest in STRIPS collateralized by other fixed income
securities, including other types of asset-backed securities.
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 a Fund's yield to maturity to the extent it
invests in IOs. Conversely, POs tend to increase in value if
prepayments are greater than anticipated and decline if
prepayments are slower than anticipated. Thus, if the
underlying assets experience greater than anticipated
prepayments of principal, a 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 a Fund's ability to buy or sell those securities at any
particular time.
The Adviser expects that IO SMBS will be purchased by the Short
and Intermediate Series for their hedging characteristics. Such
SMBS will reduce the variance of the Funds' respective net asset
values from their targeted option-adjusted durations. Under no
circumstances will the Short or Intermediate Series purchase
SMBS if such purchase would cause SMBS to exceed 5% of the
assets of a Fund.
New instruments and variations of existing mortgage-backed
securities continue to be developed. The Funds may invest in
any such instruments or variations to the extent consistent with
their investment objectives and policies and applicable
regulatory requirements.
Zero Coupon Securities. The Funds 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 Funds are required to accrue and distribute income from zero
coupon securities on a current basis, even though a Fund does
not receive the income currently. Thus, a Fund may have to sell
other investments to obtain cash needed to make income
distributions, which may reduce a Fund's assets and may thereby
increase its expense ratio and decrease its rate of return.
Hedging Instruments. The Funds may employ certain active
management techniques to achieve their duration objectives and
to hedge the interest-rate risks associated with their
fixed-income securities in accordance with such objectives. Since
some of the securities may have longer or shorter durations than
a Fund's specified duration objectives, hedging may be required
either to lengthen or to shorten the duration of a Fund's
portfolio. The Funds will seek continually to manage duration
within a narrow range.
The Funds intend to use hedging transactions primarily to
protect against interest-rate fluctuations and not as
speculative transactions. The Funds may also use hedging
transactions as a temporary substitute for purchasing particular
securities. Each 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 Funds may use SMBS to
better maintain their respective targeted option-adjusted
durations.
Any or all of these techniques may be used at one time. Use of
any particular transaction is a function of market conditions.
The hedging transactions that the Funds currently contemplate
using are described in detail in Appendix A, including a
discussion of their respective risks.
As a matter of fundamental policy, the Short and Intermediate
Series will limit purchases to the following classes of assets:
1. Securities issued directly or guaranteed by the U.S. Government or
its agencies or instrumentalities;
2. Mortgage-Backed Securities rated AAA by S&P or Aaa by Moody's or
unrated but deemed of equivalent quality by the Adviser;
3. Assets fully collateralized by assets in either of the above classes;
4. Assets which would qualify as liquidity items under federal
regulations if held by a commercial bank or savings institution; and
5. Hedge instruments,which may only be used for risk management
purposes. Any securities described in the "Hedging" section
and any stripped Mortgage-Backed Securities may only be used for risk
management purposes.
OTHER INVESTMENT PRACTICES AND RISK CONSIDERATIONS
The Funds may also engage in the following investment practices,
each of which may involve certain special risks. The Statement
of Additional Information for each Fund contains more detailed
information about these practices, including limitations
designed to reduce these risks.
Securities Loans, Repurchase Agreements and Forward Commitments.
The Funds may lend portfolio securities to broker-dealers and
may enter into repurchase agreements. These transactions must
be fully collateralized at all times but involve some risk to
the Funds if the other party should default on its obligations
and a Fund is delayed or prevented from recovering the
collateral. None of the Funds will lend portfolio securities
if, as a result, the aggregate of such loans exceeds 33 1/3% of
the total asset value (including such loans.) The Funds will
only enter into repurchase agreements with or lend securities to
(i) member banks of the Federal Reserve System having total
assets in excess of $500 million and (ii) securities dealers,
provided such banks or dealers meet the creditworthiness
standards established by the Board of Trustees ("Qualified
Institutions"). The Adviser will monitor the continued
creditworthiness of Qualified Institutions, subject to the
oversight of the Board of Trustees.
The Funds may also purchase securities for future delivery,
which may increase overall investment exposure and involves a
risk of loss if the value of the securities declines prior to
the settlement date. At the time a Fund enters into a
transaction on a when-issued or forward commitment basis, a
segregated account consisting of 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 Funds' custodian. Subject to this requirement, the Funds
may purchase securities on such basis without limit.
Settlements in the ordinary course, which may be substantially
more than three business days for mortgage-backed securities,
are not treated as when-issued or forward commitment
transactions, and are not subject to the foregoing limitations,
although some of the risks described above may exist.
Reverse Repurchase Agreements, Dollar Roll Agreements and
Borrowing. In order to increase income, the Funds may enter
into reverse repurchase agreements or dollar roll agreements
with commercial banks and registered broker-dealers in amounts
up to 33 1/3% of their assets. The Short and Intermediate Series
may only enter into these transactions with commercial banks and
registered broker-dealers which are also Qualified Institutions.
The Statement of Additional Information for each Fund contains
a more detailed explanation of these practices. Reverse
repurchase agreements and dollar rolls are considered borrowings
by a Fund and require segregation of assets with a Fund's
custodian in an amount equal to the Fund's obligations pending
completion of such transactions. Each Fund may also borrow
money from banks in an amount up to 33 1/3% of a Fund's total
assets to realize investment opportunities, for extraordinary or
emergency purposes, or for the clearance of transactions.
Borrowing from banks usually involves certain transaction and
ongoing costs and may require a Fund to maintain minimum bank
account balances. Use of these borrowing techniques to purchase
securities is a speculative practice known as "leverage."
Depending on whether the performance of the investments
purchased with borrowed funds is sufficient to meet the costs of
borrowing, a Fund's net asset value per share will increase or
decrease, as the case may be, more rapidly than if the Fund did
not employ leverage.
Short Sales. The Funds may make short sales of securities. A
short sale is a transaction in which the Fund sells a security
it does not own in anticipation that the market price of that
security will decline. The Funds expect 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 a Fund makes a short sale, it must borrow the security sold
short and deliver it to the broker-dealer through which it made
the short sale as collateral for its obligation to deliver the
security upon completion of the transaction. A Fund may have to
pay a fee to borrow particular securities and is often obligated
to relinquish any payments received on such borrowed securities.
Until a Fund replaces a borrowed security, it will maintain
daily a segregated account with its custodian 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, a Fund may not receive any
payments (including interest) on collateral deposited with the
broker. If the price of the security sold short increases
between the time of the short sale and the time a Fund replaces
the borrowed security, the Fund will incur a loss; conversely,
if the price declines, the Fund will realize a gain. Although
a Fund's gain is limited to the amount at which it sold the
security short, its potential loss is limited only by the
maximum attainable price of the security less the price at which
the security was sold.
A Fund will not make a short sale if, after giving effect to
such sale, the market value of all securities sold exceeds 25%
of the value of the Fund's total net assets. A Fund may also
effect short sales where the Fund owns or has the right to
acquire at no additional cost the identical security (a
technique known as a short sale "against the box").
Illiquid Securities. A 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 each Fund. The Adviser will
monitor a Fund's 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 a 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
a Fund whenever it believes it is appropriate to do so.
Portfolio turnover generally involves some expense to a Fund,
including brokerage commissions or dealer mark-ups and other
transaction costs on the sale of securities and reinvestment in
other securities. Such transactions may result in realization
of taxable capital gains. The portfolio turnover rate for each
Fund's previous fiscal periods is shown in the table under the
heading "Financial Highlights".
While the Funds will pay commissions in connection with options
and future transactions and, for the Equity Plus Fund only,
possibly in relation to any purchase of common stocks, most of
the securities in which the Funds invest 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 a Fund.
Another potential consequence of high portfolio turnover is that
if 30% or more of a Fund's gross income for a taxable year is
derived from gains from the sale of securities held for less
than three months, the Fund 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 Funds and
to adjust the portfolio turnover, if necessary, to ensure that
each Fund will be eligible for treatment as a regulated
investment company.
MANAGEMENT OF THE FUNDS
The business affairs of the Funds are managed by its Board of
Trustees. Each of the Funds has entered into an investment
advisory agreement with Smith Breeden Associates, Inc., 100
Europa Drive, Chapel Hill, North Carolina, 27514 ( the
"Investment Advisory Agreements"). Pursuant to such investment
advisory agreements, the Adviser furnishes continuous investment
advisory services to each of the Funds.
Trustees and Officers
The following is a listing of the Trustees and officers of the
Series Fund and Trust, the legal entities that have issued
shares in the Funds. Unless otherwise indicated, all of the
named individuals serve in their capacities for both the Series
Fund and Trust.
<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,
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.
<PAGE>
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),
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.
<PAGE>
Daniel C. Dektar Vice President, Smith Breeden Series Fund
Portfolio Manager, Short and Intermediate Series
Principal, Executive Vice President, Director of Portfolio
Management, and Director of Smith Breeden Associates. Mr.
Dektar has been primarily responsible for the day-to-day
management of the Short and Intermediate Series from their
commencement of operations in 1992. As head of Smith Breeden
Associates' portfolio management group, Mr. Dektar is constantly
in touch with developments on Wall Street. He serves as a
liaison among the portfolio management, client service, and
research groups to ensure accurate analysis and timely execution
of portfolio management opportunities. Mr. Dektar consults with
institutional clients in the areas of investments and risk
management. He has made several presentations on mortgage
investments and risk management at seminars for institutional
investors. Mr. Dektar was an Associate in the Mergers and
Acquisitions Group of Montgomery Securities in San Francisco,
California and a Financial Analyst in the Investment Banking
Division of Morgan Stanley & Co., Incorporated, New York before
joining Smith Breeden Associates. He holds a Master of Business
Administration with Concentration in Finance from Stanford
University Graduate School of Business, where he was an Arjay
Miller Scholar. Mr. Dektar received a Bachelor of Science in
Business Administration, summa cum laude, from the University of
California at Berkeley, where he was University of California
Regent's Scholar, was elected to Phi Beta Kappa and Phi Eta
Sigma, and won the White Award as the top student in finance.
John B. Sprow Vice President, Smith Breeden Trust
Portfolio Manager, Equity 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 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 Funds. Approximately 66% of
the Adviser's voting stock is owned by Douglas T. Breeden, its
Chairman and President. Under its Investment Advisory Agreement
with each Fund, the Adviser, subject to the general supervision
of the Board of Trustees, manages the Funds' portfolios and
provides for the administration of all of the Funds' other
affairs. For these services, the Adviser receives a fee,
computed daily, and payable monthly, at the annual rate of 0.70%
of the Funds' average daily net assets. Until March 31, 1997,
the Adviser has voluntarily agreed to reduce its compensation,
and to the extent necessary absorb other expenses of the Funds,
such that the total expenses (exclusive of ordinary brokerage
commissions, investment transaction taxes and extraordinary
expenses) do not exceed 0.88% of the average net assets for each
of the Equity Plus Fund and the Intermediate Series, and 0.78%
of the average net assets of the Short Series.
The Adviser places all orders for purchases and sales of the
Funds' securities. Subject to seeking the most favorable price
and execution available, the Adviser may consider sales of
shares of the Funds as a factor in the selection of broker-dealers.
Distribution
FPS Broker Services, Inc. (the "Principal Underwriter") acts as
distributor for the Funds for which the Adviser pays the
Principal Underwriter 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 Funds pay all of their own expenses, including without
limitation, the cost of preparing and printing their
registration statements required under the Securities Act of
1933 and the 1940 Act and any amendments thereto, the expense of
registering their shares with the Securities and Exchange
Commission and the various states, the printing and distribution
costs of prospectuses mailed to existing investors, reports to
investors, reports to government authorities and proxy
statements, fees paid to directors who are not interested
persons of the Adviser, interest charges, taxes, legal expenses,
association membership dues, auditing services, insurance
premiums, brokerage commissions and expenses in connection with
portfolio transactions, fees and expenses of the custodian of
their assets, printing and mailing expenses and charges and
expenses of dividend disbursing agents, accounting services
agents, registrars and stock transfer agents.
<PAGE>
PRICING OF FUND SHARES
The price you pay when buying a Fund's shares, and the price you
receive when selling (redeeming) a Fund's shares, is the net
asset value of the shares next determined after receipt of a
purchase or redemption request in proper form. No front end
sales charge or commission of any kind is added by the Fund upon
a purchase and no charge is deducted upon a redemption. The
Funds currently charge a $9 fee for each redemption made by
wire. See "How to Redeem Shares."
The per share net asset value of a Fund is determined by
dividing the total value of its assets, less its liabilities, by
the total number of its shares outstanding at that time. The net
asset value is determined as of the close of regular trading
(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 a Fund's securities such that
the net asset value of a Fund's shares might be affected.
Accordingly, Purchase Applications accepted or redemption
requests received in proper form by the Transfer Agent, or other
agent designated by the Funds, prior to 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 Funds, will be confirmed at the
net asset value of the following business day.
Current holiday schedules indicate that the Funds' net asset
values will not be calculated on New Year's Day, President's
Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day, the day following Thanksgiving, Christmas Eve
and Christmas Day. In addition, the Short and Intermediate
Series will not be priced on Martin Luther King Day, Columbus
Day and Veterans' Day.
Under procedures approved by the Board of Trustees, a Fund's
securities for which market quotations are readily available are
valued at current market value provided by a pricing service,
bank or broker/dealer experienced in such matters. Short-term
investments that will mature in 60 days or less 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
All of the Funds are no-load, so you may purchase, redeem or
exchange shares directly at net asset value without paying a
sales charge. Because the Funds' net asset value changes daily,
your purchase price will be the next net asset value determined
after the Funds' Transfer Agent, or other agent designated by
the Funds, receives and accepts your purchase order. See
"Pricing of Fund Shares."
Initial Minimum
Minimum Additional
Type of Account Investment Investment
Regular $250 $50
Automatic Investment Plan $50 $50
Individual Retirement ]
Account $250 $50
Gift to Minors $250 $50
Each 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.
How to Open Your Account by Mail. Please complete the Purchase
Application. You can obtain additional copies of the Purchase
Application and a copy of the IRA Purchase Application from the
Funds by calling 1-800-221-3138. (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 Funds 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 Funds at 1-800-221-3137 for instructions prior
to wiring funds. Funds should be wired through the Federal
Reserve System as follows:
United Missouri Bank
A.B.A. Number 10-10-00695
For the account of FPS Services, Inc.
Account Number 98-7037-071-9
For credit to (identify which Fund to purchase)
For further credit to: (investor account number)
(name or account registration)
(Social Security or Tax Identification Number)
Following such wire transfer, you must promptly complete a
Purchase Application and mail it to the Funds at the following
address: Smith Breeden Mutual Funds, 3200 Horizon Drive, P.O.
Box 61503, King of Prussia, PA 19406-0903. Shares will not be
redeemed until the Funds receive 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. Each Fund will
employ reasonable procedures to ensure that instructions
communicated by telephone are genuine. If reasonable procedures
are not implemented, the Funds may be liable for any loss due to
unauthorized or fraudulent transactions. In all other cases, you
are liable for any loss for unauthorized transactions. The
Funds reserve the right to refuse a telephone transaction if
they believe it advisable to do so.
If you have any questions, please call the Funds 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 Funds
your check, together with the additional investment form from a
recent statement. If this form is unavailable, you should send
a signed note giving the full name of the account and the
account number. For additional investments made by wire
transfer, you should use the wiring instructions listed above.
Be sure to include your account number.
Automatic Investment Plan. You may make purchases of shares of
each Fund automatically on a regular basis ($50 minimum per
transaction). You 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 Funds for participation
in the Plan. A $20 fee will be imposed by the Funds 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 Funds at 1-800-221-3138. In the event you discontinue
participation in the Plan, the Funds reserve the right to redeem
your Fund account involuntarily, upon sixty days' written
notice, if the account's net asset value is $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 a Fund may not be available or may be
modified in connection with the program of services provided,
and service providers may establish higher minimum investment
amounts. The Funds may only accept requests to purchase
additional shares into a broker-dealer street name account from
the broker-dealer.
Certain broker-dealers, financial institutions, or other service
providers that have entered into an agreement with the Adviser
or Principal Underwriter may enter purchase orders on behalf of
their customers by phone, with payment to follow within several
days as specified in the agreement. The Funds 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 Funds on a
timely basis. If payment is not received within the time
specified in the agreement, the broker-dealer, financial
institution, or other service provider could be held liable for
any resulting fees or losses.
Miscellaneous. The Funds will charge a $20 service fee against
your account for any check or electronic funds transfer that is
returned unpaid. You will also be responsible for any losses
suffered by the Funds as a result. In order to relieve you of
responsibility for the safekeeping and delivery of stock
certificates, the Funds do not currently issue certificates.
<PAGE>
HOW TO EXCHANGE SHARES
Shares of any Fund may be exchanged for shares of another Fund
at any time. This exchange offer is available only in states
where shares of such other Fund may be legally sold. You may
open a new account, or purchase additional shares in an existing
account, by making an exchange from an identically registered
Smith Breeden Fund account. A new account will have the same
registration as the existing account from which the exchange was
made, and is subject to the same initial investment 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 Funds 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 Funds will accept exchange orders by telephone or other
means of electronic transmission from broker-dealers, financial
institutions or other service providers who execute an agreement
with the Adviser or Principal Underwriter. It is the
responsibility of the broker-dealer, financial institution or
other service provider to place the exchange order on a timely
basis.
Exchanges are made on the basis of the Funds' relative net asset
values. Because the exchange is considered a redemption and
purchase of shares, the shareholder may recognize a gain or loss
for federal income tax purposes. Backup withholding and
information reporting may also apply. Additional information
regarding the possible tax consequences of such an exchange is
included under the caption "Additional Information on
Distributions and Taxation" in the Funds' Statements of
Additional Information.
There are differences among the Funds. 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 Funds may have different dividend payment dates. The
dividend payment schedules should be checked before exchanging
shares. The amount of any accumulated, but unpaid, dividend is
included in the net asset value per share.
If you buy shares by check, you may not exchange those shares
for up to 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 Funds at
1-800-221-3137 for further information.
The Funds reserve the right to temporarily or permanently
terminate, with or without advance notice, the exchange
privilege of any investor who makes excessive use of the
exchange privilege (e.g., more than 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 Funds for
additional information concerning the exchange privilege.
HOW TO REDEEM SHARES
You may redeem shares of the Funds at any time. The price at
which the shares will be redeemed is the net asset value per
share next determined after proper redemption instructions are
received by the Transfer Agent or other agent designated by the
Funds. See "Pricing of Fund Shares." There are no charges for
the redemption of shares except that a fee of $9 is charged for
each wire redemption. Depending upon the redemption price you
receive, you may realize a capital gain or loss for federal
income tax purposes.
How to Redeem by Mail to Receive Proceeds by Check. To redeem
shares by mail, simply send an unconditional written request to
the Funds specifying the number of shares or dollar amount to be
redeemed, the name of the Fund, the name(s) on the account
registration and the account number. A request for redemption
must be signed exactly as the shares are registered. If the
amount requested is greater than $25,000, or the proceeds are to
be sent to a person other than the recordholder or to a location
other than the address of record, each signature must be
guaranteed by a commercial bank or trust company in the United
States, a member firm of the National Association of Securities
Dealers, Inc. or other eligible guarantor institution. A notary
public is not an acceptable guarantor. Guarantees must be signed
by an authorized signatory of the bank, trust company, or member
firm and "Signature Guaranteed" must appear with the signature.
Additional documentation may be required for the redemption of
shares held in corporate, partnership or fiduciary accounts. In
case of any questions, please contact the Funds in advance.
A Fund will mail payment for redemption within seven days after
receiving proper instructions for redemption. However, the Funds
will delay payment for 10 calendar days on redemptions of recent
purchases made by check. This allows the Funds to verify that
the check used to purchase Fund shares will not be returned due
to insufficient funds and is intended to protect the remaining
investors from loss.
How to Redeem by Telephone. 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 Funds 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 your Fund. The request must be signed by each
registered holder of the account with the signatures guaranteed
by a commercial bank or trust company in the United States, a
member firm of the National Association of Securities Dealers,
Inc. or other eligible guarantor institution. A notary public is
not an acceptable guarantor. Further documentation as provided
above may be requested from corporations, executors,
administrators, trustees and guardians.
Payment of the redemption proceeds for Fund shares redeemed by
telephone where you request wire payment will normally be made
in federal funds on the next business day. The Funds reserve the
right to delay payment for a period of up to seven days after
receipt of the redemption request. There is currently a $9 fee
for each wire redemption. It will be deducted from your account.
The Funds reserve 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 Funds by
telephone may be modified or terminated by the Funds at any
time. In an effort to prevent unauthorized or fraudulent
redemption or exchange requests by telephone, the Funds have
implemented procedures designed to reasonably assure that
telephone instructions are genuine. These procedures include:
requesting verification of certain personal information;
recording telephone transactions; confirming transactions in
writing; and restricting transmittal of redemption proceeds only
to preauthorized designations. Other procedures may be
implemented from time to time. If reasonable procedures are not
implemented, the Funds may be liable for any loss due to
unauthorized or fraudulent transactions. In all other cases, you
are liable for any loss for unauthorized transactions.
You should be aware that during periods of substantial economic
or market change, telephone or wire redemptions may be difficult
to implement. If you are unable to contact the Funds by
telephone, you may also redeem shares by delivering or mailing
the redemption request to: Smith Breeden Mutual Funds, 3200
Horizon Drive, P.O. Box 61503, King of Prussia, PA 19406-0903.
The Funds reserve the right to suspend or postpone redemptions
during any period when trading on the New York Stock Exchange
("Exchange") is restricted, as determined by the Securities and
Exchange Commission ("SEC"), or the Exchange is closed for other
than customary weekend and holiday closing; the SEC has by order
permitted such suspension; or an emergency, as determined by the
SEC, exists, making disposal of portfolio securities or
valuation of net assets of a Fund not reasonably practicable.
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.
Check Writing. In addition to telephone and written redemption
requests, the Short Series offers redemption through check
writing. Shareholders electing this option will receive checks
that may be used like personal or business checks. There is no
limit on the number of checks you may write. Checks must be at
least $100 and may not exceed $25,000. There is a $30 fee for
returned checks. Because dividends declared on shares held in
a shareholder's account, prior redemptions, and possible changes
in net asset value may cause the value of the account to change,
shareholders should not write a check for the entire value of
the account or close the account by writing a check.
In using the check writing privilege, shareholders bear the
responsibility of ensuring that the check amount does not exceed
the value of their account on the day the check is presented to
the Transfer Agent for payment. The day the check is presented
for payment is the day the redemption of Fund shares takes
place. If insufficient shares are in the account, the check
will be returned and no shares will be redeemed. The clearing
agent for the check writing facility is United Missouri Bank.
Shareholders utilizing check writing are subject to United
Missouri Bank's rules governing checking accounts. However,
this check writing facility is purely a means to redeem Fund
shares. No facilities characteristic of bank accounts, such as
deposit insurance, are being provided along with the check
writing option.
If you would like to initiate check writing, please call
Shareholder Services at 1-800-221-3137 or check the appropriate
box on the Purchase Application.
Systematic Withdrawal Plan. A shareholder may establish a
Systematic Withdrawal Plan 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 a 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 Short and Intermediate Series intend to make monthly
distributions to their shareholders of net investment income.
The Equity Plus Fund intends to make quarterly distributions of
net investment income. All Funds will distribute net realized
gains at least annually. Each Fund may make additional
distributions if necessary to avoid imposition of a 4% excise
tax or other tax on undistributed income and gains.
The monthly distributions for the Short Series' shares are
quoted ex-dividend on the business day after record date (the
"ex-date"). Record date is usually the first or second business
day of the month. If a shareholder elects to reinvest
dividends, the date the dividends are reinvested is also the ex-date.
Dividends are paid in cash by the Short Series generally
one week after the ex-date.
The Intermediate Series will declare daily dividends for
shareholders of record. The Intermediate Series' dividend
payable date, and the day that dividends are reinvested for
shareholders who have made this election is the last business
day of the month. Shares begin accruing dividends on the
business day after federal funds (funds credited to a member
bank's account at the Federal Reserve Bank) are available from
the purchase payment for such shares and continue to accrue
dividends through, and including, the day the redemption order
for the shares is executed. If an investor closes his account,
any accrued dividends, through and including the day of
redemption, will be paid as part of the redemption proceeds.
Dividends and capital gains distributions may be declared more
or less frequently at the direction of the Trustees. In order
to be entitled to a dividend or a distribution, an investor must
acquire a Fund's shares on or before the record date. Caution
should be exercised, however, before purchasing shares
immediately prior to a distribution record date. Because the
value of a Fund's shares is based directly on the amount of its
net assets, rather than on the principle of supply and demand,
any distribution of income or capital gain will result in a
decrease in the value of its shares equal to the amount of the
distribution. While a dividend or capital gain distribution
received shortly after purchasing shares represents, in effect,
a return of the shareholder's investment, it may be taxable as
dividend income or capital gain. You may separately elect to
reinvest income dividends and capital gains distributions in
shares of a Fund or receive cash as designated on the Purchase
Application. You may change your election at any time by sending
written notification to your Fund. The election is effective for
distributions with a dividend record date on or after the date
that the Funds receive notice of the election. If you do not
specify an election, all income dividends and capital gains
distributions will automatically be reinvested in full and
fractional shares of a Fund. Reinvested dividends and
distributions receive the same tax treatment as those paid in
cash.
SHAREHOLDER REPORTS AND INFORMATION
The Funds will provide the following statements and reports:
Confirmation and Account Statements. After each transaction
that affects the account balance or account registration,
including the payment of dividends, you will receive a
confirmation statement.
Form 1099. By January 31 of each year, all shareholders will
receive Form 1099 which will report the amount and tax status of
distributions paid to you by the Funds for the preceding
calendar year.
Financial Reports. Financial reports are provided to
shareholders semiannually. Annual reports will include audited
financial statements. To reduce the Funds' expenses, one copy of
each report will be mailed to each Taxpayer Identification
Number even though the investor may have more than one account
in a Fund.
Reports to Depository Institutions. Shareholders of the Short
or Intermediate Series who are financial institutions may
request receipt of monthly or quarterly reports which provide
information about the Short or Intermediate Series' investments
considering regulatory risk-based asset categories.
If you need additional copies of previous statements, you may
order statements for the current and preceding year at no
charge. Call 1-800-221-3137 to order past statements. If you
need information on your account with the Funds or if you wish
to submit any applications, redemption requests, inquiries or
notifications, please contact: Smith Breeden Mutual Funds, 3200
Horizon Drive, P.O. Box 61503, King of Prussia, PA 19406-0903 or
call 1-800-221-3137.
<PAGE>
RETIREMENT PLANS
The Funds have a program under which you may establish an
Individual Retirement Account ("IRA") with the Funds and
purchase shares through such account. Shareholders wishing to
establish an IRA should consult their tax adviser regarding (1)
their individual qualifying status and (2) the tax regulations
governing these accounts. The minimum initial investment in each
Fund for an IRA is $250. There is a $12 annual maintenance fee
charged to process an account. You may obtain additional
information regarding establishing such an account by calling
the Funds at 1-800-221-3138.
The Funds may be used as investment vehicles for established
defined contribution plans, including simplified employee
(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
Each Fund has adopted a Distribution and Services Plan (the
"Plans") pursuant to Rule 12b-1 under the 1940 Act. The purpose
of the Plans is to permit the Adviser to compensate investment
dealers and other persons involved in servicing shareholder
accounts for services provided and expenses incurred in
promoting the sale of shares of the Funds, reducing redemptions,
or otherwise maintaining or improving services provided to
shareholders by such dealers or other persons. The Plans
provide for payments by the Adviser out of its advisory fee to
dealers and other persons at an annual rate of up to 0.25% of a
Fund's average net assets, subject to the authority of the
Trustees to reduce the amount of payments permitted under the
Plan or to suspend the Plan for such periods as they may
determine. Subject to these limitations, the 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 Plans, the terms of any related service
agreements, and any applicable limits imposed by the National
Association of Securities Dealers, Inc.
TAXES
Each Fund intends to qualify as a regulated investment company
under the Internal Revenue Code. In each taxable year that a
Fund so qualifies, such Fund (but not its shareholders) will be
relieved of federal income tax on the part of its net investment
income and net capital gain that is distributed to shareholders.
Each Fund will distribute 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
distributions of a Fund's net long-term capital gain will be
taxable to its shareholders as long-term capital gain,
regardless of how long they have held their Fund shares. Each
Fund provides federal tax information to its shareholders
annually about distributions paid during the preceding year.
It is not anticipated that any of the Funds' distributions will
qualify for either the corporate dividends-received deduction or
tax-exempt interest income. Distributions will also probably be
subject to state and local taxes depending on each shareholder's
tax situation. While many states grant tax-free status to
mutual fund distributions paid from interest income earned from
direct obligations of the U.S. Government, none of the Short or
Intermediate Series' distributions are expected to qualify for
such tax-free treatment, and only an insignificant amount of the
Equity Plus Fund's distributions are expected to so qualify.
The Funds will be required to withhold federal income tax at a
rate of 31% ("backup withholding") from distribution payments
and redemption and exchange proceeds if you fail to properly
complete the Purchase Application.
The foregoing is only a summary of some of the important federal
tax considerations generally affecting each Fund and 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 Plus
Fund, and the Smith Breeden Series Fund, which issues shares in
the Short and Intermediate Series, are both Massachusetts
business trusts. The Trust was organized under an Agreement and
Declaration of Trust, dated December 18, 1991. The Series Fund
was organized under an Agreement and Declaration of Trust dated
October 3, 1991. Copies of both Agreements, which are governed
by Massachusetts law, are on file with the Secretary of State of
the Commonwealth of Massachusetts. The Trust and the Series
Fund have the same Trustees.
The Trustees have the authority to issue shares in an unlimited
number of series of either the Series Fund or Trust. 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 separate series of the Series Fund or Trust
will vote together in electing trustees and in certain other
matters. Shareholders in each series of the Series Fund should
be aware that the outcome of the election of trustees and of
certain other matters could be controlled by the shareholders of
the other series. 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 neither the Series Fund nor the Trust is required to
hold annual meetings of its shareholders, shareholders have the
right to call a meeting to elect or remove trustees, or to take
other actions as provided in the respective Declaration of
Trust. Upon written request by the holders of at least 1% of
the outstanding shares stating that such shareholders wish to
communicate with the other shareholders for the purpose of
obtaining the signatures necessary to demand a meeting to
consider the removal of a trustee, both the Series Fund and
Trust have undertaken to provide a list of shareholders or to
disseminate appropriate materials (at the expense of the
requesting shareholders).
Under Massachusetts law, shareholders of a business trust may,
under certain circumstances, be held personally liable as
partners for its obligations. However, the risk of a
shareholder incurring financial loss on account of shareholder
liability is limited to circumstances in which both (i) any
liability was greater than a Fund's insurance coverage and (ii)
a Fund itself was unable to meet its obligations.
TRANSFER AND DIVIDEND DISBURSING
AGENT, CUSTODIAN AND
INDEPENDENT ACCOUNTANTS
FPS Services, Inc. ("FPS Services" or the "Transfer Agent"),
3200 Horizon Drive, King of Prussia, PA 19406, acts as each
Fund's Transfer and Dividend Disbursing Agent. See "Management
of the Funds." The Bank of New York acts as the custodian of
each Fund's assets. The Bank of New York's address is 48 Wall
Street, New York, New York 10286. Neither the Transfer and
Dividend Disbursing Agent nor the Custodian has any part in
deciding the Funds' investment policies or which securities are
to be purchased or sold for the Funds' portfolios. Deloitte &
Touche, LLP, has been selected to serve as independent auditors
of the Company for the fiscal year ending March 31, 1997.
FUND PERFORMANCE
Each Fund may quote the Fund's average annual total and/or
aggregate total return for various time periods in
advertisements or communications to shareholders. An average
annual total return refers to the rate of return which, if
applied to an initial investment at the beginning of a stated
period and compounded over that period, would result in the
redeemable value of the investment at the end of the period
assuming reinvestment of all dividends and distributions and
reflecting the effect of all recurring fees. An investor's
principal in each Fund and the Fund's return are not guaranteed
and will fluctuate according to market conditions. When
considering "average" total return figures for periods longer
than one year, you should note that a Fund's annual total return
for any one year in the period might have been greater or less
than the average for the entire period. Each Fund also may use
"aggregate" total return figures for various periods,
representing the cumulative change in value of an investment in
the Fund for a specific period (again reflecting changes in the
Fund's share price and assuming reinvestment of dividends and
distributions).
The Short and Intermediate Series may also advertise current
yield and distribution rate information. Current yield reflects
the income per share earned by the Short or Intermediate Series'
portfolio investments, and is calculated by dividing a Fund's
net investment income per share during a recent 30-day period by
a Fund's net asset value on the last day of that period and
annualizing the result. The current yield (or "SEC Yield"),
which is calculated according to a formula prescribed by the SEC
(see the relevant Statement of Additional Information), is not
indicative of the dividends or distributions which were or will
be paid to a Series' shareholders. SEC regulations require that
net investment income be calculated on a "yield-to-maturity"
basis, which has the effect of amortizing any premiums or
discounts in the current market value of fixed income
securities. Dividends or distributions paid to shareholders are
reflected in the current distribution rate which may be quoted
to shareholders, and may not reflect amortization in the same
manner.
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, a Fund's total return may be compared
to data prepared by Lipper Analytical Services, Inc.,
Morningstar, Inc., Value Line Mutual Fund Survey and CDA
Investment Technologies, Inc. Total return data as reported in
such national financial publications as The Wall Street Journal,
The New York Times, Investor's Business Daily, USA Today,
Barron's, Money and Forbes as well as in publications of a local
or regional nature, may be used in comparing Fund performance.
The Equity Plus 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. The Short Series' total return may
also be compared that of taxable money funds as quoted in
Donaghue's Money Fund Report and to total returns for the six
month U.S. Treasury as published by Merrill Lynch or other
suppliers. The Intermediate Series' return will most likely be
compared to the total return of the Salomon Brothers Mortgage
Index, or the total return of intermediate U.S. Treasury Notes
as published by various brokerage firms and others. Further
information on performance measurement may be found in the
relevant Statement of Additional Information.
Performance quotations of a Fund represent the Fund's past
performance and should not be considered representative of
future results. The investment return and principal value of an
investment in a Fund will fluctuate so that an investor's
shares, when redeemed, may be worth more or less than their
original cost. The methods used to compute a Fund's total return
and yield are described in more detail in the relevant Statement
of Additional Information.
<PAGE>
APPENDIX A
Hedging Instruments and Transactions (Short and Intermediate
Series and Equity 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 a 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 a Fund with another
party of their respective commitments to pay or receive
interest, for example, an exchange of floating-rate payments for
fixed-rate 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 Short or Intermediate Series will enter into interest rate
swaps only on a net basis, i.e., where the two payment streams
are netted out, with a Fund receiving or paying, as the case may
be, only the net amount of the two payments. The Fixed Income
Segment of the Equity 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
principal amount from the party selling such interest rate
floor. An interest rate collar combines the elements of
purchasing a cap and selling a floor. The collar protects
against an interest rate rise above the maximum amount but gives
up the benefits of an interest rate decline below the minimum
amount. There can be no assurance that the Funds will be able to
enter into interest rate swaps, caps, floors or collars on
favorable terms. Furthermore, there can be no assurance that
any of the Funds will be able to terminate an interest rate swap
or sell or offset interest rate caps, floors or collars
notwithstanding any terms in the agreements providing for such
termination.
Inasmuch as these hedging transactions are entered into for
hedging purposes, the Adviser and the Funds believe swaps, caps,
floors and collars do not constitute senior securities and,
accordingly, will not treat them as being subject to its
borrowing restrictions. The net amount of the excess, if any,
of a Fund's obligations over its entitlement with respect to
each interest rate swap will be accrued on a daily basis and an
amount of cash or liquid securities having an aggregate net
asset value at least equal to the accrued excess will be
maintained in a segregated account by a custodian that satisfies
the requirements of the 1940 Act. To the extent that the Fixed
Income Segment of the Equity 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 Short and Intermediate Series will not write interest rate
caps, floors and collars and will not enter into any interest
rate swap, cap, floor or collar transaction unless the unsecured
commercial paper, unsecured senior debt or the claims-paying
ability of the other party is rated either AA or A-1 or better
by Standard & Poor's or Aa or P-1 or better by Moody's Investors
Service, Inc., at the time of entering into such transaction.
The Fixed Income Segment of the Equity 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 Funds 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 Funds will have contractual remedies pursuant to the
agreements related to the transaction. There is no assurance
that interest-rate swap, cap, floor or collar counterparties
will be able to meet their obligations pursuant to their
contracts, or that, in the event of default, a Fund will succeed
in pursuing contractual remedies. The Funds thus assume the
risk that one of them may be delayed in or prevented from
obtaining payments owed to it pursuant to interest rate swaps,
caps, floors or collars.
The swap, cap, floor and collar market has grown substantially
in recent years with a large number of banks and investment
banking firms acting both as principals and as agents utilizing
standardized documentation. As a result, this market has become
relatively liquid, although the Funds will still treat these
instruments as illiquid investments subject to the limitation on
such investments described in the Prospectus at "Illiquid
Securities".
Calls and Puts on Securities. In order to reduce fluctuations
in net asset value and portfolio holdings relative to their
targeted option-adjusted duration, a 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"). A 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 Funds.
The Short and Intermediate Series will not purchase a put or
call option on U.S. Government securities or mortgage-backed
securities if, as a result of such purchase, more than 10% of
its total assets would be invested in such options. A 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
a Fund would enter into OTC option transactions under the
general supervision of the Board of Trustees. The Funds 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 Funds 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 a 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 a Fund's ability to terminate options and futures
positions at times when the Adviser deems it desirable to do so.
This ability to terminate positions when the Adviser deems it
desirable to do so may be hindered by the lack of existence of
a liquid secondary market. Although a Fund will take an options
or futures contract position only if the Adviser believes there
is a liquid secondary market for the option or futures contract,
there is no assurance that a Fund will be able to effect
closing transactions at any particular time or at an acceptable
price.
The use of options and futures strategies also involves the risk
of imperfect correlation between movements in the values of the
securities underlying the futures and options purchased and sold
by a Fund, of the option and futures contract itself, and of
the securities which are the subject of a hedge. A 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 a Fund to incur a loss on
both the hedged securities and the hedging instrument.
At times, a Fund may sell interest rate futures in a different
dollar amount than the dollar amount of securities being hedged,
depending on the expected relationship between the volatility of
the prices of such securities and the volatility of the futures
contracts, based on duration calculations by the Adviser. If
the actual price movements of the securities and futures are
inconsistent with their durations as so calculated, the hedge
may not be fully effective.
A 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, a Fund will take prompt action
to close out the appropriate number of open contracts to bring
its open futures position into compliance with this limitation.
The Funds' 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 relevant
Statement of Additional Information.
Other Portfolio Strategies (Equity 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 Equity Plus Fund's
net assets. Included within that amount, but not to exceed 2%
of the value of the Equity Plus Fund's net assets, may be
warrants which are not listed on the New York or American Stock
Exchange. Warrants acquired by the Equity Plus Fund in units or
attached to securities may be deemed to be without value.
SMITH BREEDEN TRUST
SMITH BREEDEN EQUITY PLUS FUND
STATEMENT OF ADDITIONAL INFORMATION
FEBRUARY 18, 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 Plus Fund
which may be useful to investors and is not included in
the Prospectus of the Smith Breeden Mutual Funds. The
former name of the Equity Plus Fund was the Smith Breeden
Market Tracking Fund. This Statement is not a Prospectus
and is only authorized for distribution when accompanied
or preceded by the Prospectus of the Smith Breeden Mutual
Funds dated February 18, 1997, as may be amended from
time to time. The Statement should be read together with
the Prospectus.
Contents Page
DEFINITIONS. . . . . . . . . . . . . . . . . . . . . .2
INVESTMENT RESTRICTIONS OF THE FUND. . . . . . . . . .2
MISCELLANEOUS INVESTMENT PRACTICES AND RISK
CONSIDERATIONS . . . . . . . . . . . . . . . . . . . .4
TAXES. . . . . . . . . . . . . . . . . . . . . . . . .5
FUND CHARGES AND EXPENSES. . . . . . . . . . . . . . .6
MANAGEMENT OF THE FUND . . . . . . . . . . . . . . . .6
THE INVESTMENT ADVISORY AGREEMENT AND OTHER SERVICES .7
PRINCIPAL HOLDERS OF SECURITIES AND CONTROLLING
PERSONS. . . . . . . . . . . . . . . . . . . . . . . 10
DETERMINATION OF NET ASSET VALUE . . . . . . . . . . 10
ADDITIONAL INFORMATION REGARDING PURCHASES
AND REDEMPTIONS OF FUND SHARES . . . . . . . . 11
SHAREHOLDER INFORMATION. . . . . . . . . . . . . . . 11
SUSPENSION OF REDEMPTIONS. . . . . . . . . . . . . . 12
SHAREHOLDER LIABILITY. . . . . . . . . . . . . . . . 12
STANDARD PERFORMANCE MEASURES. . . . . . . . . . . . 12
INDEPENDENT AUDITORS . . . . . . . . . . . . . . . . 14
EXPERTS. . . . . . . . . . . . . . . . . . . . . . . 14
REPORT OF INDEPENDENT AUDITORS AND FINANCIAL
STATEMENTS. . . . . . . . . . . . . . . . . . . . . 14
<PAGE>
SMITH BREEDEN TRUST,
SMITH BREEDEN EQUITY PLUS FUND
Statement of Additional Information
DEFINITIONS
The "Trust" -- Smith Breeden Trust
The "Fund" -- Smith Breeden Equity 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.
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
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.
<PAGE>
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 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 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. 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.
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 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:
<PAGE>
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 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 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
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.
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 June 30, 1996, owned 5% or more
of the shares of the Fund.
Shareholder Percentage
Owned
Charles Schwab & Company 16.73%
Attn: Mutual Funds
101 Montgomery Street
San Francisco, CA 94104
Sammie C. Bledsoe 13.01%
Sammie C. Bledsoe Trust
1737 East 30th Place
Tulsa, OK 74114
Shepard Barbash and Vicki Ragan 9.30%
1732 Meadowdale Avenue
Atlanta, GA 30306-3114
Payne & Jones Profit Sharing Plan 6.62%
Jodde Lanning & Thomas Jones, Trustees
P.O. Box 25625
Overland Park, KS 66225
A Fund Trustee owns less than 1% of the shares of the
Fund as of June 30, 1996.
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.
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 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 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.
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.
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.
<PAGE>
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 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
See attached report.
ANNUAL REPORT
PERFORMANCE REVIEW
The Smith Breeden Market Tracking Fund provided at total return
of 32.30% for the year ended March 31, 1996, while the S&P 500
index return was 32.10%. The annualized total return of the
Market Tracking Fund from its inception on June 30, 1992 through
March 31, 1996 was 17.74%, while the annualized return of the
S&P 500 index was 16.10% over the same period.
The S&P 500 index, with dividends reinvested, has posted
positive returns every month from December 1994 through March
1996, with the one exception of a -0.36% return in October of
1995. This excellent performance was supported by strong
corporate earnings combined with low inflation and generally
falling long term interest rates. Long term interest rates, as
measured by the yield on the benchmark thirty year U.S. Treasury
Bond, fell from 7.43% in March 1995 to 5.96% in December 1995.
Falling long term interest rates benefit stocks in two ways.
Firstly, as bond yields fall, the price of bond investments
increases, and stocks become more attractive as an alternative
to bonds. Secondly, lower interest rates directly help raise
corporate earnings by lowering interest expense, which in turn
supports higher stock prices.
IN ACCORDANCE WITH REG. 232.304 OF REGULATION S-T, THE FOLLOWING
IS A DESCRIPTION OF THE GRAPH PRESENTED HERE IN THE TEXT IN
COMPLIANCE WITH ITEM 5a. OF FORM N-1A:
THE GRAPH DEPICTS THE CHANGE IN VALUE OF A $10,000 INVESTMENT IN
THE MARKET TRACKING FUND VERSUS THAT OF ITS BENCHMARK, THE S&P
500 INDEX. FROM INCEPTION OF JUNE 30, 1992 THROUGH MARCH 31,
1996, AN INVESTMENT OF $10,000 IN THE MARKET TRACKING FUND WOULD
HAVE GROWN TO $18,459, VERSUS $17,514, IF INVESTED IN THE S&P
500 INDEX. THE AVERAGE ANNUAL TOTAL RETURN IN THE MARKET
TRACKING FUND WAS 32.30% FOR THE ONE YEAR PERIOD, 16.57% FOR THE
THREE YEAR PERIOD, AND 17.74% FOR THE PERIOD SINCE INCEPTION.
In the first quarter of 1996, the stock market rally continued
unabated, with the S&P 500 index returning 5.37%, and the Market
Tracking Fund returning 5.90%. Interest rates however began
climbing during the first quarter fueled by investors' fears of
higher inflation in the future. The thirty year benchmark U.S.
Treasury yield rose from 5.96% in December 1995 to 6.66% on
March 31, 1996. Despite the climb in interest rates, investors
continued to expect strong earnings growth and accordingly were
willing to buy stocks at higher prices over the quarter.
The Market Tracking Fund can be viewed as comprising income and
equity segments: the income segment invests in a combination of
U.S. Government Agency mortgage securities, hedged to a low
level of interest rate risk, along with U.S. Treasury Bills,
while the equity segment invests in S&P 500 index futures
contracts with a notional value approximately the same as the
Fund's net assets. When the return on the income segment of the
portfolio exceeds the funding cost implicit in the price of the
S&P 500 futures contracts plus the operating expenses incurred
by the Fund, the Fund is able to outperform the S&P 500 index.
This strategy was successful in the year to March 31, 1996, with
the Fund providing a total return 0.20% in excess of the total
return of the S&P 500 index.
Mortgage securities held in the income segment of the portfolio
varied from 95% of net assets in March 1995 to a low of 80% in
November 1995, and stood at 89% in March 1996. The balance of
the income segment was invested in U.S. Treasury Bills. During
the year, the Fund's holdings of 9.5% to 13.5% coupon FNMA and
FHLMC fixed-rate mortgages were reduced, dropping from 38% of
net assets in March 1995 to 10% in March 1996. In their place
GNMA and FNMA adjustable-rate mortgage securities were
purchased, and holdings of these securities rose from 52% of net
assets to 78% of assets over the year. The change in portfolio
composition resulted from opportunities to sell securities at a
relatively low risk-adjusted yield and to purchase securities at
a higher risk-adjusted yield. Portfolio turnover, which is
calculated by dividing the lesser of purchases and sales by
average assets, was 107% for the year.
SMITH BREEDEN MARKET TRACKING FUND
SCHEDULE OF INVESTMENTS MARCH 31, 1996
Market
Face Amount Security Value
U.S. GOVERNMENT & AGENCY OBLIGATIONS - 99.61%
FEDERAL HOME LOAN MORTGAGE CORPORATION - 4.49% *
FHLMC:
$146,653 9.50%, due 7/1/02 ....................... $153,163
53,465 12.50%, due 2/1/14 ...................... 60,699
TOTAL FEDERAL HOME LOAN MORTGAGE CORPORATION
(Cost $212,374)......................... 213,862
FEDERAL NATIONAL MORTGAGE ASSOCIATION - 30.92% *
FNMA:
139,126 12.50%, due 9/1/12 ...................... 159,548
109,513 13.50%, due 11/1/14 to 1/1/15 ........... 125,483
FNMA ARM:
342,269 5.98%, due 9/1/25 ....................... 350,845
758,504 7.687%, due 9/1/18 ...................... 780,943
54,881 7.839%, due 12/1/26 ..................... 56,916
TOTAL FEDERAL NATIONAL MORTGAGE ASSOCIATION
(Cost $1,460,675)....................... 1,473,735
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION - 53.22% *
GNMA ARM:
1,010,000 5.50%, due 3/20/26 ...................... 998,082
325,955 6.75%, due 2/20/16 ...................... 330,601
136,926 7.00%, due 5/20/25 ...................... 139,611
1,047,808 7.375%, due 4/20/16 to 6/20/21 .......... 1,068,366
TOTAL GOVERNMENT NATIONAL MORTGAGE ASSOCIATION
(Cost $2,536,598)....................... 2,536,660
U.S. GOVERNMENT OBLIGATIONS - 10.98%
U.S. TREASURY BILL **
300,000 5.00%, due 6/27/96 ...................... 296,375
230,000 5.02%, due 6/27/96 ...................... 227,221
TOTAL U.S. GOVERNMENT OBLIGATIONS
(Cost $523,585) ........................ 523,596
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(Cost $4,733,232)....................... 4,747,853
THREE MONTH EURODOLLAR FUTURES PUT OPTIONS - 0.01%
Contracts
20 Expires 6/96, Strike Price $93.75 ....... 500
TOTAL EURODOLLAR PUT OPTIONS (Cost $1,590) 500
TOTAL INVESTMENTS (Cost $4,734,822) -
99.62% ................................. 4,748,353
CASH AND OTHER ASSETS LESS LIABILITIES -
0.38% .................................. 18,181
NET ASSETS - 100.00% .................... $4,766,534
* Mortgage-backed obligations are subject to principal paydowns
as a result of prepayments or refinancings of the underlying
mortgage loans. As a result, the average life may be
substantially less than the original maturity. The interest
rate shown is the rate in effect at March 31, 1996. ARMs have
coupon rates which adjust periodically. The adjusted rate is
determined by adding a spread to a specified index.
** The interest rate shown is the discount rate paid at the time
of purchase by the Fund.
Portfolio Abbreviations:
ARM - Adjustable-Rate Mortgage
FHLMC - Federal Home Loan Mortgage Corporation
FNMA - Federal National Mortgage Association
GNMA - Government National Mortgage Association
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN MARKET TRACKING FUND
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 1996
ASSETS:
Investments at market value
(identified cost $4,734,822)(Note 1).............. $4,748,353
Cash................................................. 35,919
Receivables:
Interest.......................................... 26,778
Maturities........................................ 4,329
Subscriptions..................................... 4,760
Other............................................. 848
Prepaid expenses..................................... 27
Deferred organization expenses (Note 1).............. 34,587
TOTAL ASSETS.................................... 4,855,601
LIABILITIES:
Variation margin on futures contracts................ 48,342
Due to adviser (Note 3).............................. 29,004
Accrued expenses..................................... 11,721
TOTAL LIABILITIES............................... 89,067
NET ASSETS:
(Applicable to outstanding shares of 388,529;
unlimited number of shares of beneficial
interest authorized; no stated par)................. $4,766,534
Net asset value, offering price and redemption
price per share ($4,766,534 / 388,529)............ $12.27
SOURCE OF NET ASSETS:
Paid in capital...................................... $4,416,541
Undistributed net investment income.................. 12,594
Accumulated net realized gain on investments......... 299,125
Net unrealized appreciation of investments........... 38,274
NET ASSETS...................................... $4,766,534
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN MARKET TRACKING FUND
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1996
INVESTMENT INCOME:
Interest and discount earned, net of
premium amortization (Note 1).................. $199,564
EXPENSES:
Advisory fees (Note 3)......................... 21,727
Accounting and pricing services fees........... 25,000
Custodian fees................................. 8,455
Audit and tax preparation fees................. 4,800
Legal fees..................................... 2,250
Amortization of organization expenses (Note 1). 27,943
Transfer agent fees............................ 25,284
Registration fees.............................. 20,004
Trustees fees and expenses..................... 3,630
Insurance expense.............................. 2,793
Other.......................................... 150
TOTAL EXPENSES BEFORE REIMBURSEMENT........ 142,036
Expenses reimbursed by Adviser (Note 3).... (114,100)
NET EXPENSES............................... 27,936
NET INVESTMENT INCOME...................... 171,628
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized gain on investments............... 709,594
Change in unrealized appreciation of
investments.................................... (66,654)
Net realized and unrealized gain on
investments.................................... 642,940
Net increase in net assets resulting
from operations................................ $814,568
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN MARKET TRACKING FUND
STATEMENTS OF CHANGES IN NET ASSETS
FOR THE YEARS ENDED MARCH 31, 1996 AND 1995
Year Ended Year Ended
March 31, 1996 March 31, 1995
OPERATIONS:
Net investment income............ $171,628 $140,115
Net realized gain (loss) on
investments...................... 709,594 (64,050)
Change in unrealized appreciation
(depreciation) of investments.... (66,654) 229,458
Net increase in net assets
resulting from operations........ 814,568 305,523
DISTRIBUTIONS TO SHAREHOLDERS:
Dividends from net investment
income........................... (159,034) (104,085)
Dividends in excess of net
investment income................ - (251)
Distributions from net realized
gains on investments............. (371,974) (9,133)
Distributions in excess of
net realized gains on investments - (13,962)
Total distributions.............. (531,008) (127,431)
CAPITAL SHARE TRANSACTIONS:
Shares sold...................... 2,256,010 200,709
Shares issued on reinvestment of
distributions.................... 502,798 120,434
Shares redeemed.................. (383,180) (152,408)
Increase in net assets resulting
from capital share transactions
(a).............................. 2,375,628 168,735
TOTAL INCREASE IN NET ASSETS. 2,659,188 346,827
NET ASSETS:
Beginning of year................ 2,107,346 1,760,519
End of year...................... $4,766,534 $2,107,346
(a) Transactions in capital shares
were as follows:
Shares sold................. 183,531 19,300
Shares issued on reinvestment
of distributions............ 42,520 11,593
Shares redeemed............. (32,004) (14,689)
Net increase................ 194,047 16,204
Beginning balance .......... 194,482 178,278
Ending balance.............. 388,529 194,482
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN MARKET TRACKING FUND
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED MARCH 31, 1996
Year Ended
March 31, 1996
Cash Flows from Operating Activities:
Net increase in net assets resulting
from operations................................ $814,568
Net realized and unrealized gain on investments (642,940)
Net investment income........................ 171,628
Adjustments to reconcile net investment income
to net cash provided by operating activities:
Net paydown gains and losses................... 16,109
Increase in interest receivable................ (11,919)
Decrease in other assets....................... 31,562
Decrease in other liabilities.................. (19,935)
Net cash provided by operating activities.... 187,445
Cash Flows from Investing Activities:
Settlement payment on S&P 500 equity
swap contract.................................. 168,247
Proceeds from futures variations............... 554,718
Proceeds from sales of long-term investments... 2,826,874
Proceeds from maturities of short-term
investments.................................... 2,365,000
Proceeds from sales of short-term investments.. 2,627,509
Proceeds from paydowns of long-term investments 449,569
Purchases of long-term investments............. (5,625,270)
Purchases of short-term investments............ (5,439,093)
Net cash used in investing activities........ (2,072,446)
Cash Flows from Financing Activities:
Purchase of shares tendered.................... 1,868,070
Dividends from net investment income and
realized gains................................. (28,210)
Net cash provided by financing activities.... 1,839,860
Net decrease in cash......................... (45,141)
Cash at beginning of year......................... 81,060
Cash at end of year............................... $35,919
Noncash Financing Activities:
Market value of shares issued to stockholders
through reinvestment of dividends............ $502,798
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN MARKET TRACKING FUND
FINANCIAL HIGHLIGHTS
The following average per share data, ratios and supplemental information
has been derived from information provided in the financial statements.
Year Year Year Period
Ended Ended Ended Ended
March 31, 1996 March 31, 1995 March 31, 1994 March 31,1993*
Net Asset Value,
Beginning of Period $10.84 $9.88 $10.85 $10.00
Income From Investment
Operations
Net investment
income.......... 0.615 0.568 0.476 0.355
Net realized and
unrealized gain
(loss) on
investments..... 2.768 1.081 (0.216) 1.281
Total from
investment
operations.. 3.383 1.649 0.260 1.636
Less Distributions
Dividends from
net investment
income.......... (0.583) (0.568) (0.472) (0.311)
Dividends in excess
of net investment
income.......... - (0.001) - -
Distributions from
net realized gains
on investments.. (1.370) (0.047) (0.701) (0.420)
Distributions in
excess of net
realized gains on
investments..... - (0.073) (0.057) (0.055)
Total
distributions (1.953) (0.689) (1.230) (0.786)
Net Asset Value,
End of Period.... $12.27 $10.84 $9.88 $10.85
Total Return..... 32.30% 17.18% 2.19% 22.59%**
Ratios/Supplemental Data
Net assets, end
of period....... $4,766,534 $2,107,346 $1,760,519 $903,846
Ratio of expenses
to average net
assets (1)...... 0.90% 0.90% 0.90% 0.57%**
Ratio of net
investment income
to average net
assets (2)...... 5.53% 7.44% 8.02% 5.28%**
Portfolio
turnover rate... 107% 120% 119% 271%
______________________
(1) The annualized ratio of expenses to average net assets prior to
reimbursement of expenses by the Adviser was 4.58%, 7.75%, 7.08%,
and 28.48% for the years ended March 31, 1996, March 31,1995, March
31, 1994, and the period ended March 31, 1993, respectively.
(2) The annualized ratio of net investment income to average net assets
prior to reimbursement of expenses by the Adviser was 1.85%, 0.59%,
1.84%, and (22.63%) for the years ended March 31, 1996, March 31, 1995,
March 31, 1994, and the period ended March 31, 1993, respectively.
* The Smith Breeden Market Tracking Fund commenced operations June 30,1992.
** Annualized
The accompanying notes are an integral part of these financial statements.
SMITH BREEDEN MARKET TRACKING FUND
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Breeden Market Tracking Fund (the "Fund") is a series
of the Smith Breeden Trust (the "Trust"), an open-end,
diversified management investment company registered under the
Investment Company Act of 1940, as amended. The following is a
summary of significant accounting policies consistently followed
by the Fund.
A. Security Valuation: Portfolio securities are valued at
current market value provided by a pricing service or by a bank
or broker/dealer experienced in such matters, when over-
the-counter market quotations are readily available. Securities
and other assets for which market prices are not readily
available are valued at fair market value as determined in
accordance with procedures approved by the Board of Trustees.
B. Distributions and Taxes: The Fund intends to continue to
qualify for and elect the special tax treatment afforded
regulated investment companies under Subchapter M of the
Internal Revenue Code, thereby relieving the Fund of federal
income taxes. To so qualify, the Fund intends to distribute
substantially all of its net investment income and net realized
capital gains, if any, less any available capital loss
carryforward. As of March 31, 1996, the Fund had no net capital
loss carryforward.
C. Repurchase Agreements: The Fund may enter into repurchase
agreements with member banks of the Federal Reserve System
having total assets in excess of $500 million and securities
dealers, provided that such banks or dealers meet the credit
guidelines of the Fund's Board of Trustees. In a repurchase
agreement, the Fund acquires securities from a third party with
the commitment that they will be repurchased by the seller at a
fixed price on an agreed upon date. The Fund's custodian
maintains control or custody of these securities which
collateralize the repurchase agreements until maturity of the
repurchase agreements. The value of the collateral is monitored
daily, and if necessary, additional collateral is received to
ensure that the market value of the underlying assets remains
sufficient to protect the Fund in the event of the seller's
default. However, in the event of default or bankruptcy of the
seller, the Fund's right to the collateral may be subject to
legal proceedings.
D. Reverse Repurchase Agreements: A reverse repurchase
agreement involves the sale by the Fund of portfolio assets
concurrently with an agreement by the Fund to repurchase the
same assets at a later date at a fixed price. The Fund will
maintain a segregated account with its custodian, which will be
marked to market daily, consisting of cash, U.S. Government
securities or other liquid high-grade debt obligations equal in
value to its obligations under reverse repurchase agreements.
In the event the buyer of securities under a reverse repurchase
agreement files for bankruptcy or becomes insolvent, the Fund's
use of the proceeds of the agreement may be restricted pending
a determination by the other party, or its trustee or receiver
whether to enforce the Fund's obligation to repurchase the
securities.
E. Determination Of Gains Or Losses On Sales Of Securities:
Gains or losses on the sale of securities are calculated for
accounting and tax purposes on the identified cost basis.
F. Deferred Organization Expenses: Deferred organization
expenses are being amortized on a straight-line basis over five
years.
G. Securities Transactions and Investment Income: Interest
income is accrued daily on both long-term bonds and short-term
investments. Interest income also includes net amortization
from the purchase of fixed-income securities. Transactions are
recorded on the first business day following the trade date.
Realized gains and losses from security transactions are
determined and accounted for on the basis of identified cost.
2. FINANCIAL INSTRUMENTS
A. Derivative Financial Instruments Held or Issued for Purposes
other than Trading: The Fund uses interest rate futures
contracts for risk management purposes in order to manage the
Fund's interest-rate risk relative to its benchmark. Upon
entering into a futures contract, the Fund is required to
deposit either cash or securities in an amount (initial margin)
equal to a certain percentage of the contract value. Subsequent
payments (variation margin) are made or received by the Fund
each day. The variation margin payments are equal to the daily
changes in the contract value and are recorded as unrealized
gains or losses. The Fund recognizes a realized gain or loss
when the contract is closed or expires equal to the difference
between the value of the contract at the time it was opened and
the value at the time it was closed.
Futures contracts involve costs and may result in losses. The
effective use of futures strategies depends on the Fund's
ability to terminate futures positions at times when the Fund's
investment adviser deems it desirable to do so. The use of
futures also involves the risk of imperfect correlation among
movements in the values of the securities underlying the futures
purchased and sold by the Fund, of the futures contract itself,
and of the securities which are the subject of a hedge.
The Fund had the following open futures contracts, held for
purposes other than trading, as of March 31, 1996:
Notional Expiration Unrealized
Type Amount Position Month Gain/(Loss)
Eurodollar $3,000,000 Short June, 1996 $ (88)
Eurodollar 5,000,000 Short September, 1996 (1,473)
Eurodollar 6,000,000 Short September, 1997 3,973
Eurodollar 6,000,000 Short September, 1998 (601)
Eurodollar 4,000,000 Short September, 1999 (418)
$ 1,393
The aggregate market value of investments pledged to cover
margin requirements for the open positions at March 31, 1996 was
$227,221.
B. Derivative Financial Instruments Held or Issued for Trading
Purposes: The Fund invests in Futures Contracts on the S&P 500
Index whose return is expected to track movements in the S&P 500
Index.
The Fund had fifteen open futures contracts on the S&P 500 Index
as of March 31, 1996:
Notional Expiration Unrealized
Type Amount Position Month Gain
S&P 500 $4,841,250 Long June, 1996 $23,350
3. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH
AFFILIATES
Smith Breeden Associates, Inc. (the "Adviser"), a registered
investment adviser, provides the Fund with investment management
services. As compensation for these services, the Fund pays the
Adviser a fee computed daily and payable monthly, at an annual
rate equal to 0.70% of the Fund's average daily net asset value.
The Adviser has voluntarily agreed to limit the expenses of the
Fund to 0.90% of the Fund's average daily net assets. This
voluntary agreement may be terminated or modified at any time by
the Adviser in its sole discretion, except that the Adviser has
agreed to limit expenses of the Fund to 0.90% through March 31,
1996. For the year ended March 31, 1996, the Adviser received
fees of $21,727 and reimbursed the Fund $114,100.
Effective August 1, 1994, the Fund adopted a Distribution and
Services Plan (the "Plan") pursuant to Rule 12b-1 under the
Investment Company Act of 1940. The purpose of the Plan is to
permit the Adviser to compensate investment dealers and other
persons involved in servicing shareholder accounts for services
provided and expenses incurred in promoting the sale of shares
of the Fund, reducing redemptions, or otherwise maintaining or
improving services provided to shareholders by such dealers or
other persons.
The Plan provides for payments by the Adviser, out of its
advisory fee paid to it by the Fund, to dealers and other
persons at the annual rate of up to 0.25% of the Fund's average
net assets subject to the authority the Trustees of the Fund to
reduce the amount of payments permitted under the Plan or to
suspend the Plan for such periods as they may determine.
Subject to these limitations, the amount of such payments and
the purposes for which they are made shall be determined by the
Adviser.
Certain officers and trustees of the Fund are also officers and
directors of the Adviser.
4. INVESTMENT TRANSACTIONS
During the year ended March 31, 1996, purchases and proceeds
from sales of securities, other than short-term investments,
aggregated $5,597,637 and $2,831,265, respectively. The cost of
securities for federal income tax purposes is $4,734,822. Net
unrealized appreciation of investments and futures contracts
consists of:
Gross unrealized appreciation....... $47,183
Gross unrealized depreciation....... (8,909)
Net unrealized appreciation......... $38,274
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders,
Smith Breeden Market Tracking Fund of the Smith Breeden Trust:
We have audited the accompanying statement of assets and
liabilities, including the schedule of investments, of the Smith
Breeden Market Tracking Fund of the Smith Breeden Trust as of
March 31, 1996, and the related statements of operations and
cash flows for the year then ended, the statements of changes in
net assets for each of the years in the two-year period then
ended and the financial highlights for each of the years in the
three year period then ended and the period June 30, 1992
(commencement of operations) to March 31, 1993. These financial
statements and the financial highlights are the responsibility
of the Fund's management. Our responsibility is to express an
opinion on these financial statements and the financial
highlights based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements and the financial highlights are free
of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements. Our procedures included confirmation
of securities owned at March 31, 1996 by correspondence with the
custodian. An audit also includes assessing the accounting
principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements and financial
highlights referred to above present fairly, in all material
respects, the financial position of the Smith Breeden Market
Tracking Fund of the Smith Breeden Trust as of March 31, 1996,
the results of its operations and its cash flows, the changes in
its net assets, and the financial highlights for the respective
stated periods in conformity with generally accepted accounting
principles.
Deloitte & Touche LLP
Princeton, New Jersey
May 10, 1996
