As filed with the Securities and Exchange Commission
on July 23, 1997
File No. 33-44909
File No. 811-6520
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
F O R M N-1A
Registration Statement Under the Securities Act of 1933
Post-Effective Amendment No. 11
and
Registration Statement Under the Investment Company Act of 1940
Amendment No. 13
____________________
SMITH BREEDEN TRUST
(Exact Name of Registrant as Specified in Charter)
100 Europa Drive, Suite 200
Chapel Hill, North Carolina 27514
(Address of Principal Executive Office)
(919) 967-7221
(Registrant's Telephone Number, Including Area Code)
MICHAEL J. GIARLA
100 Europa Drive, Suite 200
Chapel Hill, North Carolina 27514
(Name and Address of Agent for Service)
_______________
Please Send Copy of Communications to:
MARIANTHE S. MEWKILL
Smith Breeden Associates, Inc.
100 Europa Drive, Suite 200
Chapel Hill, NC 27514
(919)-967-7221
This filing shall become effective on July 23, 1997 pursuant to
paragraph (b)(1) of Rule 485 under the Securities Act of 1933.
The Registrant has previously registered an indefinite number of
shares of beneficial interest pursuant to Rule 24f-2 under the
Investment Company Act of 1940, as amended. The Rule 24f-2 notice for
the Registrant's most recent fiscal year was filed on May, 29
1997.
<PAGE>
SMITH BREEDEN TRUST
SMITH BREEDEN EQUITY PLUS FUND
(THE "EQUITY PLUS FUND")
CROSS REFERENCE SHEET
FORM N-1A
Part A: Information Required in Prospectus
N-1A
Item No. Item Location in the
Registration Statement
by Prospectus Heading
1. Cover Page Cover Page
2. Synopsis Expense Table
3. Condensed Financial
Information Financial Highlights
4. General Description of Smith Breeden Mutual Funds:
Registrant The Equity Plus Fund
5. Management of the Fund Management of the Funds
5a. Management's Discussion
of Fund's Performance Contained in the Fund's
Annual Report to Shareholders
6. Capital Stock and Other Capital Structure
Securities Dividends and Distributions
7. Purchase of Securities Pricing of Fund Shares
Being Offered How to Purchase Shares
8. Redemption or Repurchase How to Redeem Shares
How to Exchange Shares
9. Pending Legal Proceedings Not Applicable
<PAGE>
JULY 23, 1997
SMITH BREEDEN MUTUAL FUNDS
PROSPECTUS
The Smith Breeden Mutual Funds consist of three no-
load, diversified registered investment companies (the
"Funds"). 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 Fund is a series fund of the
Smith Breeden Trust. The Equity Plus Fund does not
generally invest in the common stocks that make up the S&P
500 Index or any other index. The Equity Plus Fund
utilizes index futures contracts and equity swap contracts
to track the return of the S&P 500 Index, and invests
substantially all of its assets in fixed-income securities
and related hedging instruments. Whether the Fund's total
return equals or exceeds the performance of the S&P 500
Index depends on whether the total return on the Equity
Plus Fund's fixed-income investments equals or exceeds the
Fund's total operating expenses, as well as other factors.
See "Investment Objectives, Policies, and Risk
Considerations - Equity Plus Fund."
Smith Breeden Short Duration U.S. Government Fund (the
"Short Fund", formerly named the Smith Breeden Short Duration
U.S. Government Series) seeks a high level of current income
consistent with low volatility of net asset value. The
Short Fund 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 at times significantly exceed six months.
Smith Breeden Intermediate Duration U.S. Government Fund
(the "Intermediate Fund", formerly named the Smith Breeden
Intermediate Duration U.S. Government 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 currently include, but are not
limited to, the Salomon Brothers Mortgage Index and the
Lehman Brothers Mortgage Index. These indices include all
outstanding government sponsored fixed-rate mortgage
backed securities, weighted in proportion to their current
market capitalization. The duration, or interest-rate
risk, of these indices is similar to that of intermediate
term U.S. Treasury Notes, and typically will range between
three and five years. The Intermediate Fund consistently
seeks to achieve a volatility of net asset value similar
to that of a portfolio that invests exclusively in
mortgage-backed securities, as weighted in the major
mortgage market indices.
An investment in any of the Funds is neither insured nor
guaranteed by the U.S. Government. There can be no
assurance that any of the Funds will meet their investment
objectives. This Prospectus sets forth concisely the
<PAGE>
information about the Funds that you should know before
investing. Please read this Prospectus carefully and keep
it for future reference. A Statement of Additional
Information, dated July 23, 1997, which is incorporated
herein by reference, has been filed with the Securities
and Exchange Commission with respect to each Fund and is
available on the Commission's Web site (http://www.sec.gov).
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.
<PAGE>
TABLE OF CONTENTS
Expense Table 1
Financial Highlights--Equity Plus Fund 3
Financial Highlights--Short Fund 4
Financial Highlights--Intermediate Fund 5
Smith Breeden Mutual Funds 6
Investment Objectives, Policies and Risk Considerations 6
Other Investment Practices and Risk Considerations 18
Management of the Funds 21
Pricing of Fund Shares 26
How to Purchase Shares 26
How to Exchange Shares 29
How to Redeem Shares 30
Dividends and Distributions 33
Shareholder Reports and Information 34
Retirement Plans 35
Service and Distribution Plans 35
Taxes 35
Capital Structure 36
Transfer, Dividend Disbursing Agent, Custodian and
Independent Accountants 37
Fund Performance 37
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 of
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 Fund Fund
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% 0.18% 0.18%
Total Fund Operating Expenses
(net of reimbursement)3 0.78% 0.88% 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 Fund's
net assets out of its management fee. See "Service and
Distribution Plans."
3 The Other Expenses in the table and Total Fund
Operating Expenses reflect undertakings by the Adviser
to bear expenses of each of the Funds and/or waive its
fees to the extent necessary to limit Total Fund
Operating Expenses to 0.78% for the Short Fund and
0.88% for each of the Equity Plus Fund and Intermediate
Fund through August 1, 1998. Absent the expense
limitation, Other Expenses and Total Fund Operating
Expenses would be 0.23% and 0.93% for the Short Fund,
0.46% and 1.16% for the Intermediate Fund, and 1.90%
and 2.60% for the Equity Plus Fund.
- -1-<PAGE>
The following examples illustrate the expenses that apply to
or no redemption at the end of each time period. Except as
noted in the table above, the Funds charge no redemption
fees.
Short Duration Fund
1 Year 3 Years 5 Years 10 Years
$ 6 $ 18 $ 31 $67
Intermediate Duration Fund and Equity Plus Fund
1 Year 3 Years 5 Years 10 Years
$ 7 $ 21 $ 35 $75
These examples are based on the annual operating
expenses shown above and should not be considered a
representation of past or future expenses or performance.
Actual expenses may be greater or less than those shown.
The annual rate of return may be more or less than 5%.
The Funds may be recommended to investors by
registered investment advisors. Such advisors customarily
impose fees that would be in addition to any fees and
expenses presented in the above table. Certain broker-
dealers may also charge a fee for purchase or redemption
of shares through their network. Neither the Funds, nor
the Adviser, exercise any control over such advisory or
broker-dealer fees and may not be informed of the level
of such fees.
- -2-<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,
1997, 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 & Touche LLP thereon which appear in
the Fund's Statement of Additional Information.
<TABLE>
Selected Financial Data
<CAPTION>
Year Ended Year Ended Year Ended Year Ended Period Ended
March 31, March 31, March 31, March 31, March 31,
1997 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C>
Net Asset Value,
Beginning of Period $12.27 $10.84 $9.88 $10.85 $10.00
Income From Investment
Operations
Net investment income 0.592 0.615 0.568 0.476 0.355
Net realized and unrealized
gain (loss) on investments 1.813 2.768 1.081 (0.216) 1.281
Total from investment
operations 2.405 3.383 1.649 0.260 1.636
Less Distributions
Dividends from net
investment income (0.590) (0.583) (0.568) (0.472) (0.311)
Dividends in excess of net
investment income -- -- (0.001) -- --
Distributions from net
realized gains on investments (1.525) (1.370) (0.047) (0.701) (0.420)
Distributions in excess of
net realized gains
on investments -- -- (0.073) (0.057) (0.055)
Total distributions (2.115) (1.953) (0.689) (1.230) (0.786)
.
Net Asset Value,
End of Period $12.56 $12.27 $10.84 $9.88 $10.85
Total Return 21.41% 32.30% 17.18% 2.19% 22.59%*
Ratios/Supplemental Data
Net assets, end of period $13,507,377 $4,766,534 $2,107,346 $1,760,519 $903,846
Ratio of expenses to average
net assets
Before expense limitation 2.60% 4.58% 7.75% 7.08% 28.48%*
After expense limitation 0.88% 0.90% 0.90% 0.90% 0.57%*
Ratio of net income to
average net assets
Before expense limitation 3.58% 1.85% 0.59% 1.84% (22.63%)*
After expense limitation 5.30% 5.53% 7.44% 8.02% 5.28%*
Portfolio turnover rate 182% 107% 120% 119% 271%
* Annualized
Additional performance information is presented in the Fund's Annual Report,
which is available without charge upon request.
</TABLE>
- -3-<PAGE>
SHORT DURATION FUND
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
The following selected per share data and ratios cover the fiscal periods
from March 31, 1992, the date the Fund commenced operations, through March
31, 1997 and are a part of the Short Fund's financial statements which have
been audited by Deloitte & Touche LLP, independent auditors. This data
should be read in conjunction with the Short Fund's most recent
annual audited financial statements and the report of Deloitte & Touche LLP
thereon which appear in the Fund's Statement of Additional Information.
<TABLE>
Selected Financial Data
<CAPTION>
Year Ended Year Ended Year Ended Year Ended Period Ended
March 31, March 31, March 31, March 31, March 31,
1997 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C>
Net Asset Value,
Beginning of Period $9.74 $9.90 $9.90 $10.00 $10.00
Income From Investment
Operations
Net investment income 0.476 0.621 0.628 0.432 0.552
Net gain (loss) on securities
(both realized and unrealized) 0.146 (0.148) -- (0.070) 0.002
Total from investment operations 0.622 0.473 0.628 0.362 0.554
Less Distributions
Dividends from net investment
income (0.476) (0.621) (0.628) (0.462) (0.554)
Dividends in excess of net
net investment income (0.056) (0.012) -- -- --
Total distributions (0.532) (0.633) (0.628) (0.462) (0.554)
Net Asset Value, End of Period $9.83 $9.74 $9.90 $9.90 $10.00
Total Return 6.57% 4.95% 6.58% 3.67% 5.67%
Ratios/Supplemental Data
Net assets, end of period $118,988,609 $221,825,136 $218,431,665 $218,167,491
Ratio of expenses to average
net assets
Before expense limitation 0.93% 0.93% 0.92% 1.00% 2.58%
After expense limitation 0.78% 0.78% 0.78% 0.78% 0.78%
Ratio of net income to
average net assets
Before expense limitation 4.90% 6.13% 6.18% 3.95% 2.73%
After expense limitation 5.04% 6.29% 6.33% 4.17% 4.53%
Portfolio turnover rate 556% 225% 47% 112% 3%
</TABLE>
Additional performance information is presented in the Short Fund's Annual
Report, which is available without charge upon request.
- -4-<PAGE>
INTERMEDIATE DURATION FUND
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
The following selected per share data and ratios cover the fiscal periods
from March 31, 1992, the date the Fund commenced operations, through March
31, 1997 and are a part of the Intermediate Fund's financial statements
which have been audited by Deloitte & Touche LLP, independent auditors.
This data should be read in conjunction with the Intermediate Fund's most
recent annual audited financial statements and the report of Deloitte &
Touche LLP thereon which appear in the Fund's Statement of Additional
Information.
<TABLE>
Selected Financial Data
<CAPTION>
Year Ended Year Ended Year Ended Year Ended Period Ended
March 31, March 31, March 31, March 31, March 31,
1997 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C>
Net Asset Value,
Beginning of Period $10.01 $9.83 $10.01 $10.62 $10.00
Income From Investment
Operations
Net investment income 0.599 0.660 0.664 1.05 0.826
Net gain (loss) on securities
(both realized and unrealized) (0.024) 2.77 (0.049) (0.601) 0.621
Total from investment operations 0.575 0.937 0.615 0.449 1.447
Less Distributions
Dividends from net investment
income (0.604) (0.656) (0.664) (1.044) (0.826)
Dividends in excess of net
investment income....... ---- ----- (0.108) ---- ---
Distributions from net
realized gains on investments (0.251) (0.101) -- (0.015) --
Distributions in excess of
net realized gains on investments -- -- (0.022) -- ---
Total distributions (0.855) (0.757) (0.794) (1.059) (0.826)
Net Asset Value, End of Period $9.73 $10.01 $9.83 $10.01 $10.62
Total Return 5.92% 9.69% 6.10% 4.11% 14.93%
Ratios/Supplemental Data
Net assets, end of period $37,735,525 $36,446,940 $34,797,496 $6,779,666 $2,923,913
Ratio of expenses to average
net assets
Before expense limitation 1.16% 1.14% 2.33% 2.34% 17.52%
After expense limitation 0.88% 0.90% 0.90% 0.90% 0.82%
Ratio of net income to
average net assets
Before expense limitation 5.92% 6.26% 4.77% 6.30% (8.52%)
After expense limitation 6.19% 6.49% 6.20% 7.74% 8.18%
Portfolio turnover rate 409% 193% 557% 84% 42%
</TABLE>
Additional performance information is presented in the Intermediate Fund's
Annual Report, which is available without charge upon request.
- -5-<PAGE>
SMITH BREEDEN MUTUAL FUNDS
The Short and Intermediate Funds are funds of the Smith
Breeden Series Fund (the "Series Fund"), an open-end diversified
management investment company. The Equity Plus Fund is currently
the only fund of the Smith Breeden Trust (the "Trust"), an open-
end diversified management investment company.
Smith Breeden Associates, Inc. ("Smith Breeden" or the
"Adviser") acts as investment adviser to the Funds. Smith
Breeden is a money management and consulting firm founded in
1982 whose clients include pension funds, financial
institutions, corporations, government entities, and
charitable foundations. The firm specializes in mortgage
securities, interest-rate risk management, and the application
of option pricing to investments and banking. Smith Breeden
currently advises assets totaling over $20 billion.
INVESTMENT OBJECTIVES, POLICIES, AND RISK CONSIDERATIONS
Each of the Funds has a different investment objective
and different investment policies, and is designed to meet
different investment needs.
The investment objectives and certain investment policies of
the Short and Intermediate Funds are fundamental and may not be
changed without a vote of shareholders of the relevant
Fund. The investment 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.
Since shares of each Fund represent an investment in
securities with fluctuating market prices, the net asset value
per share of each Fund will vary as the aggregate value of a
Fund's portfolio securities increases or decreases. Due to the
risks inherent in all investments, there can be no assurance that
the objectives of the Funds will be met. The descriptions
that follow are designed to help you choose the Fund or
combination of Funds that best fits your investment objectives.
Short Fund
The Short Fund's investment objective is to provide investors
with a high level of current income, consistent with a volatility
of net asset value similar to that of a portfolio which
invests exclusively in six-month U.S. Treasury securities on a
constant maturity basis. There is no assurance that the Short
Fund will be able to maintain a low volatility of net asset
value.
- -6-<PAGE>
The Short Fund will seek its investment objective by
investing, under normal circumstances, at least 70% of its
total assets in U.S. Government Securities. The Fund will
also invest in fixedrate and adjustable-rate mortgage-backed
securities issued by nongovernmental issuers. The Fund may hold a
portion of its assets in money market instruments and in
time and savings deposits (including fixed-rate or
adjustable certificates of deposit) in commercial banks or
institutions whose accounts are insured by the FDIC, BIF or
SAIF.
Under normal circumstances the Short Fund will seek to achieve
an interest-rate risk or option-adjusted duration similar to that
of a six-month U.S. Treasury security on a constant maturity
basis. However, the Short Fund expects that, under normal
circumstances, the dollar-weighted average life (or period until
the next reset date) of its portfolio securities will be
longer than six months, sometimes significantly longer.
The Adviser believes that by investing in mortgage securities
from a variety of market sectors on a selective basis and
adjusting the overall option-adjusted duration of the portfolio
to approximate that of a six-month U.S. Treasury security,
the Short Fund will achieve a more consistent and less volatile
net asset value than is characteristic of mutual funds that
invest primarily in mortgage securities paying a fixed rate
of interest or those that invest exclusively in adjustable-rate
mortgage securities. The securities in which the Short Fund may
invest may not yield as high a level of income as other
securities in which other funds may invest. However, such
higher yielding securities may be more volatile and may be
issued by less creditworthy entities.
Intermediate Fund
The Intermediate Fund's investment objective is to provide
investors with a total return in excess of the total return of
the major market indices for mortgage-backed securities.
The Intermediate Fund will seek its investment objective by
investing, under normal circumstances, at least 70% of its
total assets in U.S. Government Securities. The Fund will
also invest in fixedrate and adjustable rate mortgage-backed
securities issued by nongovernmental issuers. The Fund may hold
a portion of its assets in money market instruments and in
time and savings deposits (including fixed-rate or
adjustable-rate certificates of deposit) in commercial banks or
institutions whose accounts are insured by the FDIC, BIF, or
SAIF.
The major market indices for mortgage-backed securities currently
include, but are not limited to, the Salomon Brothers
Mortgage Index and the Lehman Brothers Mortgage Index.
These indices include all outstanding government sponsored
fixed-rate mortgagebacked securities, weighted in proportion to
their current market capitalization. Total return is the
change in value of the investment, assuming reinvestment
of all distributions. Under normal circumstances, the
Intermediate Fund will seek to achieve an interest-rate risk or
option-adjusted duration (see below) similar to that of a
- -7-<PAGE>
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.
There is no assurance that the Intermediate Fund will be able
to maintain a total return in excess of the total return of
major market indices for mortgage-backed securities, or that
it will match the interest rate risk of a portfolio investing
exclusively in these securities.
U.S. Government Securities. The U.S. Government Securities
in which the Funds may invest include U.S. Treasury Bills,
Notes, Bonds, discount notes and other debt securities issued by
the U.S. Treasury, and obligations issued or guaranteed by
the U.S. Government, its agencies and instrumentalities
including, but not limited to, the Government National
Mortgage Association ("GNMA"), Federal National Mortgage
Association ("FNMA") and Federal Home Loan Mortgage
Corporation ("FHLMC"). (Other U.S. Government agencies or
instrumentalities include Federal Home Loan Banks, Bank for
Cooperatives, Farm Credit Banks, Tennessee Valley Authority,
Federal Financing Bank, Small Business Administration, and
Federal Agricultural Mortgage Corporation.) It is anticipated
that the Funds will invest substantially all of their assets in
FNMA, FHLMC, and GNMA mortgage-backed certificates and other
U.S. Government Securities representing ownership interests in
mortgage pools.
Privately-issued Mortgage Backed Securities. The Short
and Intermediate Funds 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 Short and Intermediate Funds will not pay any
additional fees for credit support and will not invest in
private mortgage pass-through securities unless they are rated
AAA by S&P or Aaa by Moody's, or are unrated but deemed to be
of comparable credit quality by the Adviser. In addition, the
Short and Intermediate Funds will only purchase
mortgage-backed securities which constitute "Mortgage Related
Securities" for purposes of the Secondary Mortgage Market
Enhancement Act of 1984.
Option-adjusted Duration. Option-adjusted duration is a measure
of the price sensitivity of a portfolio to changes in interest
rates. The maturity of a security, another commonly used measure
of price sensitivity, measures only the time until final
payment is due, whereas option-adjusted duration takes into
account the pattern of all payments of interest and principal
on a security over time, including how these payments are
- -8-<PAGE>
affected by prepayments and by changes in interest rates. In
computing the duration of a Fund's portfolio, the Adviser will
estimate the duration of obligations that are subject to
prepayment or redemption by the issuer, taking into account the
influence of changes in interest rates on
prepayments and coupon flows. The Adviser may use certain
hedging techniques (as described in more detail in Appendix A) to
lengthen or shorten the option-adjusted duration of a Fund.
Fundamental Policies. As a matter of fundamental policy, the
Short and Intermediate Funds 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.
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 Fund does
not invest principally in the common stocks that make up the S&P
500 Index or any other index. The Fund utilizes index futures
contracts and equity swap contracts to track the return of the
S&P 500 Index, and invests substantially all of its assets in
fixed-income securities and related hedging and other
instruments. Whether the Fund's total return equals or
exceeds the performance of the S&P 500 Index depends on whether
the total return on the Fund's fixed-income investments equals
or exceeds the Fund's total operating expenses, as well as other
factors.
The S&P 500 Index is an unmanaged index composed of 500
common stocks, most of which are listed on the New York Stock
Exchange. Standard & Poor's, which is not a sponsor of or in any
other way affiliated with the Fund, chooses the 500 stocks
included in the S&P 500 Index on the basis of market
value and industry diversification. The S&P 500 Index assigns
relative values to the stocks included in the index, weighted
according to each stock's total market value relative to the
total market value of the other stocks included in the index.
The Equity Plus Fund seeks its objective by dividing its
portfolio into two segments: an "Equity Simulation Segment"
and a "Fixed Income Segment." Through the Equity Simulation
Segment, the Fund invests in a combination of equity swap
contracts, futures contracts on the S&P 500 Index and on
other stock indices, including, but not limited to, the
- -9-<PAGE>
New York Stock Exchange Composite Index, and common stocks
whose return (before deducting allocated costs) is expected to
track movements in the S&P 500 Index. By employing this
strategy, the Equity Plus Fund seeks to achieve the same
investment opportunity and risk profile for the Equity
Simulation Segment as that of a hypothetical portfolio, equal
in size to the Fund, invested in the common stocks comprising the
S&P 500 Index in proportion to their respective weight in the
S&P 500 Index. In the Equity Simulation Segment, the Equity
Plus Fund expects its use of stock index futures other than
S&P 500 stock index futures to be minimal.
Through the Fixed Income Segment, the Fund invests in fixed-
income securities and uses related hedging techniques such as
futures, options, floors, caps and swaps. The Fixed-Income Segment
will invest substantially all of its assets in U.S.
Government Securities (as defined above), and may also
invest in bank certificates of deposit, corporate debt
obligations, and mortgagebacked and other asset-backed
securities of non-governmental issuers. The Fund may also engage
in loans of portfolio securities, dollar rolls, and reverse
repurchase agreements to enhance income and total return. With
these investments, the Fund seeks to generate income (consisting
primarily of interest income) and gains which exceed the total
costs of operating the Fund (including the costs associated with
the Equity Simulation Segment). Thus, whether the Fund's total return
equals or exceeds the performance of the S&P 500 Index depends
on whether the total return on the Fund's Fixed-Income Segment
equals or exceeds the Fund's total operating expenses, as well
as other factors described below.
The Equity Simulation Segment's actual opportunities for gain
or loss may be greater than a hypothetical portfolio invested in
the stocks comprising the S&P 500 Index depending upon the
Fund's exposure to the S&P 500 Index, which could at times be
higher or lower than the Fund's total assets. For example, the
total net notional amount of the Fund's equity swap contracts, S&P
500 or other stock index futures plus the market value of common
stocks owned by the Fund may exceed the Fund's total net
assets as a result of purchases and redemptions of Fund
shares. In addition, since S&P 500 Index futures can only be
purchased for specific amounts, the Fund might not be able to
match accurately a notional amount of futures contracts to the
Fund's total net assets. Under normal market conditions, the
Fund expects that such variations in S&P 500 Index exposure will
generally be up to 5% greater or less than the Fund's total net
assets. Also, the ability of the Equity Simulation Segment of
the Fund's portfolio to replicate the investment opportunity and
risk profile of a hypothetical stock portfolio may be diminished
by imperfect correlations between price movements of the S&P 500
Index with price movements of S&P 500 and other stock index
futures and/or the common stocks purchased by the Fund. In
addition, the purchase and sale of common stocks and S&P 500 and
other stock index futures involve transaction costs. Equity swap
contracts require the Fund to pay interest on the notional
amount of the contract. Therefore, assuming the Fund has
successfully tracked the movement of the S&P 500 Index, the
Fund will outperform the S&P 500 Index only if the total net
return on the Fixed Income Segment of the Fund's portfolio exceeds
the sum of (to the extent applicable) (1) the Fund's transaction costs
- -10-<PAGE>
on S&P 500 and other stock index futures and common stock
transactions, (2) the interest payments under the Fund's equity
swap contracts and (3) the Fund's operating expenses as
described more fully under "Management of the Fund."
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, ifany, by which the notional amount of the equity
swap contract would have increased in value had it been invested
in the basket of stocks comprising the S&P 500 Index, plus the
dividends that would have been received on those stocks. The
Fund agrees to pay to the counterparty a floating rate of interest
(typically the London Inter Bank Offered Rate) on the notional
amount of the equity swap contract plus the amount,if any, by which
that notional amount would have decreased in value had it been
invested in such 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 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 the equity swap contract
counterparties will be able to meet their obligations or that, in
the event of default, the Fund will succeed in pursuing contractual
remedies. The Fund thus assumes the risk that it may be
delayed in or prevented from obtaining payments owed to it
pursuant to these contracts. The Fund will closely monitor the
credit of equity swap contract counterparties in order to minimize
this risk. The Fund will not use equity swap contracts for leverage.
The Fund may from time to time enter into the opposite side
of equity swap contracts (i.e., where the Fund is obligated to
pay the increase (net of interest) or receive the decrease (plus
interest) on the S&P 500 Index) to reduce the amount of the
Fund's equity market exposure. These positions are sometimes
referred to as "reverse equity swap contracts".
The Equity Plus Fund will not enter into any equity swap
contract unless, at the time of entering into such
transaction, the unsecured senior debt of the counterparty is
rated at least A by Moody's 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
- -11-<PAGE>
Fund's obligations under equity swap contracts or reverse
equity swap contracts are senior securities, so long as such
a segregated account is maintained, and accordingly, the Fund
will not treat them as being subject to its borrowing
restrictions. The net amount of the excess, if any, of the
Fund's obligations over its entitlements with respect to each
equity swap contract and each reverse equity swap contract will be
accrued on a daily basis, and an amount of cash, U.S. Government
Securities or other liquid high quality debt securities having an
aggregate market value at least equal to the accrued excess will be
maintained in a segregated account by the Fund's custodian.
S&P 500 Index and Other Stock Index Futures. S&P 500 and
other stock index futures represent contracts to buy a number of
units of the S&P 500 Index or some other stock index at a
specified future date at a price agreed upon when the contract is made.
Upon entering into a contract, the Fund will be required to deposit
with its custodian in a segregated account in the name of the
futures broker a specified amount of cash or securities, generally
not exceeding 5% of the face amount of the contract. This amount is
known as "initial margin" and is in the nature of a performance bond
or good faith deposit on the contract which is returned to the Fund upon
termination of the futures contract, assuming all
contractual obligations have been satisfied. Subsequent
payments to and from the broker, called "variation margin", will
be made on a daily basis as the value of the futures contract
fluctuates.
Purchased futures contracts may be closed out only by entering
into a futures contract sale with the same terms as the contract to
be closed out on the futures exchange on which the futures are
traded. The liquidity of the market in futures contracts could be
adversely affected by daily price fluctuation limits
established by an exchange which limit the amount of
fluctuation in the price of a futures contract during a single
trading day. In such case, it may not be possible for the
Fund to close out its futures contract position, and, in the
event of adverse price movements, the Fund would continue to
be required to make daily cash payments of variation margin.
The Fund will not use futures contracts for leverage.
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 appropriate
securities in a segregated account with its Custodian, in
an amount which, together with the initial margin deposit on
the futures contract, is equal to the current delivery or cash
settlement value of the futures contract. The amounts on
deposit will constitute a portion of the Fund's Fixed
Income Segment.
Common Stocks. When index futures contracts and/or equity
swap contracts are, in the judgment of the Adviser, overpriced
relative to the common stocks underlying the S&P 500 Index, the
Fund may invest directly in the common stocks represented by
- -12-<PAGE>
the S&P 500 Index. The Fund will not own all 500 issues, but
will attempt to purchase a basket of common stocks which the
Adviser expects will, on average, match movements in the S&P
500 Index. Subject to limits on the Fund's investments in
other investment companies, the Fund may also invest in these
stocks indirectly by purchasing interests in asset pools
investing in such stocks. To the extent that the Fund
purchases interests in other investment companies, shareholders
of the Fund may be subject to a layering of expenses because
they may indirectly bear a proportionate share of the
expenses of such investment companies (including advisory fees)
in addition to bearing the direct expenses of the Fund.
Fixed Income Instruments. 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 of investment grade (rated at least Baa by S&P or BBB
by 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 or S&P. Securities rated Baa and BBB or below 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.
Example. Set forth below is an example of how the Equity Plus
Fund might invest a $100 million portfolio:
1. Enter into an equity swap contract with a notional amount
of $50 million;
2. Purchase S&P 500 index futures contracts with a total
contract value of $45 million; and
3. Purchase $5 million worth of common stocks comprising
the S&P 500 Index in proportion to their respective
weightings in the S&P 500 Index.
Because equity swap contracts and futures contracts may
generally be initially entered into without making cash
payments, the Fixed Income Segment would invest $95 million in
various fixed income securities with appropriate hedging
strategies. If, during the course of the year, the stocks
comprising the S&P 500 Index appreciate 10% on average and
pay a 4% dividend, and if the interest on the equity swap
contract's notional amount is 6%, at the end of the year the
following would occur:
1. The counterparty to the equity swap contract would be
required to pay the Fund $4 million ($7 million
appreciation and dividends minus $3 million interest);
2. The S&P 500 index futures contract would be closed out at
a gain of $3.6 million ($6.3 million S&P 500 Index
appreciation less $2.7 million for the S&P 500 Futures
implicit cost of carry);
3. Dividend income and gain on the common stocks would total
$0.7 million and in sum;
4. The Equity Simulation Segment's return, before
related operating expenses, would total $8.3 million dollars
or 8.3%.
- -13-<PAGE>
The Fund's total operating expenses (other than brokerage
expenses and the interest on the notional amount of the equity
swap contract as described above) are 0.88% of total net assets,
or $0.88 million dollars. After consideration of these
expenses, the Equity Simulation Segment's return would total
7.42%. Therefore, the Fund would achieve a total return equal to
the S&P 500 Index only if the Fixed Income Segment has a total
return equal to 6.93% per annum. If the Fixed Income Segment
achieves this result, then the Fund's total net assets would be
$114 million - an increase of 14% and a total return equal to
the S&P 500 Index. If the Fixed Income Segment's total return
is greater or less than 6.93% per annum, the Fund's total return
would, in turn, be greater or less than the S&P 500 Index.
Characteristics and Risks of the Securities in which the Short
and Intermediate Funds 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
- -14-<PAGE>
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
have interest rates that are reset at periodic intervals,
usually by reference to some interest rate index or market
interest rate. Some adjustable-rate securities are backed by
pools of mortgage loans. The Short and Intermediate Funds
will only invest in adjustable-rate securities backed by
pools of mortgage loans ("ARMs"). The Fixed Income
Segment of the Equity 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 rate on
adjustable-rate securities may lag changes in prevailing market
interest rates. Also, some adjustable-rate securities (or the
underlying mortgages or other underlying loans or receivables)
are subject to caps or floors that limit the maximum change
in interest rate during a specified period or over the life of
the security. Because of the resetting of interest rates,
adjustable-rate securities are less likely than non-
adjustable-rate securities of comparable quality and maturity
to increase significantly in value when market interest
rates fall. Adjustable-rate securities are also subject to the
prepayment risks associated generally with mortgage-backed
securities.
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
- -15-<PAGE>
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 Fund 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 Funds 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 Funds 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 Funds
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
- -16-<PAGE>
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 Funds 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 Funds 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.
Credit Risks. While certain U.S. Government securities such
as U.S. Treasury obligations and GNMAs are backed by the full
- -17-<PAGE>
faith and credit of the U.S. Government, other securities in
which the Funds may invest are subject to varying degrees of
risk of default. These risk factors include the creditworthiness
of the issuer and, in the case of mortgage-backed and asset-
backed securities, the ability of the mortgagor or other
borrower to meet its obligations. The Short and Intermediate
Funds will seek to minimize this credit risk by investing in
securities of the highest credit quality instruments, while the
Equity 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.
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
to either lengthen or 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, 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
interestrate 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.
There can be no assurance that the hedging techniques employed
by the Funds 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.
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.
OTHER INVESTMENT PRACTICES AND RISK CONSIDERATIONS
The Funds may also engage in the following investment practices
for hedging purposes or to increase investment returns, 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.
- -18-<PAGE>
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 in or
prevented from recovering the collateral. None of the Funds
will lend portfolio securities if, as a result, the aggregate
of such loans exceeds 33 1/3% of the total asset value
(including such loans). The Funds will only enter into
repurchase agreements with or lend securities to (i) member
banks of the Federal Reserve System having total assets in
excess of $500 million and (ii) securities dealers, provided
such banks or dealers meet the creditworthiness standards
established by the Board of Trustees ("Qualified Institutions").
The Adviser will monitor the continued creditworthiness of
Qualified Institutions, subject to the oversight of the Board
of Trustees.
The Funds may also purchase securities for future delivery,
which may increase overall investment exposure and involves a
risk of loss if the value of the securities declines prior to
the settlement date. At the time a Fund enters into a
transaction on a when-issued or forward commitment basis, a
segregated account consisting of 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 Funds may only enter into these transactions
with commercial banks and registered broker-dealers which
are also Qualified Institutions. The Statement of Additional
Information for each 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
- -19-<PAGE>
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 in order to shorten the overall
duration of the portfolio and 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 affect 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.
- -20-<PAGE>
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.
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 served as Associate Editor for five
journals in financial economics, and was elected to the
- -21-<PAGE>
Board of Directors of the American Finance Association.
He has published several well-cited articles in finance and
economics journals. He holds a Ph.D. in Finance from the
Stanford University Graduate School of Business, and a B.S. in
Management Science from the Massachusetts Institute of
Technology. He serves as Chairman of Harrington Financial
Group, the holding company for Harrington Bank, F.S.B., of
Richmond, Indiana.
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 served on the editorial board of a number of professional
journals including, currently, the Journal of Fixed Income,
the Review of Derivative Research, and Ricerche Economiche. He
consults for a number of leading financial institutions and is
a former Independent Board Member of the Securities and
Futures Authority of Great Britain.
Myron S. Scholes Trustee
Myron S. Scholes is a Principal in the money management
firm Long-Term Capital Management Co. (since 1993). He is the
Frank E. Buck Professor of Finance Emeritus at the Graduate
School of Business at Stanford University (since 1983. He is a
member of the Econometric Society. Professor Scholes was also a
Managing Director and co-head of the fixed income derivatives
group at Salomon Brothers between 1991-1993. Prior to coming
to Stanford University in 1983, Professor Scholes was the
Edward Eagle Brown Professor of Finance at the Graduate School
- -22-<PAGE>
of Business, University of Chicago (1974-1983). He served
as the Director of the University of Chicago's Center for
Research in Security Prices from 1974-1980. Prior to coming to
the University of Chicago, Professor Scholes was first an
Assistant Professor then an Associate Professor at the Sloan
School of Management at M.I.T. from 1968 to 1973. He received
his Ph.D. in 1969 from the Graduate School of Business,
University of Chicago. He has honorary Doctor of Law degrees
from the University of Paris and McMaster University. He is a
past president of the American Finance Association (1990).
Dr. Scholes has published numerous articles in academic
journals and in professional volumes. He is most noted as the co-
originator of the Black-Scholes Options Pricing Model as
described in the paper, "The Pricing of Options and Corporate
Liabilities," published in the Journal of Political Economy
(with Fischer Black, May 1973). His other papers include such
topics as risk-return relationships, the effects of dividend
policy on stock prices, and the effects of taxes and tax policy
on corporate decision making. His book with Mark Wolfson (Stanford
University) Taxes and Business Strategy: A Planning Approach was
published by Prentice Hall in 1991.
William F. Sharpe Trustee
William F. Sharpe is the STANCO 25 Professor of Finance at
Stanford University's Graduate School of Business. He is best
known as one of the developers of the Capital Asset Pricing
Model, including the beta and alpha concepts used in risk
analysis and performance measurement. He developed the widely-
used binomial method for the valuation of options and other
contingent claims. He also developed the computer
algorithm used in many asset allocation procedures, a procedure
for estimating the style of an investment manager from its
historic returns, and the Sharpe ratio for measuring investment
performance. Dr. Sharpe has published articles in a number of
professional journals. He has also written six books, including
Portfolio Theory and Capital Markets, (McGraw-Hill, 1970),
Asset Allocation Tools, (Scientific Press, 1987), Fundamentals
of Investments (with Gordon J. Alexander and Jeffery Bailey,
Prentice-Hall, 1993) and Investments (with Gordon J. Alexander
and Jeffrey Bailey, Prentice-Hall, 1990). Dr. Sharpe is a past
President of the American Finance Association. He also served
as consultant to a number of corporations and investment
organizations. He is Trustee of the Barr Rosenberg mutual funds,
a Director of Stanford Management Company and the Chairman of
the Board of Financial Engines, a company providing electronic
portfolio advice. He received the Nobel Prize in Economic
Sciences in 1990.
Daniel C. Dektar Vice President, Smith Breeden Series
Fund Portfolio Manager, Short and Intermediate
Funds
Daniel C. Dektar is a Principal, Executive Vice President,
Director of Portfolio Management, and Director of Smith Breeden
Associates. Mr. Dektar has been primarily responsible for
the day-to-day management of the Short and Intermediate
Funds since their commencement of operations in 1992. As
head of Smith Breeden Associates' portfolio management group,
- -23-<PAGE>
Mr. Dektar is constantly in touch with developments on Wall
Street. He serves as a liaison among the portfolio management,
client service, and research groups to ensure accurate analysis
and timely execution of portfolio management opportunities.
Mr. Dektar consults with institutional clients in the areas of
investments and risk management. He made several presentations
on mortgage investments and risk management at seminars for
institutional investors. Mr. Dektar was an Associate in the
Mergers and Acquisitions Group of Montgomery Securities in San
Francisco, California and a Financial Analyst in the Investment
Banking Division of Morgan Stanley & Co., Incorporated, New York
before joining Smith Breeden Associates. He holds a Master of
Business Administration with Concentration in Finance from
Stanford University Graduate School of Business, where he was an
Arjay Miller Scholar. Mr. Dektar received a Bachelor of Science
in Business Administration, summa cum laude, from the
University of California at Berkeley, where he was University
of California Regent's Scholar, was elected to Phi Beta Kappa and
Phi Eta Sigma, and won the White Award as the top student in
finance.
John B. Sprow Vice President, Smith Breeden Trust
Portfolio Manager, Equity Plus Fund
John B.Sprow is a Principal, Director and Executive Vice
President of Smith Breeden Associates. Mr. Sprow has
been primarily responsible for the day-to-day management of the
Equity Plus Fund from the commencement of its operations in
1992. Mr. Sprow is a senior portfolio manager who works
primarily with discretionary pension accounts. In addition to
traditional mortgage accounts, he also manages S&P 500 indexed
accounts. Prior to directly managing discretionary accounts,
Mr. Sprow assisted in the development of the Adviser's models
for pricing and hedging mortgage-related securities, risky
commercial debt, and forecasting mortgage prepayment behavior.
Mr. Sprow came to Smith Breeden Associates from the Fuqua School
of Business, Duke University, where he was Research Assistant.
Previously, Mr. Sprow was a Research Assistant to the Department
Head of the Materials Science Department, Cornell University. He
received a Master of Business Administration with Emphasis in
Finance from the Fuqua School of Business, Duke University.
Mr. Sprow holds a Bachelor of Science in Materials Science and
Engineering from Cornell University, where he was awarded the
Carpenter Technology Scholarship three successive years.
Marianthe S. Mewkill Vice President, Secretary, Treasurer,
and Chief Accounting Officer
Marianthe S. Mewkill is a Principal, Vice President and
Chief Financial Officer of Smith Breeden Associates. Ms. Mewkill
handles financial reporting, budgeting, tax research and planning
for the Smith Breeden Mutual Funds and for Smith Breeden
Associates, Inc.. She ensures compliance with agency regulations
and administers the Adviser's internal trading and other
policies. She was previously employed as a Controller for the
Hunt Alternatives Fund, as an Associate at Goldman Sachs &
Co., and as a Senior Auditor at Arthur Andersen & Co. She earned
a Master of Business Administration with Concentrations in
Finance and Accounting from New York University and graduated
from Wellesley College, magna cum laude with a Bachelor of
- -24-<PAGE>
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. 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 the
renewal date of its contracts with the Funds, August 1, 1998,
the Adviser has voluntarily agreed to reduce its compensation,
and to the extent necessary absorb other expenses of the Funds,
such that the total expenses (exclusive of ordinary brokerage
commissions, investment transaction taxes and extraordinary
expenses) do not exceed 0.88% of the average net assets for
each of the Equity Plus Fund and the Intermediate Fund, and
0.78% of the average net assets of the Short Fund.
The Adviser places all orders for purchases and sales of the
Funds' securities. Subject to seeking the most favorable
price and execution available, the Adviser may consider sales
of shares of the Funds as a factor in the selection of broker-
dealers.
Distribution
FPS Broker Services, Inc. (the "Principal Underwriter") acts
as distributor for the Funds for which the Adviser pays the
Principal Underwriter a fee of $25,000. Shares may also be sold
by authorized dealers who have entered into dealer agreements
with the Principal Underwriter or the Adviser.
Expenses
The Funds pay all of their own expenses, including,
without limitation, the cost of preparing and printing their
registration statements required under the Securities Act of 1933
and the 1940 Act and any amendments thereto, the expense of
registering their shares with the Securities and Exchange
Commission and the various states, the printing and distribution
costs of prospectuses mailed to existing investors, reports to
investors, reports to government authorities and proxy
statements, fees paid to directors who are not interested
persons of the Adviser, interest charges, taxes, legal
expenses, association membership dues, auditing services,
insurance premiums, brokerage commissions and expenses
in connection with portfolio transactions, fees and expenses of
the custodian of their assets, printing and mailing
expenses and charges and expenses of dividend disbursing
agents, accounting services agents, registrars and stock
transfer agents.
- -25-<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.
These charges may apply if you purchase or sell shares
through certain broker-dealers. The Funds currently charge a
$9 fee for each redemption made by wire. See "How to Redeem
Shares."
The per share net asset value of a Fund is determined by
dividing the total value of its assets, less its liabilities, by
the total number of its shares outstanding at that time. The net
asset value is determined as of the close of regular trading
(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, Martin Luther
King Day, President's Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day, the day
following Thanksgiving, Christmas Eve and Christmas Day. In
adddition, the Short and Intermediate Funds will not be be priced
on Columbus Day and Veterans' Day.
Under procedures approved by the Board of Trustees, a
Fund's securities for which market quotations are readily
available are valued at current market value provided by a
pricing service, bank or broker-dealer experienced in such matters.
Short-term investments that will mature in 60 days or less may be
valued at amortized cost, which approximates market value. All
other securities and assets are valued at fair market value as
determined by following procedures approved by the Board of
Trustees.
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."
- -26-<PAGE>
Initial Minimum Additional
Minimum Type of Account Investment Investment
Regular $750 $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
also be waived.
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 with 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.
- -27-<PAGE>
Telephone Transactions. The privilege to initiate redemption
or exchange transactions by telephone is made automatically
available to shareholders when opening an account, unless
they indicate otherwise by checking the appropriate boxes
on the Purchase Application. Each Fund will employ reasonable
procedures to ensure that instructions communicated by
telephone are genuine. If reasonable procedures are not
implemented, the Funds may be liable for any loss due to unauthorized
or fraudulent transactions. In all other cases, you are liable for
any loss due to unauthorized transactions. The Funds reserve the
right to refuse a telephone transaction if they believe it is
advisable to do so.
If you have any questions, please call the Funds at 1-800-221-
3138.
How to Add to Your Account. You may make additional investments
by mail or by wire in an amount equal to or greater than $50.
When adding to an account by mail, you should send the Funds your
check, together with the additional investment form from a
recent statement. If this form is unavailable, you should send
a signed note giving the full name of the account and the
account number. For additional investments made by wire
transfer, you should use the wiring instructions listed
above. Be sure to include your account number.
Automatic Investment Plan. You may make purchases of shares of
each Fund automatically on a regular basis ($50 minimum per
transaction). You must meet the Automatic Investment Plan's
("the Plan") minimum initial investment of $50 before the Plan
may be established. You have two options under the Plan
to make investments. One is by automatic payroll deduction.
Under this method, you authorize your employer to direct a portion
of each paycheck to be invested in the Fund of your choice. Your
employer must be using direct deposit to process its payroll in
order for you to elect this method. Under the other method,
your bank debits a preauthorized amount from your checking or
savings account each month and applies the amount to your
investment in Fund shares. In order to have your bank account debited
automatically for investment into the Funds, your financial institution
must be a member of the Automated Clearing House. No service fee is
currently charged by the Funds for participation in either
method under the Plan. A $20 fee will be imposed by the Funds
if sufficient funds are not available in your bank account, or
if your bank account has been closed at the time of the automatic
transaction. You may adopt either method under the Plan at the
time an account is opened by completing the appropriate
section of the Purchase Application. Enclosed with the
application are the necessary forms to deliver to your employer
to set up the payroll deduction. You may obtain an application
to establish the Automatic Investment Plan after an account
is opened by calling the Funds at 1-800-221-3138. In the event
you discontinue participation in the Plan, the Funds reserve the
right to redeem your Fund account involuntarily, upon sixty
days' written notice, if the account's net asset value is $750
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
- -28-<PAGE>
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.
HOW TO EXCHANGE SHARES
Shares of any Fund may be exchanged for shares of another Fund
at any time. This exchange offer is available only in states
where shares of such other Fund may be legally sold. You may open
a new account, or purchase additional shares in an existing
account, by making an exchange from an identically registered
Smith Breeden Fund account. A new account will have the same
registration as the existing account from which the exchange
was made, and is subject to the same initial investment
minimums.
Exchanges may be made either in writing or by telephone.
Written instructions should be mailed to 3200 Horizon Drive,
King of Prussia, PA 19406 and must be signed by all account
owners, and accompanied by any properly endorsed outstanding
share certificates, if applicable. The telephone exchange is
automatically accepted unless checked otherwise. The
telephone exchange privilege is available only for uncertificated
shares. During periods of drastic economic or market changes,
it is possible that exchanges by telephone may be difficult to
implement. In this event, shareholders should follow the written
exchange procedures. The telephone exchange privilege may be
modified or discontinued by the Funds at any time upon a 60 day
notice to the shareholders. To exchange by telephone, you must
follow the instructions below under "How to Redeem by Telephone."
The Funds will accept exchange orders by telephone or other
means of electronic transmission from broker-dealers, financial
institutions or other service providers who execute an
- -29-<PAGE>
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.
Additionalinformation 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
- -30-<PAGE>
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. The redemption of shares by
telephone is available automatically unless you elected to
refuse this redemption privilege on your Purchase Application.
Shares may be redeemed by calling the Funds at 1-800-221-3137.
Proceeds redeemed by telephone will be mailed to your address, or
wired or credited to your 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, which will be deducted from
your account.
The Funds reserve the right to refuse a telephone redemption
or exchange transaction if they believe it is advisable to
do so. Procedures for redeeming or exchanging shares of the Funds
by telephone may be modified or terminated by the Funds at any
time. In an effort to prevent unauthorized or fraudulent
redemption or exchange requests by telephone, the Funds have
implemented procedures designed to reasonably assure that
telephone instructions are genuine. These procedures include:
requesting verification of certain personal information;
recording telephone transactions; confirming transactions in
writing; and restricting transmittal of redemption proceeds
only to preauthorized designations. Other procedures may be
- -31-<PAGE>
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 $500 as a result of a
redemption or exchange, or if you discontinue the Automatic
Investment Plan before your account balance reaches $500, you
may be given a 60-day notice to bring your balance to $500 or
reactivate an Automatic Investment Plan. If this requirement
is not met, your account may be closed and the proceeds sent to
you.
Check Writing. In addition to telephone and written
redemption requests, the Short Fund offers redemption through
check writing. Shareholders electing this option will receive
checks that may be used like personal or business checks.
There is no limit on the number of checks you may write.
Checks must be written for at least $100. There is a $30
fee for returned checks. Because dividends declared on shares
held in a shareholder's account, prior redemptions, and possible
changes in net asset value may cause the value of the account
to change, shareholders should not write a check for the
entire value of the account or close the account by writing a
check.
In using the check writing privilege, shareholders bear
the responsibility of ensuring that the check amount does not
exceed the value of their account on the day the check is
presented to the Transfer Agent for payment. The day the check
is presented for payment is the day the redemption of Fund
shares takes place. If insufficient shares are in the account,
the check will be returned and no shares will be redeemed. The
clearing agent for the check writing facility is United Missouri
Bank. Shareholders utilizing check writing are subject to United
Missouri Bank's rules governing checking accounts. However, this
check writing facility is purely a means to redeem Fund
shares. No facilities characteristic of bank accounts, such as
deposit insurance, are provided along with the check writing
option.
If you would like to initiate check writing, please call
- -32-<PAGE>
Shareholder Services at 1-800-221-3137 or check the appropriate
box on the Purchase Application.
Systematic Withdrawal Plan. A shareholder may establish
a Systematic Withdrawal Plan to receive regular periodic
payments from the account. An initial balance of $10,000 is
required to establish a Systematic Withdrawal Plan. There
are no service charges for establishing or maintaining a
Systematic Withdrawal Plan. The minimum amount which the
shareholder may withdraw periodically is $100. Capital
gain distributions and income dividends to the shareholder's
account are received in additional shares at net asset value.
Payments are then made from the liquidation of shares at net
asset value to meet the specified withdrawals. Liquidation of
shares may reduce or possibly exhaust the shares in the
shareholder's account, to the extent withdrawals exceed shares
earned through dividends and distributions, particularly in the
event of a market decline. No payment pursuant to a Systematic
Withdrawal Plan will be made if there are insufficient shares on
deposit on the date of the scheduled distribution. A subsequent
deposit of shares will not result in a payment under the plan
retroactive to the distribution date. As with other redemptions,
a liquidation to make a withdrawal payment is a sale for federal
income tax purposes. The entire Systematic Withdrawal Plan
payment cannot be considered as actual yield or income since part
of the Plan's payment may be a return of capital.
A Systematic Withdrawal Plan may be terminated upon written
notice by the shareholder, or by a Fund on a 30 day written
notice, and it will terminate automatically if all shares are
liquidated or withdrawn from the account or upon the Fund's receipt
of notification of the death or incapacity of the shareholder.
Shareholders may change the amount (but not below the specified
minimums) and schedule of withdrawal payments, or suspend such
payments, by giving written notice to the Transfer Agent at least
five business days prior to the next scheduled payment. Share
certificates may not be issued while a Systematic Withdrawal Plan
is in effect.
DIVIDENDS AND DISTRIBUTIONS
The Short and Intermediate Funds intend to make monthly
distributions to their shareholders of net investment income.
The Equity 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 Fund's shares are quoted
exdividend on the business day after record date (the "ex-
date"). Record date is usually the first or second business day
of the month. If a shareholder elects to reinvest dividends, the
date the dividends are reinvested is also the ex-date. Dividends
are paid in cash by the Short Fund generally one week after the
ex-date.
The Intermediate Fund will declare daily dividends for
shareholders of record. The Intermediate Fund's dividend payable
date, and the day that dividends are reinvested for shareholders
- -33-<PAGE>
who have made this election, is the last business day of the month.
Shares begin accruing dividends on the business day after federal
funds (funds credited to a member bank's account at the Federal
Reserve Bank) are available from the purchase payment for such
shares, and continue to accrue dividends through and including
the day the redemption order for the shares is executed. If an
investor closes his account, any accrued dividends through and
including the day of redemption will be paid as part of the
redemption proceeds.
Dividends and capital gains distributions may be declared more
or less frequently at the direction of the Trustees. In order to
be entitled to a dividend or a distribution, an investor must
acquire a Fund's shares on or before the record date. Caution
should be exercised, however, before purchasing shares
immediately prior to a distribution record date. Since the value
of a Fund's shares is based directly on the amount of its net
assets, rather than on the principle of supply and demand, any
distribution of income or capital gain will result in a
decrease in the value of its shares equal to the amount of the
distribution. While a dividend or capital gain distribution
received shortly after purchasing shares represents, in effect,
a return of the shareholder's investment, it may be taxable as
dividend income or capital gain. You may separately elect to
reinvest income dividends and capital gains distributions in
shares of a Fund or receive cash as designated on the Purchase
Application. You may change your election at any time by sending
written notification to your Fund. The election is effective for
distributions with a dividend record date on or after the date
that the Funds receive notice of the election. If you do not
specify an election, all income dividends and capital gains
distributions will automatically be reinvested in full and
fractional shares of 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 Funds who are financial institutions may
request receipt of monthly or quarterly reports which provide
information about the Short or Intermediate Fund's investments
considering regulatory risk-based asset categories. If you need
- -34-<PAGE>
additional copies of previous statements, you may order statements
for the current and preceding year at no charge. Call 1-800-221-3137
to order past statements. If you need information on your account
with the Funds or if you wish to submit any applications, redemption
requests, inquiries or notifications, please contact: Smith Breeden
Mutual Funds, 3200 Horizon Drive, P.O. Box 61503, King of
Prussia, PA 19406-0903 or call 1-800-221-3137.
RETIREMENT PLANS
The Funds have a program under which you may establish
an Individual Retirement Account ("IRA") with the Funds and
purchase shares through such account. Shareholders wishing to
establish an IRA should consult their tax adviser regarding (1)
their individual qualifying status and (2) the tax
regulations governing these accounts. The minimum initial
investment in each Fund for an IRA is $500. There is a $12
annual maintenance fee charged to process an account. This fee
is waived for accounts greater than $10,000. You may obtain
additional information regarding establishing such an account
by calling the Funds at 1-800-221-3138.
The Funds may be used as investment vehicles for
established defined contribution plans, including simplified
employee, 401(k), profit-sharing, money purchase, and
simple pension plans ("Retirement Plans"). For details
concerning Retirement Plans,please call 1-800-221-3138.
SERVICE AND DISTRIBUTION PLANS
Each Fund has adopted a Distribution and Services Plan
(the "Plans") pursuant to Rule 12b-1 under the 1940 Act. The
purpose of the Plans is to permit the Adviser to compensate
investment dealers and other persons involved in servicing
shareholder accounts for services provided and expenses
incurred in promoting the sale of shares of the Funds, reducing
redemptions, or otherwise maintaining or improving services
provided to shareholders by such dealers or other persons. The
Plans provide for payments by the Adviser out of its advisory
fee to dealers and other persons at an annual rate of up to
0.25% of a Fund's average net assets, subject to the authority
of the Trustees to reduce the amount of payments permitted under
the Plan or to suspend the Plan for such periods as they may
determine. Subject to these limitations, the amount of such
payments and the purposes for which they are made shall be
determined by the Adviser. Any distribution and service related
payments made by the Adviser to investment dealers or other persons
are subject to the continuation of the Plans, the terms of any
related service agreements, and any applicable limits imposed by
the National Association of Securities Dealers, Inc.
TAXES
Each Fund intends to qualify as a regulated investment
company under the Internal Revenue Code. In each taxable year
that a Fund so qualifies, such Fund (but not its shareholders)
will be relieved of federal income tax on the part of its net
- -35-<PAGE>
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 Fund's 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 and the Smith Breeden Series Fund are
both Massachusetts business trusts. The Trust was organized
under an Agreement and Declaration of Trust, dated December 18,
1991. The Series Fund was organized under an Agreement and
Declaration of Trust dated October 3, 1991. Copies of both
Agreements, which are governed by Massachusetts law, are on
file with the Secretary of State of the Commonwealth of
Massachusetts. The Trust and the Series Fund have the same
Trustees.
The Trustees have the authority to issue shares in an
unlimited number of funds of either the Series Fund or Trust.
Each such fund's shares may be further divided into classes.
The assets and liabilities of each such fund will be separate
and distinct. All shares when issued are fully paid, non-assessable
and redeemable, and have equal voting, dividend and liquidation
rights.
Shareholders of the separate funds of the Series Fund or Trust
- -36-<PAGE>
will vote together in electing trustees and in certain other
matters. Shareholders in each fund of the Series Fund should be
aware that the outcome of the election of trustees and of
certain other matters could be controlled by the shareholders
of another fund. The shares have 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, 1998.
FUND PERFORMANCE
Each Fund may quote the Fund's average annual total and/or
aggregate total return for various time periods in advertisements
or communications to shareholders. An average annual total return
refers to the rate of return which, if applied to an initial
investment at the beginning of a stated period and compounded over
that period, would result in the redeemable value of the investment
at the end of the period assuming reinvestment of all dividends and
distributions and reflecting the effect of all recurring fees. An
investor's principal in each Fund and the Fund's return are not
guaranteed and will fluctuate according to market conditions. When
considering "average" total return figures for periods longer than
one year, you should note that a Fund's annual total return for any
one year in the period might have been greater or less than the
- -37-<PAGE>
average for the entire period. Each Fund also may use "aggregate" total
return figures for various periods, representing the cumulative change
in value of an investment in the Fund for a specific period (again
reflecting changes in the Fund's share price and assuming reinvestment
of dividends and distributions).
The Short and Intermediate Funds may also advertise current
yield and distribution rate information. Current yield
reflects the income per share earned by the Short or Intermediate
Fund's portfolio investments, and is calculated by dividing a Fund's
net investment income per share during a recent 30-day period by a
Fund's net asset value on the last day of that period and annualizing
the result. The current yield (or "SEC Yield"), which is calculated
according to a formula prescribed by the SEC (see the relevant Statement
of Additional Information), is not indicative of the dividends or
distributions which were or will be paid to a Fund's shareholders.
SEC regulations require that net investment income be calculated on a
"yield-to-maturity" basis, which has the effect of amortizing any premiums
or discounts in the current market value of fixed income securities.
Dividends or distributions paid to shareholders are reflected in the
current distribution rate which may be quoted to shareholders, and may
not reflect amortization in the same manner.
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 Fund's total return may also be compared to 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 Fund's return will most
likely be compared to the total return of the Salomon Brothers Mortgage
Index, or the total return of intermediate U.S. Treasury Notes as published
by various brokerage firms and others. 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.
APPENDIX A
Hedging Instruments and Transactions (Short and Intermediate
Funds and Equity Plus Fund's Fixed Income Segment)
- -38-<PAGE>
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 that 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 Funds 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 Funds will not write interest rate
- -39-<PAGE>
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 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 under "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 Funds will not purchase a put or
call option on U.S. Government securities or mortgage-backed
securities if, as a result of such purchase, more than 10% of its
total assets would be invested in such options. 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.
- -40-<PAGE>
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.
- -41-<PAGE>
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.
- -42-
Part B: Information Required in
Statement of Additional Information
N-1A
Item No. Item Location in the Registration
Statement
10. Cover Page Cover Page
11. Table of Contents "Table of Contents"
12. General Information
and History See Part A Item 4.
13. Investment Objective "Miscellaneous
and Policies Investment Practices and
Risk Considerations"
14. Management of the
Registrant "Management of the Fund
15. Control Persons and
Principal Holders of "Principal Holders of Securities
Securities and Controlling Persons"
16. Investment Advisory "The Investment Advisory
and Other Services Agreement and Other Services"
17. Brokerage Allocation "The Investment Advisory
Agreement and Other
Services"
18. Capital Stock and "Additional Information
Other Securities Regarding Purchases and
Redemptions of Fund Shares"
19. Purchase, Redemption "Additional Information
and Pricing of Regarding Purchases and
Securities Being Redemptions of Fund
Offered Shares"
20. Tax Status "Taxes"
21. Underwriters Additional Information
Regarding Purchases and
Redemptions of Fund
Shares"
22. Calculation of
Performance Data "Standard Performance
Measures"
23. Financial Statements "Report of Independent
Auditors and Financial
Statements"
SMITH BREEDEN TRUST
SMITH BREEDEN EQUITY PLUS FUND
STATEMENT OF ADDITIONAL
INFORMATION JULY 23, 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 July 23, 1997, as may be amended from time to
time. The Statement should be read together with the
Prospectus.
1<PAGE>
Contents Page
DEFINITIONS. . . . . . . . . . . . . . . . . . . . . .3
INVESTMENT RESTRICTIONS OF THE FUND. . . . . . . . . .3
MISCELLANEOUS INVESTMENT PRACTICES AND
RISK CONSIDERATIONS . . . . . . . . . . . . . . .6
TAXES . . . . . . . . . . . . . . . . . . . . . . . .9
FUND CHARGES AND EXPENSES. . . . . . . . . . . . . . 10
MANAGEMENT OF THE FUND . . . . . . . . . . . . . . . 11
INVESTMENT ADVISORY AGREEMENT AND OTHER SERVICES . . 12
PRINCIPAL HOLDERS OF SECURITIES AND
CONTROLLING PERSONS. . . . . . . . . . . . . . .17
DETERMINATION OF NET ASSET VALUE. . . . . . . . . . .17
ADDITIONAL INFORMATION REGARDING PURCHASES
AND REDEMPTIONS OF FUND SHARES . . . . . . . . .18
SHAREHOLDER INFORMATION . . . . . . . . . . . . . . .20
SUSPENSION OF REDEMPTIONS . . . . . . . . . . . . . .20
SHAREHOLDER LIABILITY . . . . . . . . . . . . . . . .20
STANDARD PERFORMANCE MEASURES . . . . . . . . . . . .21
INDEPENDENT AUDITORS. . . . . . . . . . . . . . . . .24
EXPERTS . . . . . . . . . . . . . . . . . . . . . . .24
REPORT OF INDEPENDENT AUDITORS AND
FINANCIAL STATEMENTS . . . . . . . . . . . . . .24
2<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
3<PAGE>
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
4<PAGE>
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.
5<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 highgrade 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
6<PAGE>
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 shortterm 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
7<PAGE>
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
8<PAGE>
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
9<PAGE>
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, 1997 were $53,341. Advisory fees for each of the
last three fiscal years ended March 31 were $11,056,
$21,727, and $53,341 respectively. The amounts paid
in prior fiscal years from March 31, 1994 through
August 1, 1994 reflect a previous advisory contract
rate of 0.35% of average net assets. For each of
10<PAGE>
the last three fiscal years ended March 31, the
Adviser reimbursed the Fund $128,959, $114,100 and
$131,965, 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, 1997:
Director Aggregate
Compensation
William F. Sharpe $ 1,400
Myron S. Scholes $ 0
Stephen M. Schaefer $ 3,373
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.
11<PAGE>
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 61% of
the common stock of Harrington Financial Group, the
holding company for Harrington Bank, FSB of
Richmond, Indiana (the "Association"). As of May
31, 1997, the Association had total assets of $485
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
12<PAGE>
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
13<PAGE>
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 August 1, 1998
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
14<PAGE>
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 $3,000 in brokerage commissions on
futures and options transactions for the last
fiscal year and approximately $1,000 for each of
the two prior fiscal years ended March 31.
The 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
15<PAGE>
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.
16<PAGE>
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
There were no beneficial owners who owned 5%
or more of the Fund at June 30, 1997.
A Fund Trustee owns less than 1% of the
shares of the Fund as of June 30, 1997.
DETERMINATION OF NET ASSET VALUE
The Fund determines net asset value as of the close
of regular trading on the New York Stock Exchange
at 4 p.m.
If any securities held by the Fund are restricted
as to resale, the Adviser determines their fair
value following procedures approved by the
Trustees. The Trustees periodically review such
valuation procedures. The fair value of such
securities is generally determined as the amount
which the Fund could reasonably expect to realize
from an orderly disposition of such securities over
a reasonable period of time. The valuation
procedures applied in any specific instance are
likely to vary from case to case. However,
consideration is generally given to the financial
position of the issuer and other fundamental
17<PAGE>
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.
18<PAGE>
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
brokerdealer. 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
19<PAGE>
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
20<PAGE>
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 $750 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,
1997, the average annual total return for the Fund
since inception is 18.50% and the average annual
total return for the one year period ended March
31, 1997 is 21.41%. 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
21<PAGE>
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
LongTerm HighYield Index, Intermediate-Term
HighYield 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
22<PAGE>
Yankee bonds.
j) Lehman Brothers Government/Corporate Bond
Index.
k) Other taxable investments including
certificatesof deposit (CD's), money market
deposit accounts (MMDA's), checking accounts,
savings accounts, money market mutual funds,
repurchase agreements, and government
securities.
l) Historical data supplied by the research
departments of Lehman Brothers, First Boston
Corporation, Morgan Stanley, Salomon Brothers,
Merrill Lynch, Goldman Sachs, Prudential
Securities and Donaldson Lufkin and Jenrette.
m) Donoghues's Money Fund Report - industry
averages for seven-day annualized and compounded
yields taxable, tax-free and government money funds.
n) Total returns and yields for Treasury Securities
and fixed income indices as published by Ryan
Laboratories or other suppliers.
Volatility. Occasionally statistics may be used to
specify Fund volatility or risk. Measures of volatility
or risk are generally used to compare fund net asset
value or performance relative to a market
index. One measure of volatility is beta. The ratio of
the expected excess return on the portfolio to the
expected excess return on the market index is
called beta. Equity funds commonly use the S&P 500
as their market index. A beta of more than 1.00
indicates volatility greater than the market, and a
beta of less than 1.00 indicates volatility less
than the market. Another measure of volatility or
risk is standard deviation. Standard deviation is
used to measure variability of net asset value or
total return around an average, over a specified
period of time. The premise is that greater
volatility connotes greater risk undertaken in
achieving performance.
A statistic often used by sophisticated
institutional investors when comparing the relative
performance of portfolios is the Sharpe Ratio.
This statistic is the portfolio's excess return
(relative to T-Bills) divided by the standard
deviation of its returns.
All data are based on past performance and do not
predict future results.
23<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 attached to this Statement of
Additional Information have been so attached in
reliance upon the report of Deloitte & Touche
LLP, independent auditors, given on the
authority of said firm as experts in auditing
and accounting.
REPORT OF INDEPENDENT AUDITORS
AND FINANCIAL STATEMENTS
See attached report.
ANNUAL REPORT
Smith Breeden Equity Plus Fund
March 31, 1997
1<PAGE>
Smith Breeden Equity Plus Fund Annual Report and Performance
Review
Performance Review
The Smith Breeden Equity Plus Fund provided a total return of
21.41% in the year ending March 31, 1997. The Fund's return exceeded
the 19.84% return of its benchmark, the S&P 500 Index, by 1.57%. Since
the Fund's inception on June 30, 1992, its return has exceeded that of its
benchmark by 14.22%, and on an annualized basis by 1.62%. The graph
below plots the Fund's return versus its benchmark and versus the average
return of Morningstar Inc.'s Growth and Income fund category.
THE LINE GRAPH DETAILING PERFORMANCE VERSUS THE EQUITY PLUS' INDEX
ACCORDING TO ITEM 5a. OF FORM N1-A IS LOCATED HERE IN THE TEXT AND IS
DESCRIBED BELOW IN ACCORDANCE WITH REG 232.304 OF REGULATION S-T:
THE GRAPH DEPICTS THE CHANGE IN VALUE OF A $10,000 INVESTMENT IN
THE VERSUS THE S&P 500 AND VERSUS THE AVERAGE OF
THE FUNDS IN MORNINGSTAR'S GROWTH AND INCOME CATEGORY.
THE EQUITY PLUS' AVERAGE ANNUAL RETURN WAS 21.41% FOR THE ONE YEAR PERIOD,
23.47% THE THREE YEAR PERIOD, 18.50% FOR THE PERIOD
SINCE INCEPTION. THE AVERAGE ANNUAL RETURN OF THE S&P 500 WAS 19.84%
FOR THE ONE YEAR PERIOD, 22.31% FOR THE THREE YEAR PERIOD, 16.88% FOR THE
PERIOD FROM INCEPTION. THE AVERAGE ANNUAL
RETURN OF THE AVERAGE OF THE FUNDS IN MORNINGSTAR'S GROWTH AND INCOME
CATEGORY WAS 16.10% FOR THE ONE YEAR PERIOD, 18.35% FOR THE THREE YEAR PERIOD,
AND 14.87% FOR THE FIVE YEAR AND SINCE INCEPTION RETURNS.
FROM INCEPTION THROUGH MARCH 31, 1997, AN INVESTMENT
OF $10,000 IN THE EQUITY PLUS WOULD HAVE GROWN TO $22,411, VERSUS
$20,988 IN ITS BENCHMARK, AND $19,320 OF THE AVERAGE OF THE FUNDS IN
MORNINGSTAR'S GROWTH AND INCOME CATEGORY.
The S&P 500 index return was produced by strong corporate
earnings rather than by falling interest rates in the year ending March 31,
1997. Corporate earnings were approximately 15% higher in the year
ending December 1996 over a year earlier. First quarter 1997 earnings
were also generally strong, in many cases exceeding analysts' expectations.
The growth in corporate earnings, combined with low unemployment
rates, caused some concern that the U.S. economy is growing too fast and
this led to moderately rising interest rates due to increased fears of
inflation. The thirty-year U.S. Treasury bond yield rose from 6.66% in
March 1996 to 7.09% in March 1997. Rising interest rates in turn
produced several small sell-offs in the stock market, resulting in declines in
the S&P 500 Index in three out of the last twelve months. It is by no
means clear that inflation is on the rise however, and much of the gain in
corporate earnings can be explained by the high levels of productive
investment made by corporations during this economic expansion.
2<PAGE>
The strategy employed by the Equity Plus Fund to achieve its goal
of providing a return in excess of the S&P 500 index has two components.
The Fund uses equity index futures contracts to track the S&P 500 index,
and it uses a hedged bond portfolio to provide income to cover the
operating costs of the fund as well as the financing costs of the equity index
futures contracts. Equity index futures contracts are available with
different maturity dates. Because the fund controls when it sells one equity
futures contract and buys a new one, it can take advantage of times when
one futures contract is cheap relative to another. Approximately 0.30% of
the Fund's return in excess of its benchmark for the year ending March
1997 was due to purchasing equity index futures at favorable prices relative
to the price of the contracts sold.
U.S. Government agency mortgage securities produced excellent
hedged returns in the year ended March 31, 1997, and the Equity Plus
Fund was able to take advantage of this performance to generate the rest of
the Fund's excess return over the S&P 500 index. One factor explaining
the superior performance by mortgages was a decline in interest rate
volatility. Mortgage buyers demand a yield premium when they purchase
mortgage bonds against the risk that interest rates will move in an
unfavorable direction. Because interest rate volatility measures the
likelihood of changes in the level of interest rates, when volatility falls
mortgage buyers demand a smaller premium and consequently the yield on
mortgages falls relative to the yield on U.S. Treasury securities. The
Equity Plus Fund held approximately 60% of its assets in adjustable-rate
mortgages during the year ended on March 31, 1997, and about 20% in
fixed-rate mortgages. The remaining assets were invested in U.S. Treasury
Bills.
3<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
SCHEDULE OF INVESTMENTS MARCH 31, 1997
Market
Face Amount Security Value
U.S. GOVERNMENT & AGENCY OBLIGATIONS - 121.45%
FEDERAL HOME LOAN MORTGAGE CORPORATION - 7.92% *
FHLMC:
$983,120 7.50%, due (a) ................................... $963,150
103,239 9.50%, due 7/1/02 ................................ 106,178
TOTAL FEDERAL HOME LOAN MORTGAGE CORPORATION
(Cost $1,090,669) 1,069,328
FEDERAL NATIONAL MORTGAGE ASSOCIATION - 6.94% *
FNMA:
110,165 12.50%, due 9/1/12 .............................. 126,541
104,722 13.50%, due 11/1/14 to 1/1/15 .................. 120,635
FNMA ARM:
660,968 7.753%, due 9/1/18.............................. 689,968
TOTAL FEDERAL NATIONAL MORTGAGE ASSOCIATION
(Cost $916,731) 937,144
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION - 66.09% *
GNMA ARM:
2,020,000 5.00%, due 3/20/27 ........................... 1,953,136
1,990,000 5.50%, due (a) ............................... 1,944,294
2,632,161 6.50%, due 2/20/16 to 10/20/26 ............... 2,676,380
2,295,509 7.125%, due 4/20/16 to 9/20/22 ............... 2,353,002
TOTAL GOVERNMENT NATIONAL MORTGAGE ASSOCIATION
(Cost $8,904,340) 8,926,812
U.S. GOVERNMENT OBLIGATIONS - 40.50%
U.S. TREASURY BILL **
20,000 5.38%, due 5/29/97 ............................. 19,832
1,000,000 5.05%, due 5/29/97 ............................. 991,622
600,000 4.94%, due 5/29/97*** .......................... 594,973
2,000,000 5.12%, due 5/29/97 ............................. 1,983,244
600,000 5.08%, due 5/29/97 ............................. 594,973
700,000 5.06%, due 5/29/97 ............................. 694,136
500,000 5.02%, due 5/29/97 ............................. 495,812
100,000 5.21%, due 11/13/97*** ......................... 96,566
TOTAL U.S. GOVERNMENT OBLIGATIONS (Cost $5,472,482) 5,471,158
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(Cost $16,384,222) 16,404,442
Contracts OPTION CONTRACTS - 0.13%
3 Call on 5 Year US Treasury Note futures, expires 5/97,
strike price $110 47
37 Put on 5 Year US Treasury Note futures, expires 5/97,
strike price $104 17,922
TOTAL OPTION CONTRACTS (Cost $10,196) ................ 17,969
TOTAL INVESTMENTS (Cost $16,394,418) - 121.58% .... 16,422,411
CASH AND OTHER ASSETS LESS LIABILITIES - (21.58%) (2,915,034)
NET ASSETS - 100.00% ........................ $13,507,377
4<PAGE>
* Mortgage-backed obligations are subject to principal paydowns as a result
of prepayments or refinancings of the underlying mortgage loans. As a
result, the average life may be substantially less than the original
maturity. The interest rate shown in the rate in effect at March 31,
1997. ARMs have coupon rates which adjust periodically. The adjusted
rate is determined by adding a spread to a specified index.
** The interest rate shown is the discount rate paid at the time of purchase
by the Fund.
*** Security is segregated as collateral.
(a) To be Announced
Portfolio Abbreviations:
ARM - Adjustable-Rate Mortgage
FHLMC - Federal Home Loan Mortgage Corporation
FNMA - Federal National Mortgage Association
GNMA - Government National Mortgage Association
The accompanying notes are an integral part of these financial statements.
5<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
STATEMENT OF ASSETS AND LIABILITIES
31-Mar-97
ASSETS:
Investments at market value (identified cost $16,394,418)
(Note 1) $16,422,411
Cash........................................................ 62,780
Receivables:
Subscriptions............................................ 180,877
Interest................................................. 53,648
Maturities............................................... 2,590
Securities sold......................................... 2,925,313
Deferred organization expenses (Note 1)................... 6,796
TOTAL ASSETS.......................................... 19,654,415
LIABILITIES:
Variation margin on futures contracts (Note 2).............. 192,294
Payables:
Redemptions .............................................. 50,041
Securities purchased...................................... 5,876,144
Due to adviser (Note 3)..................................... 8,343
Accrued expenses............................................. 20,216
TOTAL LIABILITIES......................................... 6,147,038
NET ASSETS:
(Applicable to outstanding shares of 1,075,509; unlimited number of shares
of beneficial interest authorized; no stated par)....... $13,507,377
Net asset value, offering price and redemption
price per share ($13,507,377/ 1,075,509)................ $12.56
SOURCE OF NET ASSETS:
Paid in capital............................................. $13,094,357
Undistributed net investment income.......................... 36,234
Accumulated net realized gain on investments................. 865,097
Net unrealized depreciation of investments................... (488,311)
NET ASSETS............................................ $13,507,377
The accompanying notes are an integral part of these financial statements.
6<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1997
INVESTMENT INCOME:
Interest and discount earned, net of premium amortization
(Note 1)...... $473,488
EXPENSES:
Advisory fees (Note 3)........................................... 53,341
Accounting and pricing services fees........................... 25,141
Custodian fees................................................. 13,067
Audit and tax preparation fees.................................... 10,250
Legal fees....................................................... 2,799
Amortization of organization expenses (Note 1).......... 27,791
Transfer agent fees.............................................. 29,506
Registration fees............................................... 27,132
Trustees fees and expenses................................... 3,751
Insurance expense.................................... 6,549
Other.............................................................. 40
TOTAL EXPENSES BEFORE REIMBURSEMENT............ 199,367
Expenses reimbursed by Adviser (Note 3)....................... (131,965)
NET EXPENSES................................................ 67,402
NET INVESTMENT INCOME....................................... 406,086
REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gain on investments............................... 1,374,343
Change in unrealized appreciation (depreciation) of investments (526,585)
Net realized and unrealized gain on investments................ 847,758
Net increase in net assets resulting from operations......... $1,253,844
The accompanying notes are an integral part of these financial statements.
7<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
Year Ended Year Ended
March 31, 1997 March 31, 1996
OPERATIONS:
Net investment income....................... $406,086 $171,628
Net realized gain on investments............... 1,374,343 709,594
Change in unrealized appreciation (depreciation)
of investments..... (526,585) (66,654)
Net increase in net assets resulting from
operations.................. 1,253,844 814,568
DISTRIBUTIONS TO SHAREHOLDERS:
Dividends from net investment income.......... (382,446) (159,034)
Distributions from net realized gains on
investments............ (808,371) (371,974)
Total distributions........................ (1,190,817) (531,008)
CAPITAL SHARE TRANSACTIONS:
Shares sold................................ 8,844,701 2,256,010
Shares issued on reinvestment of distributions 1,125,870 502,798
Shares redeemed.......................... (1,292,755) (383,180)
Increase in net assets resulting from capital
share transactions (a) 8,677,816 2,375,628
TOTAL INCREASE IN NET ASSETS..... 8,740,843 2,659,188
NET ASSETS:
Beginning of year.......................... 4,766,534 2,107,346
End of year................................. $13,507,377 $4,766,534
(a) Transactions in capital shares were as follows:
Shares sold........................... 695,525 183,531
Shares issued on reinvestment of distributions 93,492 42,520
Shares redeemed........................ (102,037) (32,004)
Net increase........................... 686,980 194,047
Beginning balance ..................... 388,529 194,482
Ending balance........................ 1,075,509 388,529
The accompanying notes are an integral part of these financial statements.
8<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
FINANCIAL HIGHLIGHTS
<TABLE>
The following average per share data, ratios and supplemental information has been derived from information provided in the
financial statements.
<CAPTION>
Year Year Year Year Period
Ended Ended Ended Ended Ended
31-Mar-97 31-Mar-96 31-Mar-95 31-Mar-94 31-Mar-93*
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period...........................$12.27 $10.84 $9.88 $10.85 $10.00
Income From Investment Operations
Net investment income......................................... 0.592 0.615 0.568 0.476 0.355
Net realized and unrealized gain (loss) on investments.........1.813 2.768 1.081 (0.216) 1.281
Total from investment operations.......................... 2.405 3.383 1.649 0.26 1.636
Less Distributions
Dividends from net investment income.......................... (0.59) (0.583) (0.568) (0.472) (0.311)
Dividends in excess of net investment income.................. - - 0.001 - -
Distributions from net realized gains on investments......... (1.525) (1.37) (0.047) (0.701) (0.42)
Distributions in excess of net realized gains on investments. - - (0.073) (0.057) (0.055)
Total distributions........................................(2.115) (1.953) (0.689) (1.23) (0.786)
Net Asset Value, End of Period.............................. $12.56 $12.27 $10.84 $9.88 $10.85
Total Return.................................................... 21.41% 32.30% 17.18% 2.19% 22.59%**
Ratios/Supplemental Data
Net assets, end of period................................ $13,507,377 $4,766,534 $2,107,346 $1,760,519 $903,846
Ratio of expenses to average net assets <F1>................. 0.88% 0.90% 0.90% 0.90% 0.57%**
Ratio of net investment income to average net assets <F2>.......5.30% 5.53% 7.44% 8.02% 5.28%**
Portfolio turnover rate.........................................182% 107% 120% 119% 271%
<FN>
<F1>
The annualized ratio of expenses to average net assets prior to reimbursement of expenses by the Adviser was 2.60%, 4.58%,
7.75%, 7.08%, and 28.48% for the years ended March 31, 1997, March 31, 1996, March 31, 1995, March 31, 1994, and the period ended
March 31, 1993, respectively.
</FN>
<FN>
<F2> The annualized ratio of net investment income to average net assets prior to reimbursement of expenses by the Adviser was
3.58%, 1.85%, 0.59%, 1.84%, and (22.63%) for the years ended March 31, 1997, March 31, 1996, March 31, 1995, March 31, 1994,
and the period ended March 31, 1993, respectively.
</FN>
</TABLE>
* Commenced operations June 30, 1992.
** Annualized
The accompanying notes are an integral part of these financial
statements.
9<PAGE>
SMITH BREEDEN EQUITY PLUS FUND
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Breeden Equity Plus Fund (the "Fund") is a series of the
Smith Breeden Trust (the "Trust"), an open-end, diversified
management investment company registered under the Investment
Company Act of 1940, as amended. The following is a summary of
significant accounting policies consistently followed by the Fund.
A. Security Valuation: Portfolio securities are valued at current
market value provided by a pricing service or by a bank or
broker/dealer experienced in such matters, when over-the-counter
market quotations are readily available. Securities and other assets for
which market prices are not readily available are valued at fair market
value as determined in accordance with procedures approved by the
Board of Trustees.
B. Distributions and Taxes: Dividends to shareholders are
recorded on the ex-dividend date. The Fund intends to continue to
qualify for and elect the special tax treatment afforded regulated
investment companies under Subchapter M of the Internal Revenue
Code, thereby relieving the Fund of federal income taxes. To so
qualify, the Fund intends to distribute substantially all of its net
investment income and net realized capital gains, if any, less any
available capital loss carryforward. As of March 31, 1997, the Fund
had no net capital loss carryforward.
C. Repurchase Agreements: The Fund may enter into
repurchase agreements with member banks of the Federal Reserve
System having total assets in excess of $500 million and securities
dealers, provided that such banks or dealers meet the credit guidelines
of the Fund's Board of Trustees. In a repurchase agreement, the Fund
acquires securities from a third party with the commitment that they
will be repurchased by the seller at a fixed price on an agreed upon
date. The Fund's custodian maintains control or custody of these
securities which collateralize the repurchase agreements until maturity
of the repurchase agreements. The value of the collateral is monitored
daily, and if necessary, additional collateral is received to ensure that
the market value of the underlying assets remains sufficient to protect
the Fund in the event of the seller's default. However, in the event of
default or bankruptcy of the seller, the Fund's right to the collateral
may be subject to legal proceedings.
D. Reverse Repurchase Agreements: A reverse repurchase
agreement involves the sale by the Fund of portfolio assets
concurrently with an agreement by the Fund to repurchase the same
assets at a later date at a fixed price. The Fund will maintain a
segregated account with its custodian, which will be marked to market
daily, consisting of cash, U.S. Government securities or other liquid
high-grade debt obligations equal in value to its obligations under
reverse repurchase agreements. In the event the buyer of securities
under a reverse repurchase agreement files for bankruptcy or becomes
insolvent, the Fund's use of the proceeds of the agreement may be
restricted pending a determination by the other party, or its trustee or
receiver, whether to enforce the Fund's obligation to repurchase the
securities.
10<PAGE>
NOTES TO FINANCIAL STATEMENTS (cont.)
E. Determination Of Gains Or Losses On Sales Of
Securities: Gains or losses on the sale of securities are calculated for
accounting and tax purposes on the identified cost basis.
F. Deferred Organization Expenses: Deferred organization
expenses are being amortized on a straight-line basis over five years.
G. Securities Transactions and Investment Income: Interest
income is accrued daily on both long-term bonds and short-term
investments. Interest income also includes net amortization from the
purchase of fixed-income securities. Discounts and premiums on
securities purchased are amortized over the life of the respective
securities. Transactions are recorded on the first business day
following the trade date. Realized gains and losses from security
transactions are determined and accounted for on the basis of
identified cost.
2. FINANCIAL INSTRUMENTS
A. Derivative Financial Instruments Held or Issued for
Purposes other than Trading: The Fund uses interest rate futures
contracts for risk management purposes in order to manage the Fund's
interest-rate risk relative to its benchmark. Upon entering into a
futures contract, the Fund is required to deposit either cash or
securities in an amount (initial margin) equal to a certain percentage of
the contract value. Subsequent payments (variation margin) are made
or received by the Fund each day. The variation margin payments are
equal to the daily changes in the contract value and are recorded as
unrealized gains or losses. The Fund recognizes a realized gain or loss
when the contract is closed or expires equal to the difference between
the value of the contract at the time it was opened and the value at the
time it was closed.
Futures contracts involve costs and may result in losses. The effective
use of futures strategies depends on the Fund's ability to terminate
futures positions at times when the Fund's investment adviser deems it
desirable to do so. The use of futures also involves the risk of
imperfect correlation among movements in the values of the securities
underlying the futures purchased and sold by the Fund, of the futures
contract itself, and of the securities which are the subject of a hedge.
11<PAGE>
NOTES TO FINANCIAL STATEMENTS (cont.)
The Fund had the following open futures contracts as of March 31,
1997:
Type Notional Position Expiration Unrealized
Amount Month Gain/(Loss)
3 Month Eurodollar $18,000,000 Long June, 1997 $(6,781)
3 Month Eurodollar 9,000,000 Short March, 1998 8,297
3 Month Eurodollar 9,000,000 Short September, 1998 2,210
3 Month Eurodollar 13,000,000 Short March, 1999 9,692
3 Month Eurodollar 9,000,000 Short September, 1999 584
3 Month Eurodollar 12,000,000 Short March, 2000 8,322
3 Month Eurodollar 1,000,000 Short June, 2000 1,845
3 Month Eurodollar 10,000,000 Short September, 2000 10,705
3 Month Eurodollar 13,000,000 Short March, 2001 10,016
10 Year Treasury 400,000 Short June, 1997 5,982
Total $50,872
B. Derivative Financial Instruments Held or Issued for
Trading Purposes:
The Fund invests in futures contracts on the S&P 500 Index and New
York Stock Exchange Index whose returns are expected to track
movements in the S&P 500 Index and New York Stock Exchange
Index.
The Fund had the following open futures contracts on the S&P 500
and New York Stock Exchange Indices as of March 31, 1997:
Type Notional Position Expiration Unrealized
Amount Month Gain/Loss
S&P 500 $10,599,680 Long June, 1997 $(423,940)
S&P 500 2,271,360 Long September, 1997 (134,280)
NYSE 199,275 Long June, 1997 (8,956)
Total $(567,176)
The aggregate market value of investments pledged to cover margin
requirements for the open positions at March 31, 1997 was $691,539.
3. INVESTMENT ADVISORY FEES AND OTHER
TRANSACTIONS WITH AFFILIATES
Smith Breeden Associates, Inc. (the "Adviser"), a registered
investment adviser, provides the Fund with investment management
services. As compensation for these services, the Fund pays the
12<PAGE>
NOTES TO FINANCIAL STATEMENTS (cont.)
Adviser a fee computed daily and payable monthly, at an annual rate
equal to 0.70% of the Fund's average daily net asset value.
The Adviser has voluntarily agreed to reduce or otherwise limit the
expenses of the Fund to 0.88% of the Fund's average daily net assets.
This voluntary agreement may be terminated or modified at any time
by the Adviser in its sole discretion, except that the Adviser has
agreed to limit expenses of the Fund to 0.88% through March 31,
1997. For the year ended March 31, 1997, the Adviser received fees
of $53,341 and reimbursed the Fund $131,965.
Effective August 1, 1994, the Fund adopted a Distribution and
Services Plan (the "Plan") pursuant to Rule 12b-1 under the
Investment Company Act of 1940. The purpose of the Plan is to
permit the Adviser to compensate investment dealers and other
persons involved in servicing shareholder accounts for services
provided and expenses incurred in promoting the sale of shares of the
Fund, reducing redemptions, or otherwise maintaining or improving
services provided to shareholders by such dealers or other persons.
The Plan provides for payments by the Adviser, out of its advisory fee
paid to it by the Fund, to dealers and other persons at the annual rate
of up to 0.25% of the Fund's average net assets subject
to the authority of the Trustees of the Fund to reduce the amount of
payments permitted under the Plan or to suspend the Plan for such
periods as they may determine. Subject to these limitations, the
amount of such payments and the purposes for which they are made
shall be determined by the Adviser.
Certain officers and trustees of the Fund are also officers and directors
of the Adviser.
4. INVESTMENT TRANSACTIONS
During the year-ended March 31, 1997, purchases and proceeds from
sales of securities, other than short-term investments, aggregated
$19,129,765 and $11,798,195, respectively. The cost of securities for
federal income tax purposes is $16,394,418. Net unrealized
depreciation of investments and futures contracts consists of:
Gross unrealized appreciation $ 81,061
Gross unrealized depreciation (569,372)
Net unrealized depreciation $ (488,311)
13<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders,
Smith Breeden Equity Plus Fund of the Smith Breeden Series Trust:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of the Smith Breeden Equity
Plus Fund of the Smith Breeden Series Trust as of March 31, 1997, and
the related statements of operations and cash flows for the year then
ended, the statements of changes in net assets for each of the years in
the two-year period then ended and the financial highlights for each of
the years in the four-year period then ended and the period June 30,
1992 (commencement of operations) to March 31, 1993. These
financial statements and the financial highlights are the responsibility of
the Fund's management. Our responsibility is to express an opinion on
these financial statements and the financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial
statements and the financial highlights are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. Our procedures
included confirmation of securities owned at March 31, 1997 by
correspondence with the custodian and brokers. An audit also includes
assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for
our opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of
the Smith Breeden Equity Plus Fund of the Smith Breeden Series Trust
as of March 31, 1997, the results of its operations and its cash flows,
the changes in its net assets, and the financial highlights for the
respective stated periods in conformity with generally accepted
accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
May 12, 1997
14<PAGE>
SMITH BREEDEN TRUST
SMITH BREEDEN EQUITY PLUS
FORM N-1A
PART C. OTHER INFORMATION
Item 24. Financial Statements and Exhibits.
(a) Financial Statement filed with Part B
(b) Exhibits:
(1) Declaration of Trust:Incorporated by Reference
(2) By-Laws:Incorporated by Reference
(3) Voting Trust Agreement--Not Applicable
(4) Specimen Share Certificate--Incorporated by Reference
(5) Form of Investment Advisory Agreement
for Smith Breeden Trust: Incorporated by Reference
(6) Form of Underwriting or Distribution
Agreement: Incorporated by Reference
(7) Bonus, Profit Sharing, Pension and Other
Similar Arrangements -- Not Applicable
(8) Custodian Agreement: Incorporated by Reference
(9)(a) Shareholder Services Agreement: Incorporated by Reference
(9)(b) Accounting Services Agreement: Incorporated by Reference
(9)(c) Sub-Administration Agreement- Not Applicable
(10) Opinion and Consent of Counsel: Incorporated by Reference
to Pre-Effective Amendment Number 2 filed April 14, 1992
(11) Independent Auditor's Consent
(12) Financial Statements Omitted from Item 23 --
Not Applicable
(13) Letter of Understanding relating to
initial capital--Incorporated by Reference
(14) Model Retirement Plan -- Not Applicable
(15) Form of Rule 12b-1 Plan for Smith
Breeden Trust: Incorporated by Reference
(16) Performance Calculation --
Not Applicable
(17) Powers of Attorney--Incorporated by Reference
(18) Financial Data Schedule
Item 25. Persons Controlled by or under Common Control with Registrant.
There were no persons controlled by under Common Control with Registrant.
Item 26. Number of Holders of Securities.
NUMBER OF RECORD HOLDERS
TITLE OF CLASS AS OF JUNE 30, 1997
Smith Breeden Equity Plus Fund 1314
Shares of Beneficial Interest
Item 27. Indemnification.
Reference is made to Article IV,Sections 4.2 and 4.3 of Registrant's
Declaration of Trust with respect to indemnification of the Trustees and
officers of Registrant against liabilities which may be incurred by them
in such capacities.
Insofar as indemnification for liability arising under the Securities Act
of 1933, as amended (the "Act"), may be permitted to directors, officers and
controlling persons of the Registrant pursuant to the foregoing provisions,
or otherwise, the Registrant has been advised that, in the opinion of the
Securities and Exchange Commission ("SEC"), such indemnification is against
public policy as expressed in the Act, and is therefore, unenforceable.
In the event that a claim for indeminfication against such liabilities
(other than the payment by the Registrant of expenses incurred or paid by
a trustee, an officer or a controlling person of the Registrant in
the successful defense of any action, suit or proceeding) is asserted by
such trustee, officer or controlling person in connection with the
securities being registered, the Registrant will, unless in the opinion
of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed
in the Act and will be governed by the final adjudication of such
issue.
Each disinterested Trustee has entered into an indemnity agreement with
the Adviser whereby the Adviser indemnifies each disinterested Trustee
against defense costs in connection with a civil claim which involves
the Trustee by virtue of his position with the Fund.
Item 28. Business and Other Connections of Adviser.
Smith Breeden Associates, Inc. (the "Adviser") acts as
investment adviser to financial institution, insurance, pension,
charitable foundation clients and other registered investment
companies. For a description of the officers and directors of
the Adviser and their business affiliations, see "Management of
the Fund" in the Prospectus contained within this Registration
Statement.
Item 29. Principal Underwriters
(a) FPS Broker Services, Inc., located at 3200 Horizon Drive,
P.O. Box 61503, King of Prussia, Pennsylvania 19406-0903, is
the principal underwriter. FPS Broker Services also serves
as the Principal Underwriter for the following entities:
The Govett Funds, Inc.
Bjurman Funds
Farrell ALpha Strategies
Focus Trust, Inc.
IAA Trust Growth Fund, Inc.
IAA Trust Asset Allocation Fund, Inc.
IAA Trust Tax Exempt Bond Fund, Inc.
IAA Trust Taxable Fixed Income Series Fund, Inc.
Matthews International Funds
MCM Funds
Metropolitan West Funds
Polynous Trust
Sage/TSO Trust
Smith Breeden Series Fund
Smith Breeden Trust
The Stratton Funds, Inc.
Stratton Growth Fund, Inc.
Stratton Monthly Dividend Shares,Inc.
Trainer Wortham First Mutual Funds.
(b) The table below sets forth certain information as to
the Underwriter's Directors, Officers and Control Persons:
NAME AND PRINCIPAL POSITION AND OFFICES POSITION
BUSINESS ADDRESS WITH UNDERWRITER AND OFFICES
WITH REGISTRANT
Kenneth J. Kempf Director and President None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA
19406-0903
Lynne M. Cannon Vice President and Principal None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA
19406-0903
Rocco C. Cavalieri Director and Vice President None
3200 Horizon Drive
P.O Box 61503
King of Prussia, PA
19406-0903
Gerald J. Holland Director, Senior Vice None
3200 Horizon Drive President and Principal
P.O. Box 61503
King of Prussia, PA
19406-0903
Joseph M. O'Donnell Director and Vice President None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA
19406-0903
Sandra L. Adams Assistant Vice President None
3200 Horizon Drive and Principal
P.O. Box 61503
King of Prussia, PA
19406-0903
John H. Leven Treasurer None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA
19406-0903
Mary P. Efstration Secretary None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA
19406-0903
Bruno DiStefano Principal None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA
19406-0903
James W. Stratton may be considered a control person of the
Underwriter due to his direct or indirect ownership of FPS
Services, Inc., the parent of the Underwriter.
c) Not Applicable.
Item 30. Locations of Accounts and Records.
The accounts, books or other documents required to be
maintained by Section 31(a) of the Investment Company Act of 1940
and the Rules thereunder will be kept by the Registrant at the
following offices:
(1) FPS Services, Inc., 3200 Horizon Drive, P. O. Box
61503, King of Prussia, Pennsylvania 19406-0903
(2) Smith Breeden Associates, Inc., 100 Europa Drive,
Suite 200, Chapel Hill, NC 27514
Item 31. Management Services.
There are no management-related service contracts not
discussed in Part A or Part B.
Item 32. Undertakings.
(a) The Registrant previously has undertaken to promptly
call a meeting of shareholders for the purpose of voting upon the
question of removal of any trustee or trustees when requested in
writing to do so by the record holders of not less than 10
percent of the Registrant's outstanding shares and to assist its
shareholders in accordance with the requirements of Section 16(c)
of the Investment Company Act of 1940 relating to shareholder
communications.
(b) The registrant hereby undertakes to furnish to each
person to whom a prospectus is delivered a copy of the
Registrant's latest annual report to shareholders upon request
and without charge.
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933,
as amended, and the Investment Company Act of 1940, as amended,
the Registrant has duly caused this Amendment
to the Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Chapel Hill,
the State of North Carolina, on the 23rd day of July, 1997.
SMITH BREEDEN TRUST
By
Michael J. Giarla
President
Pursuant to the requirements of the Securities Act of 1933,
this Amendment to the Registration Statement has been signed
below by the following persons in the capacities and on the dates
indicated.
SIGNATURE TITLE DATE
Michael J. Giarla President, July 23, 1997
Trustee
Douglas T. Breeden* Trustee July 23, 1997
Stephen M. Schaefer* Trustee July 23, 1997
Myron S. Scholes* Trustee July 23, 1997
William F. Sharpe* Trustee July 23, 1997
Marianthe S. Mewkill Principal Financial July 23, 1997
and Accounting Officer
* By:
Marianthe S. Mewkill
*Attorney-in-Fact pursuant to power-of-attorney filed previously.
CONSENT OF INDEPENDENT AUDITORS
Smith Breeden Trust:
We consent to the use in Post-Effective Amendment No. 11 to Registration
Statement No. 33-44909 of our report dated May 12, 1997 relating to the
Smith Breeden Equity Plus Fund of Smith Breeden Trust and the Smith Breeden
Short Duration U.S. Government Series and Smith Breeden Intermediate Duration
Series of the Smith Breeden Series Fund incorporated by reference in the
Statement of Additional Information which is a part of such Registration
Statement, and to the references to us under the captions "Experts" appearing
in the Statement of Additional Information and "Financial Highlights"
appearing in the Prospectus, which also is a part of such Registration
Statement.
DELOITTE & TOUCHE LLP
Princeton, New Jersey
July 23, 1997
<TABLE> <S> <C>
<ARTICLE> 6
<SERIES>
<NUMBER> 1
<NAME> SMITH BREEDEN EQUITY PLUS FUND
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> MAR-31-1997
<PERIOD-END> MAR-31-1997
<INVESTMENTS-AT-COST> 16394418
<INVESTMENTS-AT-VALUE> 16422411
<RECEIVABLES> 3162428
<ASSETS-OTHER> 69576
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 19654415
<PAYABLE-FOR-SECURITIES> 5876144
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 270894
<TOTAL-LIABILITIES> 6147038
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 13094357
<SHARES-COMMON-STOCK> 1075509
<SHARES-COMMON-PRIOR> 388529
<ACCUMULATED-NII-CURRENT> 36234
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 865097
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> (488311)
<NET-ASSETS> 13507377
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 473488
<OTHER-INCOME> 0
<EXPENSES-NET> 67402
<NET-INVESTMENT-INCOME> 406086
<REALIZED-GAINS-CURRENT> 1374343
<APPREC-INCREASE-CURRENT> (526585)
<NET-CHANGE-FROM-OPS> 1253844
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 382446
<DISTRIBUTIONS-OF-GAINS> 808371
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 695525
<NUMBER-OF-SHARES-REDEEMED> 102037
<SHARES-REINVESTED> 93492
<NET-CHANGE-IN-ASSETS> 8740843
<ACCUMULATED-NII-PRIOR> 12594
<ACCUMULATED-GAINS-PRIOR> 299125
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 53341
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 199367
<AVERAGE-NET-ASSETS> 7655310
<PER-SHARE-NAV-BEGIN> 12.270
<PER-SHARE-NII> 0.592
<PER-SHARE-GAIN-APPREC> 1.813
<PER-SHARE-DIVIDEND> 0.590
<PER-SHARE-DISTRIBUTIONS> 1.525
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 12.560
<EXPENSE-RATIO> 0.88
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
