<PAGE>
SMITH BREEDEN EQUITY MARKET PLUS FUND
===============================================================================
PERFORMANCE REVIEW
The Smith Breeden Equity Market Plus Fund provided a total return of 45.71%
in the year ending March 31, 1998. The S&P 500 return for the same period was
48.00%. The one-year return on the average Growth and Income Fund was 41.23%, as
measured by Morningstar. This placed the fund in the top 30% of the Growth and
Income category. The five-year return on the Fund was 22.89%, versus 22.38% for
the S&P 500 and 19.31% for the average Growth and Income fund. Since the Fund's
inception on June 30, 1992, its return has exceeded that of the S&P 500 by 1.08%
on an annualized basis. The graph below plots the Fund's return versus its
benchmark and versus the average return of Growth and Income Funds, as measured
by Morningstar.
(graph appears here with the following plot points)
CHANGE IN VALUE OF A $10,000 INVESTMENT
Cumulative Returns (%)-Period Ended March 31, 1998 (1)
Since
Inception
1 yr 5 yr 6/30/92
---- ---- -------
Smith Breeden Equity Market Plus Fund 45.71 22.89 22.85
Morningstar Avg. Growth & Income 41.23 19.31 19.18
S & P 500 48.00 22.38 21.77
<TABLE>
<CAPTION>
Fund Name Sep-92 Dec-92 Mar-93 Jun-93 Sep-93 Dec-93 Mar-94 Jun-94 Sep-94
- --------- ------ ------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Obj: Growth and Income 1.281 1.473 2.462 0.403 -0.157 2.053 -4.188 -2.348 -2.283
2.62% 8.49% 13.37% 14.05% 17.89% 20.52% 16.54% 16.27% 21.23%
$10,262 $10,849 $11,337 $11,405 $11,789 $12,052 $11,654 $11,627 $12,123
Equity Market Plus 1.58% 1.07% 2.56% 0.43% -0.66% 1.27% -5.45% -2.48% -2.09%
5.23% 10.54% 16.52% 18.10% 21.63% 25.15% 19.07% 19.29% 25.13%
$10,523 $11,054 $11,652 $11,810 $12,163 $12,515 $11,907 $11,929 $12,513
S&P 500 1.18% 1.23% 2.11% 0.29% -0.79% 1.21% -4.36% -2.45% -2.44%
3.16% 8.36% 13.09% 13.63% 16.54% 19.25% 14.71% 15.20% 20.83%
$10,316 $10,836 $11,309 $11,363 $11,654 $11,925 $11,471 $11,520 $12,083
Fund Name Dec-94 Mar-95 Jun-95 Sep-95 Dec-95 Mar-96 Jun-96 Sep-96 Dec-96
- --------- ------ ------ ------ ------ ------ ------ ------ ------ ------
Obj: Growth and Income 1.099 2.585 2.145 3.262 1.691 1.203 -0.22 4.842 -1.253
19.45% 29.34% 39.82% 50.13% 57.62% 66.40% 72.03% 77.27% 90.72%
$11,945 $12,934 $13,982 $15,013 $15,762 $16,640 $17,203 $17,727 $19,072
Equity Market Plus 2.16% 2.98% 1.54% 4.41% 1.33% 1.15% 1.12% 5.61% -1.49%
27.45% 39.53% 52.39% 66.00% 74.30% 84.59% 93.50% 99.03% 116.77%
$12,745 $13,953 $15,239 $16,600 $17,430 $18,459 $19,350 $19,903 $21,677
S&P 500 1.49% 2.95% 2.32% 4.22% 1.93% 0.96% 0.38% 5.63% -1.98%
20.82% 32.58% 45.23% 56.78% 66.22% 75.14% 83.00% 88.67% 104.41%
$12,082 $13,258 $14,523 $15,678 $16,622 $17,514 $18,300 $18,867 $20,441
Fund Name Mar-97 YTD 1YR 3YR LIFE
- --------- ------ --- --- --- ----
Obj: Growth and Income -3.749
93.20% 1.30% 16.10% 18.35% 14.87%
$19,320
Equity Market Plus -3.98%
124.11%
$22,411
S&P 500 -4.11%
109.88%
$20,988
</TABLE>
Morning. EQ+ S&P
-------- --- ---
6/30/92 $10,000 $10,000 $10,000
9/30/92 $10,263 $10,523 $10,316
12/31/92 $10,855 $11,054 $10,836
3/31/93 $11,343 $11,652 $11,309
6/30/93 $11,420 $11,810 $11,363
9/30/93 $11,808 $12,163 $11,654
12/31/93 $12,070 $12,515 $11,925
3/31/94 $11,671 $11,907 $11,471
6/30/94 $11,647 $11,929 $11,520
9/30/94 $12,144 $12,513 $12,083
12/31/94 $11,969 $12,745 $12,082
3/31/95 $12,963 $13,953 $13,258
6/30/95 $14,015 $15,239 $14,523
9/30/95 $15,053 $16,600 $15,678
12/31/95 $15,808 $17,430 $16,622
3/31/96 $16,690 $18,459 $17,514
6/30/96 $17,263 $19,350 $18,300
9/30/96 $17,799 $19,903 $18,867
12/31/96 $19,153 $21,677 $20,441
3/31/97 $19,416 $22,411 $20,988
6/30/97 $22,272 $26,217 $24,653
9/30/97 $24,199 $28,033 $26,500
12/31/97 $24,486 $28,676 $27,261
3/31/98 $27,421 $32,655 $31,063
(1) Fund Returns are net of fees and sales charges. Index returns are market
returns without deduction of fees or rebalancing transaction costs.
Past performance is no guarantee of future results.
With strong growth in the economy, average earnings for companies in the
S&P 500 grew by about 8% in the year to March 31, 1998. This level of earnings
growth is in line with the average annual growth in earnings for recent decades.
The factor primarily responsible for the outstanding stock market performance
was the decline in interest rates. The yield on the thirty-year U.S. Treasury
Bond fell from 7.09% at March 31, 1997 to 5.94% at March 31, 1998. An investment
in stocks is in some respects similar to an investment in a long-term bond: with
both, the investor is buying a series of future cash flows. In the case of
bonds, the investor is buying future coupon payments. In the case of stocks, the
investor buys future earnings of the company. When interest rates fall, the bond
investor is willing to pay more for future coupon payments. Likewise when
interest rates fall, the stock investor is willing to pay more for future
earnings, and so the price of stocks generally rises.
The Equity Market Plus Fund invests in a combination of fixed income
securities and S&P 500 Index futures contracts. The return on S&P 500 futures
contracts generally tracks the return on the S&P 500 index, less an implied
funding cost. The advantage in using futures is that no initial investment is
required to purchase a futures contract, beyond the requirement to deposit cash
or Treasury Bills worth about 4% of the value of the contract with the broker.
This leaves 96% of the Fund's assets available for investment in other
securities. The objective of the fixed-income segment of the Fund is to provide
a return, after expenses, exceeding the implied funding cost of the futures
contracts.
25
<PAGE>
SMITH BREEDEN EQUITY MARKET PLUS FUND
===============================================================================
We invested the fixed-income segment of the fund in a combination of
fixed-rate mortgages, adjustable-rate mortgages and money-market investments. In
addition, interest rate futures and options were used to reduce the interest
rate risk of the fixed income segment to a cash-equivalent level. We held the
weighting in fixed-rate mortgages, which have higher prepayment risk than
adjustable-rate mortgages, below 20% of assets through late 1997. As mortgage
prices adjusted to reflect the higher prepayment risk created by the fall in
interest rates, the fixed-rate sector became relatively more attractive, and we
increased the fund holdings to 38% of net assets as of March 31, 1998. The level
of cash in the fund remained at about 20% during the year.
The Fund grew by a factor of ten in the year, with net assets rising from
$13 million at March 31, 1997 to $136 million at March 31, 1998. The Fund was
successful in investing those large new inflows quickly at a very competitive
rate of return.
26
<PAGE>
<TABLE>
<S> <C>
SMITH BREEDEN EQUITY MARKET PLUS FUND
===================================================================================================================================
SCHEDULE OF INVESTMENTS MARCH 31, 1998
Market
Face Amount Security Value
------------- -------- ----------
U.S. GOVERNMENT & AGENCY OBLIGATIONS -- 79.41%
Freddie Mac -- 22.72% (1)
FH Gold
$3,000,000 6.00%, due date to be announced............................................... $2,956,523
20,000,000 6.50%, due date to be announced............................................... 20,073,437
8,032,880 6.50%, due 4/1/13 to 12/1/27.................................................. 7,954,493
69,434 9.50%, due 7/1/02............................................................. 71,785
-----------
31,056,238
-----------
Fannie Mae -- 7.82% (1)
FN
10,000,000 7.00%, due date to be announced............................................... 10,087,891
90,361 12.50%, due 9/1/12............................................................ 103,883
62,799 13.50%, due 1/1/15............................................................ 73,181
FN ARM
411,705 7.732%, due 9/1/18............................................................ 428,714
----------
10,693,669
----------
Government National Mortgage Association -- 45.70% (1)
GNMA
5,000,000 7.00%, due 3/15/28............................................................ 5,053,730
4,796,293 7.50%, due 9/15/27 to 12/15/27................................................ 4,920,882
GNMA ARM
22,500,292 5.00%, due 1/20/28 to 3/20/28................................................. 22,392,086
3,000,000 5.00%, due date to be announced............................................... 2,984,531
18,830,860 5.50%, due 10/20/27 to 3/20/28................................................ 18,938,435
4,928,547 6.00%, due 1/20/28............................................................ 5,000,207
1,678,743 7.00%, due 2/20/16 to 9/20/22................................................. 1,722,673
1,403,411 7.375%, due 5/20/16 to 5/20/22................................................ 1,442,494
----------
62,455,038
----------
U.S. Treasury Obligations -- 3.17% (2)
400,000 5.11% Bill, due 8/20/98 (3)................................................... 392,026
800,000 5.14% Bill, due 10/15/98 (3).................................................. 777,717
750,000 5.20% Bill, due 5/28/98 (3)................................................... 743,825
500,000 5.25% Bill, due 8/20/98 (3)................................................... 490,032
100,000 5.32% Bill, due 5/28/98 (3)................................................... 99,200
830,000 5.52% Bill, due 5/28/98 (3)................................................... 823,363
1,000,000 5.50% Note, due 11/15/98 (3).................................................. 1,000,000
-----------
4,326,163
-----------
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(Cost $108,614,137)........................................................... 108,531,108
-----------
</TABLE>
27
<PAGE>
<TABLE>
<S> <C>
SMITH BREEDEN EQUITY MARKET PLUS FUND
====================================================================================================================================
SCHEDULE OF INVESTMENTS (continued) MARCH 31, 1998
Market
Contracts Security Value
----------- -------- -----------
Options Contracts -- 0.09%
115 Call on Ten-Year US Treasury Note Futures, expires 5/98, strike price
$114.0............................................................................ $28,751
60 Call on Ten-Year US Treasury Note Futures, expires 5/98, strike price
$117.0............................................................................ 1,875
91 Put on Five-Year US Treasury Note Futures, expires 5/98, strike price
$107.5............................................................................ 12,787
60 Put on Five-Year US Treasury Note Futures, expires 5/98, strike price
$108.0............................................................................ 14,053
153 Put on Five-Year US Treasury Note Futures, expires 5/98, strike price
$108.5............................................................................ 59,766
-----------
Total Options Contracts (Cost $211,000)............................................ 117,252
-----------
Total Investments (Cost $108,825,137)--78.50%...................................... 108,648,360
Face Amount Repurchase Agreements -- 44.63%
- -----------
$33,500,000 Merrill Lynch, 5.84%, due 4/6/99 dated 3/30/98..................................... 33,500,000
27,500,000 Dresdner Kleinworth Benson, 5.80%, due 4/2/98 dated 3/26/98........................ 27,500,000
------------
61,000,000
------------
Liabilities, Less Cash and Other Assets -- (24.13%)................................ (32,980,921)
-------------
NET ASSETS -- 100.00%.............................................................. $138,667,439
============
(1) Mortgage-backed obligations are subject to principal paydowns as a result
of prepayments or refinancings of the underlying mortgage instruments. As a
result, the average life may be substantially less than the original
maturity. ARMs have coupon rates that adjust periodically. The interest
rate shown is the rate in effect at March 31, 1998. The adjusted rate is
determined by adding a spread to a specified index.
(2) The interest rate shown for U.S. Treasury Bills is the discount rate paid
at the time of purchase by the Fund.
(3) Security is held as collateral by Carr Futures, Inc.
Portfolio Abbreviations:
ARM -- Adjustable-Rate Mortgage
FH -- Freddie Mac
FN -- Fannie Mae
GNMA -- Government National Mortgage Association
===================================================================================================================================
The accompanying notes are an integral part of these financial statements.
</TABLE>
28
<PAGE>
<TABLE>
<S> <C>
SMITH BREEDEN EQUITY MARKET PLUS FUND
================================================================================================================================
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 1998
Assets
Investments at market value (identified cost $108,825,137) (Note 1)................................. $108,648,360
Cash................................................................................................ 118,315
Repurchase Agreements (Cost $61,000,000) (Note 1)................................................... 61,000,000
Receivables:
Variation margin on futures contracts (Note 2).................................................... 1,644,132
Subscriptions..................................................................................... 1,231,913
Interest.......................................................................................... 483,578
Maturities........................................................................................ 1,096
Securities sold................................................................................... 10,152,396
Other Assets........................................................................................ 11,697
------------
Total Assets...................................................................................... 183,291,487
------------
Liabilities
Payables:
Redemptions....................................................................................... 78,039
Securities purchased.............................................................................. 46,395,547
Due to Advisor (Note 3)............................................................................. 46,231
Accrued expenses.................................................................................... 104,231
-----------
Total Liabilities................................................................................. 46,624,048
-----------
Net Assets
(Applicable to outstanding shares of 8,107,634; unlimited number of shares of beneficial
interest authorized; no stated par)............................................................... $136,667,439
============
Net asset value, offering price and redemption price per share ($136,667,439 / 8,107,634) $16.86
============
Source of Net Assets
Paid in capital..................................................................................... $119,446,947
Undistributed net investment income................................................................. 312,398
Accumulated net realized gain on investments........................................................ 7,822,813
Net unrealized appreciation of investments.......................................................... 9,085,281
------------
Net Assets........................................................................................ $136,667,439
============
===================================================================================================================================
The accompanying notes are an integral part of these financial statements.
</TABLE>
29
<PAGE>
<TABLE>
<S> <C>
SMITH BREEDEN EQUITY MARKET PLUS FUND
==================================================================================================================================
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1998
Investment Income
Interest and discount earned, net of premium amortization (Note 1)................................ $3,441,096
Expenses
Advisory fees (Note 3)............................................................................ 423,706
Accounting and pricing services fees.............................................................. 42,554
Custodian fees.................................................................................... 30,546
Audit and tax preparation fees.................................................................... 24,323
Legal fees........................................................................................ 19,115
Amortization of organization expenses (Note 1).................................................... 6,929
Transfer agent fees............................................................................... 78,658
Registration fees................................................................................. 78,391
Trustees fees and expenses........................................................................ 30,267
Insurance expense................................................................................. 9,338
Other............................................................................................. 3,881
----------
Total Expenses Before Reimbursement............................................................ 747,708
Expenses reimbursed by Advisor (Note 3)........................................................ (215,049)
----------
Net Expenses................................................................................... 532,659
----------
Net Investment Income.......................................................................... 2,908,437
----------
Realized and Unrealized Gain on Investments
Net realized gain on investments.................................................................. 9,514,596
Change in unrealized appreciation (depreciation) of investments................................... 9,573,592
-----------
Net realized and unrealized gain on investments................................................... 19,088,188
-----------
Net increase in net assets resulting from operations.............................................. $21,996,625
===========
===================================================================================================================================
The accompanying notes are an integral part of these financial statements.
</TABLE>
30
<PAGE>
<TABLE>
<S> <C>
SMITH BREEDEN EQUITY MARKET PLUS FUND
====================================================================================================================================
STATEMENTS OF CHANGES IN NET ASSETS
Year Ended Year Ended
March 31, 1998 March 31, 1997
-------------- ---------------
Operations
Net investment income............................................................ $2,908,437 $406,086
Net realized gain on investments................................................. 9,514,596 1,374,343
Change in unrealized appreciation (depreciation) of investments.................. 9,573,592 (526,585)
-------------- -------------
Net increase in net assets resulting from operations............................. 21,996,625 1,253,844
-------------- -------------
Distributions to Shareholders
Dividends from net investment income............................................. (2,632,273) (382,446)
Distributions from net realized gains on investments............................. (2,556,880) (808,371)
-------------- --------------
Total distributions.............................................................. (5,189,153) (1,190,817)
--------------- -------------
Capital Share Transactions
Shares sold...................................................................... 123,373,056 8,844,701
Shares issued on reinvestment of distributions................................... 4,918,950 1,125,870
Shares redeemed.................................................................. (21,939,416) (1,292,755)
--------------- -------------
Increase in net assets resulting from capital share transactions (a)............. 106,352,590 8,677,816
-------------- -------------
Total Increase in Net Assets................................................... 123,160,062 8,740,843
Net Assets
Beginning of period.............................................................. 13,507,377 4,766,534
-------------- ------------
End of period.................................................................... $136,667,439 $13,507,377
============== ============
(a) Transactions in capital shares were as follows:
Shares sold....................................................................... 8,130,007 695,525
Shares issued on reinvestment of distributions.................................... 330,714 93,492
Shares redeemed................................................................... (1,428,596) (102,037)
-------------- ------------
Net increase...................................................................... 7,032,125 686,980
Beginning balance................................................................. 1,075,509 388,529
-------------- ------------
Ending balance.................................................................... 8,107,634 1,075,509
============== ============
===================================================================================================================================
The accompanying notes are an integral part of these financial statements.
</TABLE>
31
<PAGE>
<TABLE>
<S> <C>
SMITH BREEDEN EQUITY MARKET PLUS FUND
===================================================================================================================================
FINANCIAL HIGHLIGHTS
The following average per share data, ratios and supplemental information has
been derived from information provided in the financial statements.
Year Year Year Year Year Period
Ended Ended Ended Ended Ended Ended
March 31, March 31, March 31, March 31, March 31, March 31,
1998 1997 1996 1995 1994 1993 (1)
---------- ----------- ----------- ----------- ----------- ------------
Net Asset Value, Beginning
of Period..................... $12.56 $12.27 $10.84 $9.88 $10.85 $10.00
------ ------ ------ ----- ------ ------
INCOME FROM INVESTMENT
OPERATIONS
Net investment income......... 0.591 0.592 0.615 0.568 0.476 0.355
Net realized and
unrealized gain (loss) on
investments................. 4.940 1.813 2.768 1.081 (0.216) 1.281
----- ----- ----- ----- ------- -----
Total from investment
operations.................. 5.531 2.405 3.383 1.649 0.260 1.636
LESS DISTRIBUTIONS
Dividends from net
investment income........... (0.586) (0.590) (0.583) (0.568) (0.472) (0.311)
Dividends in excess of net
investment income........... -- -- -- (0.001) -- --
Distributions from net
realized gains on
investments................. (0.645) (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......... (1.231) (2.115) (1.953) (0.689) (1.230) (0.786)
------- ------- ------- ------- ------- -------
Net Asset Value, End of
Period........................ $16.86 $12.56 $12.27 $10.84 $9.88 $10.85
------ ------ ------- ------- ----- -------
Total Return................... 45.71% 21.41% 32.30% 17.18% 2.19% 16.52%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period..... $136,667,439 $13,507,377 $4,766,534 $2,107,346 $1,760,519 $903,846
Ratio of expenses to
average net assets.......... 0.88% 0.88% 0.90% 0.90% 0.90% 0.57%*
Ratio of net investment
income to average net
assets...................... 4.79% 5.30% 5.53% 7.44% 8.02% 5.28%*
Portfolio turnover rate....... 424% 182% 107% 120% 119% 271%
Ratio of expenses to
average net assets
before reimbursement of
expenses by the Advisor 1.23% 2.60% 4.58% 7.75% 7.08% 28.48%*
Ratio of net investment
income to average net
assets before
reimbursement of
expenses by the Advisor 4.44% 3.58% 1.85% 0.59% 1.84% -22.63%*
- -------------------------
(1) Commenced operations June 30, 1992.
* Annualized
====================================================================================================================================
The accompanying notes are an integral part of these financial statements.
</TABLE>
32
<PAGE>
SMITH BREEDEN EQUITY MARKET PLUS FUND
===============================================================================
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Breeden Trust (the "Trust") is an open-end, diversified management
investment company registered under the Investment Company Act of 1940, as
amended. The Fund offers shares in two series: the Smith Breeden Equity Market
Plus Fund (the "Fund", formerly the Smith Breeden Equity Plus Fund) and the
Smith Breeden Financial Services Fund. The following is a summary of accounting
policies consistently followed by the Fund.
A. Security Valuation: Portfolio securities are valued at the 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. Repurchase Agreements: Repurchase agreements may be entered into with member
banks of the Federal Reserve System with 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 the securities collateralizing the
repurchase agreement until maturity. The value of the collateral is monitored
daily, and, if necessary, additional collateral is received to ensure that the
market value of the collateral 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.
C. Reverse Repurchase Agreements: A reverse repurchase agreement involves the
sale of portfolio assets together with an agreement to repurchase the same
assets later at a fixed price. Additional assets are maintained in a segregated
account with the custodian, and are marked to market daily. The segregated
assets may consist of cash, U.S. Government securities, or other liquid
high-grade debt obligations equal in value to the obligations under the reverse
repurchase agreements. In the event the buyer of securities under a reverse
repurchase agreement files for bankruptcy or becomes insolvent, the Fund's use
of the proceeds under the agreement may be restricted pending a determination by
the other party, or its trustee or receiver, whether to enforce the obligation
to repurchase the securities.
D. Dollar Roll Agreements: A dollar roll is an agreement to sell securities for
delivery in the current month and to repurchase substantially similar (same type
and coupon) securities on a specified future date. During the roll period,
principal and interest paid on these securities are not received. 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
earnings on the cash proceeds of the initial sale.
E. 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, 1998, the Fund had no net capital
loss carryforward.
F. Securities Transactions, Investment Income and Expenses: Interest income is
accrued daily, and 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. Securities transactions are recorded on
the trade date. Gains or losses on the sale of securities are calculated for
accounting and tax purposes on the identified cost basis.
Expenses are accrued daily. Common expenses incurred by the Trust are allocated
among the funds comprising the Trust based on the ratio of net assets of each
fund to the combined net assets of the Trust. Other expenses are charged to each
fund on a specific identification basis.
G. Deferred Organization Expenses: Deferred organization expenses are being
amortized on a straight-line basis over five years.
33
<PAGE>
SMITH BREEDEN EQUITY MARKET PLUS FUND
================================================================================
NOTES TO FINANCIAL STATEMENTS (continued)
1. SIGNIFICANT ACCOUNTING POLICIES -- Continued H. Accounting Estimates: The
preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the amounts of income and expense during the reporting
period. Actual results could differ from those estimates.
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 reduce fluctuations in the Fund's net asset value relative
to its targeted option-adjusted duration. On entering into a futures contract,
either cash or securities in an amount equal to a certain percentage of the
contract value (initial margin) must be deposited with the futures broker.
Subsequent payments (variation margin) are made or received by the Fund each
day. The variation margin payments equal 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 transactions involve costs and may result in losses. The effective use
of futures depends on the Fund's ability to close futures positions at times
when the Fund's Advisor 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.
<TABLE>
<S> <C>
The Fund had the following open futures contracts as of March 31, 1998:
Number of Expiration Unrealized
Type Contracts Position Month Gain/(Loss)
- ---- --------- -------- ----------- ------------
3 Month Eurodollar.................... 210 Long June, 1998 $(48,195)
3 Month Eurodollar.................... (103) Short September, 1998 (53,501)
3 Month Eurodollar.................... (85) Short March, 1999 (45,358)
3 Month Eurodollar.................... (108) Short September, 1999 (65,261)
3 Month Eurodollar.................... (56) Short March, 2000 (55,152)
3 Month Eurodollar.................... (109) Short September, 2000 (72,265)
3 Month Eurodollar.................... (45) Short March, 2001 (54,378)
3 Month Eurodollar.................... (105) Short September, 2001 (86,272)
3 Month Eurodollar.................... (32) Short March, 2002 (9,894)
3 Month Eurodollar.................... (99) Short September, 2002 5,729
3 Month Eurodollar.................... (24) Short March, 2003 (1,458)
3 Month Eurodollar.................... (15) Short March, 2004 3,683
3 Month Eurodollar.................... (14) Short March, 2005 2,737
5 Year Treasury....................... (51) Short June, 1998 24,177
10 Year Treasury...................... (28) Short June, 1998 25,374
----------
Total $(430,034)
==========
</TABLE>
34
<PAGE>
<TABLE>
<S> <C>
SMITH BREEDEN EQUITY MARKET PLUS FUND
===================================================================================================================================
NOTES TO FINANCIAL STATEMENTS (continued)
B. Derivative Financial Instruments Held or Issued for Trading Purposes: The
Fund invests in futures contracts on the S&P 500 Index whose returns are
expected to track movements in the S&P 500 Index.
The Fund had the following open futures contracts on the S&P 500 Index as of
March 31, 1998:
Number of Expiration Unrealized
Type Contracts Position Month Gain
- ----- ---------- -------- ------------- ---------
S&P 500.................... 202 Long June, 1998 $4,923,564
S&P 500.................... 297 Long September, 1998 4,768,528
-----------
Total $9,692,092
==========
</TABLE>
The aggregate market value of investments pledged to cover margin requirements
for the open positions at March 31, 1998 was $4,326,163.
3. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES
Smith Breeden Associates, Inc. (the "Advisor"), a registered Investment Advisor,
provides the Fund with investment management services. As compensation for these
services, the Fund pays the Advisor a fee computed daily and payable monthly, at
an annual rate equal to 0.70% of the Fund's average daily net assets.
The Advisor 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 Advisor in its sole
discretion, except that the Advisor has agreed to limit expenses of the Fund to
0.88% through August 1, 1998. For the year ended March 31, 1998, the Advisor
received fees of $423,706 and reimbursed the Fund $215,049.
The Fund has adopted a Distribution and Services Plan (the "Plan") under Rule
12b-1 under the Investment Company Act of 1940. The purpose of the Plan is to
permit the Advisor 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 Advisor, out of the
advisory fee 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 Advisor shall determine the amount of such payments and the purposes for
which they are made.
Certain officers and trustees of the Fund are also officers and directors of the
Advisor.
4. INVESTMENT TRANSACTIONS
During the year ended March 31, 1998, purchases and proceeds from sales of
securities, other than short-term investments, aggregated $297,189,593 and
$202,355,199, respectively. The cost of securities for federal income tax
purposes is $108,825,137.
Net unrealized depreciation of investments and futures contracts consists of:
Gross unrealized appreciation $10,045,826
Gross unrealized depreciation (960,545)
-----------
Net unrealized depreciation $9,085,281
===========
35
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders, Smith Breeden Equity Market Plus Fund of
the Smith Breeden Series Trust:
We have audited the accompanying statements of assets and liabilities, including
the schedule of investments, of the Smith Breeden Equity Market Plus Fund
(formerly "Equity Plus Fund") of the Smith Breeden Series Trust (the "Fund") as
of March 31, 1998, and the related statements of operations 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 five-year period presented. 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, 1998 by correspondence with the custodian and brokers, and where replies
were not received, we performed other auditing procedures. 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, such financial statements and financial highlights referred to
above present fairly, in all material respects, the financial positions of the
Smith Breeden Equity Market Plus Fund of the Smith Breeden Series Trust as of
March 31, 1998, the results of its operations, 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 15, 1998
36
<PAGE>
SMITH BREEDEN FINANCIAL SERVICES FUND
===============================================================================
PERFORMANCE REVIEW
Since it commenced operations on December 22, 1997, through March 31, 1998,
The Smith Breeden Financial Services Fund generated a total return of 11.78%.
The return on the Lipper Analytical Financial Services Fund Index was 12.02% for
the same period. The graph below shows the return on the Fund as compared to an
investment in the funds underlying the Lipper Analytical Index and in the S&P
500.
(graph appears here with the following plot points)
CHANGE IN VALUE OF A $10,000 INVESTMENT
Cumulative Returns (%)-Period Ended March 31, 1998 (1)
Since
Inception
12/22/97
Smith Breeden Financial Services Fund 11.78
Lipper Fin. Svs. Fund Index 12.02
S & P 500 16.01
<TABLE>
<CAPTION>
<S> <C>
12/22/97 12/31/97 01/31/98 02/98/98 03/31/98
Lipper Fin. Svs. Fund Index 10,000 10,201 9,849 10,646 11,202
Smith Breeden Financial Services 10,000 10,100 9,544 10,344 11,178
S & P 500 10,000 10,181 10,293 11,036 11,601
</TABLE>
January proved to be a difficult month, with the stocks of money-center
banks suffering from fears that earnings would be weak due to the effect of the
Asian financial crisis. We weighted this sector relatively heavily in the Fund
on the belief that the ongoing consolidation and restructuring in the industry
would particularly benefit those stocks. Reported earnings in fact showed little
effect from Asia, and the sector recovered rapidly.
The stocks contributing the most to the total return of the Fund in the
first quarter of 1998 were, in order: H.F. Ahmanson, Chase Manhattan Bank, Banc
One, and Lehman Brothers.
H.F. Ahmanson announced a merger with Washington Mutual Savings in March.
The market received news of the merger, which will create a dominant thrift in
the Northwest, very favorably. Ahmanson's stock rose 16.2% in the quarter. The
Fund owned both Ahmanson and Washington Mutual stock, and together they
accounted for about 16% of gains generated in the period.
Chase Manhattan Bank suffered from the "Asian flu" in January, but it posted
earnings which were stronger than expected while also announcing a major
restructuring, and the stock quickly rallied. Chase stock gained 23.9% in the
quarter, and accounted for about 10% of the total gains generated by the Fund.
37
<PAGE>
SMITH BREEDEN FINANCIAL SERVICES FUND
===============================================================================
Banc One is a "super-regional" bank, which has grown in the past through
acquisition of local banking franchises. The bank announced a major change in
its management approach in the quarter. Where formerly it operated as a loose
alliance of local banks, it proposed to reorganize around lines of business.
Banc One accounted for 8% of gains in the Fund and rose 28.9% in the quarter.
Lehman Brothers is a dominant firm in bond underwriting. Corporations have
been issuing new debt at record levels and Lehman was a major beneficiary, with
its stock climbing 47%. Lehman Brothers accounted for 7% of the Fund's gains.
The U.S. financial services industry is undergoing a secular change, which
we believe will continue to create opportunities for management to enhance
shareholder value. The forces driving this change include the repeal of
depression-era regulations, the on-going effort to enhance returns from the
industry's huge investment in information technology, and a shift from interest
income to fee-based income. We believe this process will allow valuations of
firms in the industry to rise relative to the stock market as a whole, and
consequently for the sector to provide superior risk-adjusted returns to
investors.
38
<PAGE>
<TABLE>
<S> <C>
SMITH BREEDEN FINANCIAL SERVICES FUND
===================================================================================================================================
SCHEDULE OF INVESTMENTS MARCH 31, 1998
Market
Shares Security Value
------ --------- --------
EQUITY HOLDINGS -- 98.4%
Commercial Banking -- 33.7%
6,000 Crestar Financial Corp............................................................ $354,750
3,200 Fleet Financial Group, Inc........................................................ 272,200
7,000 KeyCorp........................................................................... 264,687
10,000 Mercantile Bancorporation......................................................... 548,125
14,000 Pacific Century Financial Corp.................................................... 333,375
6,000 PNC Bank Corp..................................................................... 359,625
1,000 Wells Fargo & Co.................................................................. 331,250
----------
2,464,012
----------
Investment Banking and Brokerage -- 4.1%
4,000 Lehman Brothers, Inc.............................................................. 299,500
----------
299,500
----------
Money Center Banking -- 27.7%
4,950 Banc One Corp..................................................................... 313,088
3,500 BankAmerica Corp.................................................................. 289,188
3,500 Chase Manhattan Corp.............................................................. 472,062
3,000 First Chicago NBD Corp............................................................ 264,375
2,400 J.P. Morgan & Co., Inc............................................................ 322,350
5,000 NationsBank Corp.................................................................. 364,688
----------
2,025,751
----------
Investment Management and Advisory -- 9.6%
10,500 (2) PIMCO Advisors Holdings LP........................................................ 351,750
5,000 Price (T. Rowe) Assoc., Inc....................................................... 351,875
----------
703,625
----------
Consumer Finance -- 3.8%
2,000 Household International, Inc...................................................... 275,500
----------
275,500
----------
Savings & Loans -- 19.5%
17,000 FirstFed America Bancorp, Inc. (1)................................................ 359,125
3,500 Golden West Financial Corp........................................................ 335,343
4,200 HF Ahmanson & Co.................................................................. 325,500
12,000 Marion Capital Holdings, Inc...................................................... 337,500
6,700 Piedmont Bancorp, Inc............................................................. 72,025
---------
1,429,493
---------
TOTAL EQUITY HOLDINGS (Cost $6,518,572)........................................... 7,197,881
---------
Cash and Other Assets Less Liabilities -- 1.6%.................................... 118,835
---------
NET ASSETS -- 100.0%.............................................................. $7,316,716
==========
- ----------------
(1) Non-income producing security
(2) Limited partnership units
==================================================================================================================================
The accompanying notes are an integral part of these financial statements.
</TABLE>
39
<PAGE>
<TABLE>
<S> <C>
SMITH BREEDEN FINANCIAL SERVICES FUND
==================================================================================================================================
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 1998
Assets
Investments at market value (identified cost $6,518,572) (Note 1)...................................... $7,197,881
Cash................................................................................................... 17,488
Receivables:
Variation margin on futures contracts (Note 2)....................................................... 18,250
Subscriptions........................................................................................ 15,000
Dividends............................................................................................ 13,153
Due from Advisor (Note 3)............................................................................ 2,987
Securities sold...................................................................................... 37,691
Deferred organization expenses (Note 1).............................................................. 7,175
Prepaid Expenses..................................................................................... 19,787
Other Assets........................................................................................... 3,346
----------
Total Assets......................................................................................... 7,332,758
----------
Liabilities
Accrued expenses....................................................................................... 16,042
---------
Total Liabilities.................................................................................... 16,042
---------
Net Assets
(Applicable to outstanding shares of 727,608; unlimited number of shares of beneficial
interest authorized; no stated par).................................................................. $7,316,716
==========
Net asset value, offering price and redemption price per share ($7,316,716 / 727,608) ... $ 10.06
==========
Source of Net Assets
Paid in capital........................................................................................ $6,575,099
Undistributed net investment income.................................................................... 12,416
Accumulated net realized gain on investments........................................................... 50,407
Net unrealized appreciation of investments............................................................. 678,794
----------
Net Assets........................................................................................... $7,316,716
==========
===================================================================================================================================
The accompanying notes are an integral part of these financial statements.
</TABLE>
40
<PAGE>
SMITH BREEDEN FINANCIAL SERVICES FUND
==============================================================================
STATEMENT OF OPERATIONS
FOR THE PERIOD ENDED MARCH 31, 1998
(COMMENCEMENT OF OPERATIONS WAS ON DECEMBER 22, 1997)
Investment Income
Dividends and interest earned (Note 1)..................... $35,567
Expenses
Advisory fees (Note 3)..................................... 23,152
Accounting and pricing services fees....................... 6,903
Custodian fees............................................. 2,719
Audit and tax preparation fees............................. 2,490
Legal fees................................................. 931
Amortization of organization expenses (Note 1)............. 378
Transfer agent fees........................................ 6,696
Registration fees.......................................... 5,948
Trustees fees and expenses................................. 456
Insurance expense.......................................... 293
Other...................................................... 51
---------
Total Expenses Before Reimbursement..................... 50,017
Expenses reimbursed by Advisor (Note 3)................. (26,865)
---------
Net Expenses............................................ 23,152
---------
Net Investment Income................................... 12,415
---------
Realized and Unrealized Gain on Investments
Net realized gain on investments........................... 50,408
Net unrealized appreciation of investments................. 678,794
---------
Net realized and unrealized gain on investments............ 729,202
---------
Net increase in net assets resulting from operations....... $741,617
=========
==============================================================================
The accompanying notes are an integral part of these financial statements.
41
<PAGE>
<TABLE>
<S> <C>
SMITH BREEDEN FINANCIAL SERVICES FUND
====================================================================================================================
STATEMENT OF CHANGES IN NET ASSETS
Period Ended
March 31, 1998(1)
Operations
Net investment income........................................................................... $12,415
Net realized gain on investments................................................................ 50,408
Net unrealized appreciation of investments...................................................... 678,794
---------
Net increase in net assets resulting from operations............................................ 741,617
---------
Distributions to Shareholders
Dividends from net investment income............................................................ --
Distributions from net realized gains on investments............................................ --
---------
Total distributions............................................................................. --
---------
Capital Share Transactions
Shares sold..................................................................................... 6,588,508
Shares issued on reinvestment of distributions.................................................. --
Shares redeemed................................................................................. (13,409)
---------
Increase in net assets resulting from capital share transactions (a)............................ 6,575,099
---------
Total Increase in Net Assets.................................................................. 7,316,716
Net Assets
Beginning of period............................................................................. --
----------
End of period................................................................................... $7,316,716
==========
(a) Transactions in capital shares were as follows:
Shares sold.................................................................................... 729,112
Shares issued on reinvestment of distributions................................................. --
Shares redeemed................................................................................ (1,504)
----------
Net increase....................................................................................... 727,608
Beginning balance.................................................................................. --
---------
Ending balance..................................................................................... 727,608
=========
- --------------------
(1) Commenced operations on December 22, 1997.
==================================================================================================================================
The accompanying notes are an integral part of these financial statements.
</TABLE>
42
<PAGE>
<TABLE>
<S> <C>
SMITH BREEDEN FINANCIAL SERVICES FUND
==================================================================================================================================
FINANCIAL HIGHLIGHTS
The following average per share data, ratios and supplemental information has
been derived from information provided in the financial statements.
Period Ended
March 31, 1998 (1)
------------------
Net Asset Value, Beginning of Period............................................................... $ 9.00
-----------
INCOME FROM INVESTMENT OPERATIONS
Net investment income............................................................................ 0.017
Net realized and unrealized gain (loss) on investments........................................... 1.043
-----------
Total from investment operations............................................................... 1.060
-----------
LESS DISTRIBUTIONS
Dividends from net investment income............................................................. --
Dividends in excess of net investment income..................................................... --
Distributions from net realized gains on investments............................................. --
Distributions in excess of net realized gains on investments..................................... --
-----------
Total distributions............................................................................ --
-----------
Net Asset Value, End of Period..................................................................... $ 10.06
-----------
Total Return....................................................................................... 11.78%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period........................................................................ $ 7,316,716
Ratio of expenses to average net assets.......................................................... 1.48%*
Ratio of net investment income to average net assets............................................. 0.79%*
Portfolio turnover rate.......................................................................... 85%
Ratio of expenses to average net assets before reimbursement of expenses by the
Advisor........................................................................................ 3.20%*
Ratio of net investment income to average net assets before reimbursement of expenses
by the Advisor................................................................................. -0.92%*
Average commission paid per share................................................................ $ 0.09
- ---------------
(1) Commenced operations on December 22, 1997.
* Annualized
===================================================================================================================================
The accompanying notes are an integral part of these financial statements.
</TABLE>
43
<PAGE>
SMITH BREEDEN FINANCIAL SERVICES FUND
===============================================================================
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Breeden Trust (the "Trust") is an open-end, diversified management
investment company registered under the Investment Company Act of 1940, as
amended. The Fund offers shares in two series: the Smith Breeden Equity Market
Plus Fund (formerly the Smith Breeden Equity Plus Fund) and the Smith Breeden
Financial Services Fund (the "Fund"). The following is a summary of accounting
policies consistently followed by the Fund.
A. Security Valuation: Portfolio securities are valued at the 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. Repurchase Agreements: Repurchase agreements may be entered into with member
banks of the Federal Reserve System with 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 the securities collateralizing the
repurchase agreement until maturity. The value of the collateral is monitored
daily, and, if necessary, additional collateral is received to ensure that the
market value of the collateral 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.
C. Reverse Repurchase Agreements: A reverse repurchase agreement involves the
sale of portfolio assets together with an agreement to repurchase the same
assets later at a fixed price. Additional assets are maintained in a segregated
account with the custodian, and are marked to market daily. The segregated
assets may consist of cash, U.S. Government securities, or other liquid
high-grade debt obligations equal in value to the obligations under the reverse
repurchase agreements. In the event the buyer of securities under a reverse
repurchase agreement files for bankruptcy or becomes insolvent, the Fund's use
of the proceeds under the agreement may be restricted pending a determination by
the other party, or its trustee or receiver, whether to enforce the obligation
to repurchase the securities.
D. 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, 1998, the Fund had no net capital
loss carryforward.
E. Securities Transactions, Investment Income and Expenses: Securities
transactions are recorded on the trade date. Interest income is accrued daily,
and 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. Gains or losses on the sale of securities are
calculated for accounting and tax purposes on the identified cost basis.
Expense are accrued daily. Common expenses incurred by the Trust are allocated
among the funds comprising the Trust based on the ratio of net assets of each
fund to the combined net assets of the Trust. Other expenses are charged to each
fund on a specific identification basis.
F. Deferred Organization Expenses: Deferred organization expenses are being
amortized on a straight-line basis over five years.
G. Accounting Estimates: The preparation of financial statements in accordance
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the amounts of income
and expense during the reporting period. Actual results could differ from those
estimates.
44
<PAGE>
SMITH BREEDEN FINANCIAL SERVICES FUND
================================================================================
NOTES TO FINANCIAL STATEMENTS (continued)
2. FINANCIAL INSTRUMENTS
A. Derivative Financial Instruments Held or Issued for Purposes other than
Trading: The Fund uses equity index futures contracts for risk management
purposes in order to manage the Fund's equity-market risk relative to its
benchmark. On entering into a futures contract, either cash or securities in an
amount equal to a certain percentage of the contract value (initial margin) must
be deposited with the futures broker. Subsequent payments (variation margin) are
made or received by the Fund each day. The variation margin payments equal 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 transactions involve costs and may result in losses. The effective use
of futures depends on the Fund's ability to close futures positions at times
when the Fund's Advisor 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.
<TABLE>
<S> <C>
The Fund had the following open futures contracts as of March 31, 1998:
Number of Expiration Unrealized
Type Contracts Position Month Gain/(Loss)
- ----- ---------- -------- ---------- -----------
S&P 500.................... (2) Short June, 1998 (515)
-------
Total $(515)
=======
</TABLE>
The value of assets required to cover margin requirements for the open positions
at March 31, 1998 was $20,100.
3. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES
Smith Breeden Associates, Inc. (the "Advisor"), a registered Investment Advisor,
provides the Fund with investment management services. As compensation for these
services, the Fund pays the Advisor a fee computed daily and payable monthly, at
an annual rate equal to 1.50% of the Fund's average daily net assets.
The Advisor has voluntarily agreed to reduce or otherwise limit the expenses of
the Fund to 1.50% of the Fund's average daily net assets. This voluntary
agreement may be terminated or modified at any time by the Advisor in its sole
discretion, except that the Advisor has agreed to limit expenses of the Fund to
1.50% through August 1, 1998. For the period ended March 31, 1998, the Advisor
received fees of $23,152 and reimbursed the Fund $26,865.
The Fund has adopted a Distribution and Services Plan (the "Plan") under Rule
12b-1 under the Investment Company Act of 1940. The purpose of the Plan is to
permit the Advisor 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 Advisor, out of the
advisory fee 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 Advisor shall determine the amount of such payments and the purposes for
which they are made.
Certain officers and trustees of the Fund are also officers and directors of the
Advisor.
45
<PAGE>
SMITH BREEDEN FINANCIAL SERVICES FUND
===============================================================================
NOTES TO FINANCIAL STATEMENTS (continued)
4. INVESTMENT TRANSACTIONS
During the period ended March 31, 1998, purchases and proceeds from sales of
securities, other than short-term investments, aggregated $11,371,913 and
$5,031,366, respectively. The cost of securities for federal income tax purposes
is $6,518,572. Net unrealized depreciation of investments and futures contracts
consists of:
Gross unrealized appreciation............................. $693,282
Gross unrealized depreciation............................. (14,488)
--------
Net unrealized appreciation............................... $678,794
========
46
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders, Smith Breeden Financial Services Fund of
the Smith Breeden Series Trust:
We have audited the accompanying statements of assets and liabilities, including
the schedule of investments, of the Smith Breeden Financial Services Fund of the
Smith Breeden Series Trust (the "Fund") as of March 31, 1998, and the related
statements of operations, the statement of changes in net assets, and the
financial highlights for the period December 22, 1997 (commencement of
operations) to March 31, 1998. 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, 1998 by correspondence with the custodian and brokers, and where replies
were not received, we performed other auditing procedures. 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, such financial statements and financial highlights referred to
above present fairly, in all material respects, the financial positions of the
Smith Breeden Financial Services Fund of the Smith Breeden Series Trust as of
March 31 1998, the results of its operations, 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 15, 1998
47
