As filed with the Securities and Exchange Commission
on July 31, 1998
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. 15
and
Registration Statement Under the Investment Company
Act of 1940
Amendment No. 17
_____________________
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 October 15, 1998
pursuant to paragraph (a)(2) 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 June 5, 1998.
_
SMITH BREEDEN TRUST
SMITH BREEDEN U.S. EQUITY MARKET PLUS FUND
(THE "U.S. EQUITY MARKET PLUS FUND")
SMITH BREEDEN FINANCIAL SERVICES FUND
(THE "FINANCIAL SERVICES FUND")
SMITH BREEDEN HIGH YIELD BOND FUND
(THE "HIGH YIELD BOND FUND")
SMITH BREEDEN ASIA/PACIFIC FUND
(THE "ASIA/PACIFIC FUND")
SMITH BREEDEN EUROPE FUND
(THE "EUROPE FUND")
CROSS REFERENCE SHEET
FORM N-1A
Part A: Information Required in Prospectus
N-1A
Item No. Item Location in the
Registratation Statement
by Prospectus Heading
1. Cover Page Cover Page
2. Synopsis Expense Table
3. Condensed Financial Financial Highlights
Information
4. General Description Smith Breeden Mutual Funds;
of Registrant U.S. Equity Market Plus
Fund; Financial Services
Fund; High Yield Bond Fund;
Asia/Pacific Fund; Europe
Fund
5. Management of the Fund Management of the Funds
5a. Management's Discussion Contained in the Funds'
of Fund's Performance Annual Report to
Shareholders
6. Capital Stock and Other Dividends and Distributions;
Securities Capital Structure
7. Purchase of Securities How to Purchase Shares;
Being Offered Pricing of Fund Shares
8. Redemption or How to Redeem Shares;
Repurchase How to Exchange Shares
9. Pending Legal Not Applicable
Proceedings
OCTOBER 15, 1998
SMITH BREEDEN MUTUAL FUNDS
PROSPECTUS
This prospectus describes seven no-load mutual funds (the "Funds")
offering you a broad choice of investments, to help fulfill your asset
allocation needs. Each Fund is a diversified series of a management
investment company - either the Smith Breeden Series Fund or the
Smith Breeden Trust. The investment adviser for the Funds is Smith
Breeden Associates, Inc. (the "Adviser").
Smith Breeden Short Duration Fund
Smith Breeden Intermediate Duration Fund
Smith Breeden High Yield Bond Fund
Smith Breeden U.S. Equity Market Plus Fund
Smith Breeden Asia/Pacific Fund
Smith Breeden Europe Fund
Smith Breeden Financial Services Fund
An investment in any of the Funds is neither insured nor guaranteed
by the U.S. Government. There can be no assurance that any of the
Funds will meet their investment objectives. This Prospectus sets forth
concisely the information about the Funds that you should know before
investing. Please read this Prospectus carefully and keep it for future
reference. Statements of Additional Information dated October 15, 1998
have been filed with the Securities and Exchange Commission with
respect to each of the Smith Breeden Series Fund and Smith Breeden
Trust and are legally part of this Prospectus. The Statements of
Additional Information can be obtained without charge by writing to the
Funds at 100 Europa Drive, Chapel Hill, North Carolina 27514 or by
calling 1-800-221-3138 or by visiting the Securities and Exchange
Commission's (the "SEC") website (www.sec.gov)
THESE SECURITIES HAVE NOT BEEN APPROVED OR
DISAPPROVED BY THE SECURITIES AND EXCHANGE
COMMISSION OR ANY STATE SECURITIES COMMISSION
NOR HAS THE SECURITIES AND EXCHANGE COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
1<PAGE>
SMITH BREEDEN BOND FUNDS
Smith Breeden Short Duration U.S. Government Fund (the "Short
Fund", a series of the Smith Breeden Series Fund) seeks a high level of
current income consistent with low volatility of net asset value. The
Short Fund seeks to match the duration, or interest-rate risk, of a
portfolio that invests exclusively in six month U.S. Treasury securities
on a constant maturity basis. The dollar weighted average maturity of
the Fund's securities may at times significantly exceed six months.
Smith Breeden Intermediate Duration U.S. Government Fund (the
"Intermediate Fund", a series of the Smith Breeden Series Fund) seeks a
total return in excess of the total return of the major market indices for
mortgage-backed securities. The major market indices for mortgage-
backed securities currently include, but are not limited to, the Salomon
Brothers Mortgage Index and the Lehman Brothers Mortgage Index.
These indices include all outstanding government sponsored fixed-rate
mortgage-backed securities, weighted in proportion to their current
market capitalization. The duration, or interest-rate risk, of these indices
is similar to that of intermediate-term U.S. Treasury Notes, and typically
will range between three and five years. The Intermediate Fund
consistently seeks to achieve a volatility of net asset value similar to that
of a portfolio that invests exclusively in mortgage-backed securities, as
weighted in the major mortgage market indices.
Smith Breeden High Yield Bond Fund (the "High Yield Bond
Fund", a series of the Smith Breeden Trust) seeks high current income
and capital appreciation. Under normal conditions, the Fund invests at
least 65% of its total assets in lower rated debt securities and
convertiblesecurities rated below investment grade by major rating agencies,
commonly referred to as "junk bonds". There is no limit on either
portfolio maturity or the acceptable rating of securities. The Fund may
invest up to 35% of its net assets in U.S. and foreign equity securities.
The Fund may also use options, futures and forward contracts and
interest rate and currency swaps as investment or hedging
instruments.
2<PAGE>
SMITH BREEDEN EQUITY FUNDS
Smith Breeden U.S. Equity Market Plus Fund (the "U.S. Equity
Market Plus Fund", a series of the Smith Breeden Trust) seeks to
provide a total return exceeding the Standard & Poor's 500 Composite
Stock Index (the "S&P 500 Index") without additional equity market
risk. 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 Fund does not invest principally in the common stocks that make up
the S&P 500 Index (the "Index") or any other index. Instead, the Fund
uses S&P 500 futures and swaps in an effort to maintain an equity
market exposure similar to that which would be achieved if all of the
Fund's assets were invested in the stocks comprising the Index. Since the
use of futures and swaps can be implemented with the commitment of
only a small percentage of the Fund's cash, it can use the remainder to
purchase fixed-income securities and related hedging instruments.
Whether the Fund's total return equals or exceeds the performance of
the S&P 500 Index depends largely on whether the total return on the
Fund's fixed-income investments equals or exceeds the Fund's total
operating expenses, as well as other factors.
Smith Breeden Asia/Pacific Fund (the "Asia/Pacific Fund", a
series of the Smith Breeden Trust) seeks capital appreciation through
investments in financial instruments related to the major equity markets
of Asia and the Pacific region. The fund does not invest principally in
the common stocks of the Asian and Pacific markets. Instead the Fund
uses futures, options, swaps, and forwards on the equity and currency
markets of Asia and the Pacific region to maintain its equity exposure.
Since the use of futures and swaps can be implemented with the
commitment of only a small percentage of the Fund's cash, it can use the
remainder to purchase fixed-income securities and related hedging
instruments. Whether the Fund's total return equals or exceeds the
performance of the equity markets of Asia and the Pacific region
depends largely 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.
Smith Breeden Europe Fund (the "Europe Fund", a series of the
Smith Breeden Trust) seeks capital appreciation through investments in
financial instruments related to the major equity markets of Europe. The
fund does not invest principally in the common stocks of the European
markets. Instead the Fund uses futures, options, swaps, and forwards on
the equity and currency markets of Europe to maintain its equity
exposure. Since the use of futures and swaps can be implemented with
the commitment of only a small percentage of the Fund's cash, it can use
the remainder to purchase fixed-income securities and related hedging
instruments. Whether the Fund's total return equals or exceeds the
performance of the equity markets of Europe depends largely 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.
Smith Breeden Financial Services Fund (the "Financial Services
Fund", a series of the Smith Breeden Trust) seeks capital appreciation.
To pursue this goal, the Fund invests in U.S. and foreign financial
services companies. These include banks, thrift, finance and leasing
companies, brokerage, investment banking and advisory firms, real
estate related firms and insurance companies.
3<PAGE>
TABLE OF CONTENTS
Expense Table. 5
Financial Highlights - U.S. Equity Market Plus 7
Financial Highlights - Financial Services Fund 8
Financial Highlights - Short Fund 9
Financial Highlights - Intermediate Fund 10
Smith Breeden Mutual Funds 11
Investment Objectives, Policies and Risk Considerations. 11
Other Investment Practices and Risk Considerations. 22
Management of the Funds 26
Pricing of Fund Shares. 31
How to Purchase Shares. 32
How to Exchange Shares. 35
How to Redeem Shares. 36
Dividends and Distributions 39
Shareholder Reports and Information 41
Retirement Plans 42
Service and Distribution Plans. 42
Taxes 42
Capital Structure 43
Transfer, Dividend Disbursing Agent, Custodian and
Independent Accountants. 43
Fund Performance. 43
Appendix. 45
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.
4<PAGE>
<TABLE>
EXPENSE TABLE
The following table is designed to assist you in understanding the expenses
you will bear as a shareholder of a Fund. Shareholder Transaction Expenses are
charges paid when shares of a Fund are bought or sold. Annual Fund Operating
Expenses are paid out of a Fund's assets and include fees for portfolio
management, maintenance of shareholder accounts, shareholder servicing,
accounting and other services. The annual fund operating expenses shown below
reflect expense limitations agreed to by the Adviser, and are based on each
Fund's expenses for the past fiscal year, if applicable, or, in the case of
new Funds, on good faith estimates provided by the Adviser.
<CAPTION>
U.S. Equity
Market Asia/Pacific,
Plus & Financial Europe &
Intermediate Services Short High Yield Bond
<S> Funds Fund Fund Funds
Shareholder Transaction Expenses <C> <C> <C> <C>
Maximum Sales Load Imposed on Purchases None None None None
Maximum Sales Load Imposed on Reinvested Dividends None None None None
Deferred Sales Load Imposed on Redemptions None None None None
Redemption Fees1 None None None None
Exchange Fees None None None None
Annual Fund Operating Expenses
(as a percentage of average net assets)
Management Fees2 0.70% 1.50% 0.70% 0.70%
Other Expenses (net of reimbursement)3 0.18% (0.02)% 0.08% 0.28%
Total Fund Operating Expenses (net of reimbursement)3 0.88% 1.48% 0.78% 0.98%
- -------------------------
</TABLE>
1 A transaction charge of $9 may be imposed on redemptions by wire
transfer.
2 Pursuant to a distribution and services plan in respect of each Fund, the
Adviser may pay annual distribution and servicing fees of up to 0.25% of each
of the Fund's net assets out of its management fee. See "Service and
Distribution Plans."
3 The Other Expenses and Total Fund Operating Expenses in the table
reflect voluntary undertakings by the Adviser to bear expenses of each of the
Fundsand/or waive its fees to the extent necessary to limit Total Fund
Operating Expenses to 0.78% for the Short Fund, to 0.88% for each of the
Intermediate Fund and U.S. Equity Market Plus Fund, to 1.48% for the
Financial Services Fund, and to 0.98% for each of the High Yield Bond Fund,
Asia/Pacific Fund,and Europe Fund through August 1, 1999. Absent the expense
limitations,Other Expenses and Total Fund Operating Expenses for the past
fiscal year would have been 0.30% and 1.00% for the Short Fund, 0.43% and
1.13% for the Intermediate Fund, 0.53% and 1.23% for the U.S. Equity Market
Plus Fund, and are estimated to be about 1.70% and 3.20% for the Financial
Services Fund,and about 2.28% and 2.98% for each of the High Yield Bond Fund,
Asia/Pacific Fund, and Europe Fund.
5<PAGE>
The following examples illustrate the expenses that apply to a $1,000
investment in each Fund over various time periods assuming: (1) a 5% annual
rate of return, and (2) redemption or no redemption at the end of each time
period. Except as noted in the table above, the Funds charge no redemption fees.
Short Duration Fund
1 Year 3 Years 5 Years 10 Years
$8 $26 $45 $99
Intermediate Duration Fund and U.S. Equity Market Plus Fund
1 Year 3 Years 5 Years 10 Years
$9 $29 $50 $111
High Yield Bond Fund, Asia/Pacific Fund, and Europe Fund
1 Year 3 Years 5 Years 10 Years
$10 $32 $56 $123
Financial Services Fund
1 Year 3 Years 5 Years 10 Years
$16 $48 $83 $182
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
advisers. Such advisers 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.
6<PAGE>
<TABLE>
U.S. EQUITY MARKET PLUS FUND
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
The following selected per share data and ratios cover the fiscal periods
from June 30, 1992, the date the Fund commenced operations, through March 31,
1998, and are part of the Fund's financial statements, which have been audited
by Deloitte & Touche LLP, independent auditors. This data should be read in
conjunction with the Fund's most recent annual audited financial statements
and the report of Deloitte & Touche LLP thereon, which appear in the
Statement of Additional Information for the Smith Breeden Trust.
<CAPTION>
Year Ended Year Ended Year Ended Year Ended Year Ended Period Ended
March 31, March 31, March 31, March 31, March 31, March 31,
1998 1997 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, $12.56 $12.27 $10.84 $9.88 $10.85 $10.00
Beginning of Period
Income From Investment
Operations
Net investment 0.591 0.592 0.615 0.568 0.476 0.355
income.................
Net realized and
unrealized gain (loss) 4.940 1.813 2.768 1.081 (0.216) 1.281
on Investments.........
Total from investment 5.531 2.405 3.383 1.649 0.260 1.636
operations.............
Less Distributions
Dividends from net (0.586) (0.590) (0.583) (0.568) (0.472) (0.311)
investment income......
Dividends in excess of -- -- -- (0.001) -- --
net investment income..
Distributions from net
realized gains on (0.645) (1.525) (1.370) (0.047) (0.701) (0.420)
Investments............
Distributions in excess
of net realized gains -- -- -- (0.073) (0.057) (0.055)
on Investments.........
Total distributions..... (1.231) (2.115) (1.953) (0.689) (1.230) (0.786)
Net Asset Value, End of $16.86 $12.56 $12.27 $10.84 $9.88 $10.85
Period..................
Total Return............ 45.71% 21.41% 32.30% 17.18% 2.19% 22.59%*
Ratios/Supplemental Data
Net assets, end of $136,667,439 $13,507,377 $4,766,534 $2,107,346 $1,760,519 $903,846
period.................
Ratio of expenses to
average net assets
Before expense 1.23% 2.60% 4.58% 7.75% 7.08% 28.48%*
limitation..........
After expense 0.88% 0.88% 0.90% 0.90% 0.90% 0.57%*
limitation..........
Ratio of net income to
average net assets
Before expense 4.44% 3.58% 1.85% 0.59% 1.84% (22.63%)*
limitation..........
After expense 4.79% 5.30% 5.53% 7.44% 8.02% 5.28%*
limitation..........
Portfolio turnover 424% 182% 107% 120% 119% 271%
rate...................
<FN>
<F1>
* Annualized
Additional performance information is presented in the Fund's Annual Report,
which is available without charge upon request.
</FN>
</TABLE>
7<PAGE>
FINANCIAL SERVICES FUND
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
The following selected per share data and ratios cover the period from December
22, 1997, the date the Fund commenced operations, through March 31, 1998, and
are part of the Fund's financial statements, which have been audited by
Deloitte & Touche LLP, independent auditors. This data should be read in
conjunction with the Fund's most recent audited financial statements and the
report of Deloitte & Touche LLP thereon, which appear in the Statement of
Additional Information for the Smith Breeden Trust.
Period Ended
March 31, 1998
--------------
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
Before expense limitation ...................................... 3.20%*
After expense limitation ....................................... 1.48%*
Ratio of net income to average net assets
Before expense limitation ...................................... -0.92%*
After expense limitation ....................................... 0.79%*
Portfolio turnover rate ......................................... 85%
Average Commission Paid Per Share ............................... $ 0.09
* Annualized
Additional performance information is presented in the Fund's Annual Report,
which is available without charge upon request.
8<PAGE>
<TABLE>
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, 1998, and are part of the Short Fund's financial statements which have
been audited by Deloitte & Touche LLP, independent auditors. This data
should be read in conjunction with the Short Fund's most recent annual audited
financial statements and the report of Deloitte & Touche LLP thereon, which
appear in the Statement of Additional Information for the Smith Breeden Series
Fund.
<CAPTION>
Year Ended Year Ended Year Ended Year Ended Year Ended Period Ended
March 31, March 31, March 31, March 31, March 31, March 31,
1998 1997 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, $9.83 $9.74 $9.90 $9.90 $10.00 $10.00
Beginning of Period
Income From Investment
Operations
Net investment 0.484 0.476 0.621 0.628 0.432 0.552
income.................
Net gain (loss) on
securities 0.114 0.146 (0.148) -- (0.070) 0.002
(both realized and
unrealized)............
Total from investment 0.598 0.622 0.473 0.628 0.362 0.554
operations..............
Less Distributions
Dividends from net (0.508) (0.476) (0.621) (0.628) (0.462) (0.554)
investment income......
Dividends in excess of -- (0.056) (0.012) -- -- --
net investment income..
Total distributions..... (0.260) (0.532) (0.633) (0.628) (0.462) (0.554)
Net Asset Value, End of $9.92 $9.83 $9.74 $9.90 $9.90 $10.00
Period.................
Total Return............ 6.24% 6.57% 4.95% 6.58% 3.67% 5.67%
Ratios/Supplemental Data
Net assets, end of $78,427,855 $118,988,609 $221,825,136 $218,431,665 $218,167,491 $48,531,206
period.................
Ratio of expenses to
average net assets
Before expense 1.00% 0.93% 0.93% 0.92% 1.00% 2.58%
limitation...........
After expense 0.78% 0.78% 0.78% 0.78% 0.78% 0.78%
limitation...........
Ratio of net income to
average net assets
Before expense 5.06% 4.90% 6.13% 6.18% 3.95% 2.73%
limitation...........
After expense 5.28% 5.04% 6.29% 6.33% 4.17% 4.53%
limitation...........
Portfolio turnover 626% 556% 225% 47% 112% 3%
rate...................
<FN>
<F1>
Additional performance information is presented in the Short Fund's Annual
Report, which is available without charge upon request.
</FN>
</TABLE>
9<PAGE>
<TABLE>
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, 1998, and are part of the Intermediate Fund's financial statements which
have been audited by Deloitte & Touche LLP, independent auditors. This
data should be read in conjunction with the Intermediate Fund's most recent
annual audited financial statements and the report of Deloitte & Touche LLP
thereon, which appear in the Statement of Additional Information for the Smith
Breeden Series Fund.
<CAPTION>
Year Ended Year Ended Year Ended Year Ended Year Ended Period Ended
March 31, March 31, March 31, March 31, March 31, March 31,
1998 1997 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, $9.73 $10.01 $9.83 $10.01 $10.62 $10.00
Beginning of Period
Income From Investment
Operations
Net investment 0.590 0.599 0.660 0.664 1.05 0.826
income.................
Net gain (loss) on
securities 0.419 (0.024) 0.277 (0.049) (0.601) 0.621
(both realized and
unrealized)............
Total from investment 1.009 0.575 0.937 0.615 0.449 1.447
operations.............
Less Distributions
Dividends from net (0.561) (0.604) (0.656) (0.664) (1.044) (0.826)
investment income......
Dividends in excess of ---- ---- ---- (0.108) ---- --
net investment
income.................
Distributions from net
realized gains on (0.178) (0.251) (0.101) -- (0.015) --
Investments............
Distributions in excess
of net realized gains -- -- -- (0.022) -- --
on Investments.........
Total distributions..... (0.739) (0.855) (0.757) (0.794) (1.059) (0.826)
Net Asset Value, End of $ 10.00 $9.73 $10.01 $9.83 $10.01 $10.62
Period.................
Total Return............ 6.33% 5.92% 9.69% 6.10% 4.11% 14.93%
Ratios/Supplemental Data
Net assets, end of $38,641,879 $37,735,525 $36,446,940 $34,797,496 $6,779,666 $2,923,913
period.................
Ratio of expenses to
average net assets
Before expense 1.13% 1.16% 1.14% 2.33% 2.34% 17.52%
limitation...........
After expense 0.88% 0.88% 0.90% 0.90% 0.90% 0.82%
limitation...........
Ratio of net income to
average net assets
Before expense 5.36% 5.92% 6.26% 4.77% 6.30% (8.52%)
limitation...........
After expense 5.61% 6.19% 6.49% 6.20% 7.74% 8.18%
limitation...........
Portfolio turnover 583% 409% 193% 557% 84% 42%
rate....................
<FN>
<F1>
Additional performance information is presented in the Intermediate Fund's
Annual Report, which is available without charge upon request.
</FN>
</TABLE>
10<PAGE>
SMITH BREEDEN MUTUAL FUNDS
The Short and Intermediate Funds are series of the Smith Breeden
Series Fund (the "Series Fund"), an open-end diversified management
investment company. The High Yield Bond, U.S. Equity Market Plus,
Asia/Pacific, Europe, and Financial Services Funds are series of the
Smith Breeden Trust (the "Trust"), an open-end diversified management
investment company.
Smith Breeden Associates, Inc. ("Smith Breeden" or the "Adviser") acts
as investment adviser to the Funds. Smith Breeden is a money
management and consulting firm founded in 1982 whose clients include
pension funds, financial institutions, corporations, government entities
and charitable foundations.
INVESTMENT OBJECTIVES, POLICIES, AND RISK
CONSIDERATIONS
Each of the Funds has a different investment objective and different
investment policies, and is designed to meet different investment needs.
The investment objectives and certain investment policies of the
Short and Intermediate Funds are fundamental and may not be changed
without a vote of shareholders of the relevant Fund. The investment
objectives of the High Yield Bond, U.S. Equity Market Plus,
Asia/Pacific, Europe, and Financial Services Funds are not
fundamental.
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 investments 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 and Intermediate Funds
The Short Fund's investment objective is to provide investors with a
high level of current income, consistent with a low volatility of net asset
value. Under normal circumstances the Short Fund will seek to achieve
an interest-rate risk or option-adjusted duration (See "Other Investment
Practices and Risk Considerations - Adjusting Investment and Interest
Rate Risk Exposure") similar to that of a six-month U.S. Treasury
security on a constant maturity basis. However, the Short Fund expects
that, under normal circumstances, the dollar-weighted average life (or
period until the next reset date) of its portfolio securities will be longer
than six months, sometimes significantly longer. There is no assurance
that the Short Fund will be able to maintain a low volatility of net asset
value.
11<PAGE>
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.
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 major market indices for
mortgage-backed securities currently include, but are not limited to, the
Salomon Brothers Mortgage Index and the Lehman Brothers Mortgage
Index. These indices include all outstanding government sponsored
fixed-rate mortgage-backed securities, weighted in proportion to their
current market capitalization. Total return is the change in value of the
investment, assuming reinvestment of all distributions. Under normal
circumstances, the Intermediate Fund will seek to achieve an interest-
rate risk or option-adjusted duration (see "Other Investment, Practices
and Risk Considerations") similar to that of a portfolio that invests
exclusively in mortgage-backed securities, as weighted in the major
market indices. The duration, or interest-rate risk, of these indices is
believed by the Adviser to be similar to the that of intermediate-term
U.S. Treasury Notes, and typically will range between three and five
years. When market interest rates decline, the value of a portfolio
invested in intermediate-term fixed-rate obligations can be expected to
rise. Conversely, when market interest rates rise, the value of a portfolio
invested in intermediate-term fixed-rate obligations can be expected to
fall. There is no assurance that the Intermediate Fund will be able to
maintain a total return in excess of the total return of major market
indices for mortgage-backed securities, or that it will match the interest
rate risk of a portfolio investing exclusively in these securities.
The Short and Intermediate Funds will seek their investment
objective by investing, under normal circumstances, at least 70% of their
total assets in U.S. Government Securities. It is anticipated that the
Funds will invest primarily in mortgage-backed securities issued by the
U.S. Government, its agencies and instrumentalities. The Funds will also
invest in fixed-rate and adjustable-rate mortgage-backed securities
issued by non-governmental issuers. Each 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 Federal Deposit
Insurance Corporation .
As a matter of fundamental policy, the Short and Intermediate
Funds will limit purchases to securities from the following classes of
assets:
1. Securities issued directly or guaranteed by the U.S. Government or
its agencies or instrumentalities;
2. Mortgage-Backed Securities rated AAA by Standard & Poor's
Corporation (S&P) or Aaa by Moody's Investors Service, Inc.
("Moody's) or unrated but deemed of equivalent quality by the Adviser;
12<PAGE>
3. Securities fully collateralized by assets in either of the above
classes;
4. Assets which would qualify as liquidity items under federal
regulations if held by a commercial bank or savings institution; and
5. Hedge instruments, which may only be used for risk management
purposes. Any securities described in the "Hedging" section and any
stripped Mortgage-Backed Securities may only be used for risk
management purposes.
The Federal regulations referred to in Item 4 may change from time
to time.
High Yield Bond Fund
The High Yield Bond Fund seeks high current income and capital
appreciation. The Fund invests primarily in lower rated debt securities
commonly referred to as "junk bonds." The Fund may also invest in
unrated securities. There is no limit on the acceptable rating of securities
bought by the Fund. See the Appendix for an explanation of credit
ratings.
At least 65 % of the Fund's securities will be invested in these high
yield debt securities rated below investment grade by national rating
agencies such as S&P and Moody's (or unrated securities of comparable
credit quality and similarly rated (or unrated) convertible securities).
Investment in such securities is considered speculative. Investors should
expect greater fluctuations in share price, yield and total return than
compared with less aggressive bond funds and the Smith Breeden Short
and Intermediate Funds.
The value of the High Yield Bond Fund's fixed-income investments
will fluctuate with changes in interest rates. When interest rates go up,
the prices of debt securities generally fall, and conversely when interest
rates fall, the value of debt securities increases. This interest rate risk
will generally not be hedged in the High Yield Bond Fund, and the
Fund's duration will not be managed to any specific target. In addition
to interest rate risk, the Fund's investments are subject to other risks.
Lower rated securities, while usually offering higher yields, generally
have more risk and volatility because of reduced creditworthiness and
greater chance of default. Issuers of high yield bonds are typically in
weak financial health and their ability to pay interest and principal is
uncertain. High yield bond markets may react strongly to adverse news
about an issuer or the economy, or the perception or expectation of
adverse news. High yield bonds also present certain risks based on
payment expectations. For example high yield bonds may contain
redemption and call provisions. If an issuer exercises these provisions in
a declining interest rate market, the Fund would have to replace the
security with a lower yielding security, resulting in a decreased return
for investors. The manager may use options to mitigate the prepayment
risk but such a strategy may not be successful. See "Other Investment
Practices and Risk Considerations" for a more detailed discussion of the
risks associated with the use of options.
13<PAGE>
The market for high yield bonds may be thinner and less active than
that for higher-quality debt securities, which can adversely affect the
prices at which the former are sold. If market quotations are not
available, lower-quality debt securities will be valued in accordance with
procedures established by the Board of Trustees, including the use of
outside pricing services. Judgment plays a greater role in valuing high-
yield corporate debt securities than is the case for securities for which
more external sources for quotations and last-sale information is
available. Adverse publicity and changing investor perceptions may
affect the ability of outside pricing services to value lower-quality debt
securities and the High Yield Bond Fund's ability to dispose of these
securities.
To the extent the Fund invests in foreign securities, performance
will also depend on changes in foreign currency values, differing
political and regulatory environments and overall economic factors in
the foreign country where the Fund invests. The Fund may also invest
35% of its total assets in equity securities, namely common or preferred
stock and warrants, of U.S. and foreign companies. To the extent the
Fund invests in stocks, the value of these equity investments will
fluctuate day to day with movements in the stock market, as well as in
response to the activities of individual companies.
The Fund may also use options, future contracts, options on futures
contracts and swaps to increase or decrease its exposure to changing
security prices, interest or currency exchange rates, or other factors that
affect security values. The risks associated with such financial
instruments are explained more fully in the section of this prospectus
entitled "Other Investment Practises and Risk Considerations."
The success of a strategy of investment in high-yielding bonds
depends on the Adviser's skills, including credit analysis. In selecting
securities, Smith Breeden will consider industries or individual
companies that have stable or improving fundamental characteristics. In
selecting securities, the manager will evaluate the issuer's credit and
market risk in relationship to the securities' expected rate of return.
U.S. Equity Market Plus Fund, Asia/Pacific Fund, Europe Fund
The U.S. Equity Market Plus Fund seeks to provide a total return
exceeding the S&P 500 Index without additional equity market risk.
The Asia/Pacific Fund seeks capital appreciation through investments in
financial instruments related to the major equity markets of the Asia and
the Pacific region. The Europe Fund seeks capital appreciation through
investments in securities related to the major equity markets of Europe.
None of the funds invest principally in the common stocks of the regions
or indices whose returns they are targeting. Instead each Fund uses
futures, options, and swaps to maintain their equity exposure in their
respective markets. The Asia/Pacific and Europe Funds may also
employ futures and forwards on the currency markets of their respective
regions to maintain the relevant market exposure.
14<PAGE>
When futures contracts are purchased, only a small percentage of
the notional value of the contract must be posted as margin. ( This
percentage is as low as 5% for contracts traded in U.S. markets (which
may include certain contracts on Asian and European indices which are
traded in the U.S.), is about 15% in Asia, and between 6% to 8% on
European exchanges.) No margin is generally required when entering
into a swap or option contract. Each of the U.S. Equity Market Plus,
Asia/Pacific, and Europe Funds therefore commits only a small
percentage of its net assets to purchasing the instruments which it uses to
capture its equity market risk. With its remaining cash, each Fund will
invest in a low duration fixed income strategy substantially similar to
that of the Short Fund. Each Fund invests in fixed-income securities and
uses related hedging techniques such as interest rate futures, options,
floors, caps and swaps to reduce the interest-rate risk of its fixed-income
securities to less than two years. The Funds' fixed income securities will
consist primarily of U.S. Government Securities, including U.S. Agency
mortgage-backed securities, but may also include corporate debt
securities, and mortgage-backed and other asset-backed securities of
non-governmental issuers. The Funds may also engage in loans of
portfolio securities, dollar rolls, and reverse repurchase agreements to
enhance income and total return. With these fixed-income related
investments, each Fund seeks to generate income and gains exceeding
the total operating costs of the Fund. The operating costs of the Funds
include the transaction and financing costs of entering into the futures,
options and swap contracts used to replicate the respective stock market
returns. Thus, whether a Fund's total return equals or exceeds the
performance of the index or market it targets (the S&P 500 index in the
case of the U.S. Equity Market Plus Fund, the Asia/Pacific region in the
case of the Asia/Pacific Fund, the European region in the case of the
Europe Fund) depends largely on whether the total return on the Fund's
fixed-income portfolio equals or exceeds the Fund's total operating
expenses. Other factors which will impact the success of the Funds'
strategies relate to how well the returns of the futures, swaps and options
chosen by the Adviser as the Fund's investments correlate to the markets
tracked, as described below and in "Other Investment Practices and Risk
Considerations." Each Fund has also applied for an exemptive order
with the SEC which would permit the Fund to invest in the Short Fund
for purposes of pursuing it short duration fixed income strategy. There
is no assurance such an order will be granted.
When futures contracts and/or swap contracts are, in the judgment
of the Adviser, overpriced relative to the common stocks of the index or
market being tracked, a Fund may invest directly in the common stocks
represented by the index or in the region being tracked. The Fund will
not own all issues, but will attempt to purchase a basket of common
stocks which the Adviser expects will, on average, match movements in
the index or market being tracked. Subject to limits on the Fund's
investments in other investment companies, a Fund may also invest in
other mutual funds. 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 in which they
have invested.
15<PAGE>
Each Fund's opportunity for gain or loss may be greater than if the
Fund invested directly in the stocks represented by the relevant market
or index because the notional value of the financial instruments utilized
may not match exactly a Fund's net assets. For example, in the U.S.
Equity Market Plus Fund, the total net notional amount of the Fund's
equity swap contracts, S&P 500 Index futures contracts, plus the market
value of any common stocks owned may be more or less than the Fund's
total net assets. (Under normal market conditions, the U.S. Equity
Market Plus Fund expects that such variations in its exposure to the S&P
500 Index will be up to 5% more or less than the Fund's net assets.) For
the Asia/Pacific and Europe Funds, there are no futures traded which
match exactly the stock market capitalization of the Asia/Pacific or
European regions. As a result, the Asia/Pacific and Europe Funds will
utilize a composite of the futures traded in these regions. Futures
contracts may not be available to trade in all countries making up a
region, or a Fund may not be able to match exactly the weighting of a
country's market capitalization in a region due to size limitations on the
notional amount of the futures being purchased. Due to the lower
correlation of the selected country or region futures with the return of
the region in total, this process may magnify the "tracking error" of a
Fund's performance.
In addition to the risks described above, the U.S Equity Market
Plus, Asia/Pacific, and Europe Funds are all subject to market risk, the
possibility that the stocks underlying the equity markets whose returns
the Funds are tracking will decline in price over short or long periods.
Both U.S. and foreign stock markets tend to be cyclical, with periods
when stock prices generally rise and periods when stock prices generally
decline.
The Asia/Pacific and Europe Funds invest in foreign markets which
can be as, if not more volatile, than U.S. markets. Investment abroad is
also influenced by currency risk. Currency risk is the risk that changes
in foreign exchange rates will affect, favorably or unfavorably, the value
of a Fund's foreign securities. Although the Funds will enter into
currency futures and forwards to maintain the same currency exposure
of the markets in which they invest, there is no guarantee that the use of
such techniques will be successful. (The risks associated with the use of
futures and forwards is explained generally in "Other Investment
Practices and Risk Considerations" and in the Statement of Additional
Information of the Smith Breeden Trust.) Other risks and considerations
relate to the higher transaction costs of trading in foreign securities;
lower liquidity which may result in greater price volatility; the
possibility of expropriation or confiscatory taxation; adverse change in
investment or exchange control regulation; difficulty in obtaining a
judgement from a foreign court; political instability; and potential
restrictions on the flow of international capital.
16<PAGE>
Financial Services Fund
The Financial Services Fund seeks capital appreciation. To pursue this
goal, the fund will invest at least 65% of its assets in U.S. and foreign
financial services companies. These include banks, thrifts, finance and
leasing companies, brokerage, investment banking and advisory firms,
real estate related firms and insurance companies. The Fund will
generally invest in common stock and in other equity securities such as
preferred stock and warrants. The Fund may also engage in other
investment practices. See "Other Investment Practices and Risk
Considerations."
Because the Financial Services Fund invests in a single sector, its
performance is largely dependent on the sector's performance, which
may differ from that of the overall stock market. Changing interest rates
or deteriorating economic conditions can adversely affect the
performance of financial services companies' stocks. The Fund may buy
or sell interest rate futures and options to attempt to mitigate the effect
of changing interest rates upon the portfolio. However, the use of
interest rate futures in such a strategy involves the risk that the price
movements of the hedging instrument will not accurately reflect price
movements in the securities, so that the hedge will not be fully effective
or may result in losses.
The Fund may also buy or sell stock index futures or options on
such indices to adjust the risk and return characteristics of the Fund's
stock portfolio. If the Adviser judges market conditions incorrectly or
employs a strategy that does not correlate well with the Fund's
investments, the use of stock index futures could result in a loss,
regardless of whether the intent was to reduce risk or increase return.
These techniques may also increase the volatility of the Fund relative to
the financial services sector of the stock market. See also "Other
Investment Practices and Risk Considerations" and the Statement of
Additional Information of the Smith Breeden Trust for a discussion of
the use of financial futures and options and their risks.
Financial services companies are subject to extensive government
regulation which may limit both the amounts and types of loans and
other financial commitments they can make, and the interest rates and
fees they charge. Profitability is largely dependent upon on the
availability and cost of capital funds, and can fluctuate significantly
when interest rates change. Credit losses resulting from the financial
difficulties of borrowers can negatively affect the industry. Insurance
companies may be subject to severe price competition. Legislation is
currently being considered which would reduce the separation between
commercial and investment banking businesses. If enacted this could
significantly harm the financial services sector and the Fund.
The Fund may purchase securities of foreign financial services
companies, which are subject to additional risks. Currency fluctuations
can adversely affect the returns on investments held in foreign
corporations. Other risks relate to the fact that differences exist in
accounting, auditing and financial reporting standards. Political
developments may also have an adverse impact. There is also the
possibility of changes in investment or exchange control regulations,
restrictions on the flow of international capital, and difficulties in
17<PAGE>
pursuing legal remedies against issuers. The Fund will primarily invest
in foreign financial securities through American Depository Receipts
("ADRs") which represent shares of a foreign corporation held by an
U.S. bank that entitles the holder to all dividends and capital gains.
ADRs are denominated in U.S. dollars and trade in the U.S. securities
markets. ADRs are still subject to the risks associated with foreign
investment generally described above. The Financial Services Fund may
hedge against fluctuations in foreign exchange rates by entering into
foreign currency forward and futures contracts. For more discussion of
these contracts and their risks, see "Other Investment Practices and Risk
Considerations" and the Statement of Additional Information of the
Smith Breeden Trust .
Under regulations imposed by the Investment Company Act of 1940 and
its rules (the "1940 Act"), the Fund may not purchase more than 10% of
the securities of any domestic or foreign insurance company. The Fund
may also not invest more than 5% of its total assets in the equity
securities of any company that derives more than 15% of its revenues
from brokerage or investment management activities, unless such
investment is limited to not more than 5% of the equity securities or
10% of the debt securities of such company, and such investment
represents not more than 5% of the net assets of the Fund.
The Financial Services Fund intends to be a diversified fund, as defined
under the 1940 Act, and as such, with respect to 75% of its assets, will
not invest more than 5% of its assets in any single issuer, and such 5%
holding cannot represent more than a 10% voting interest in the acquired
company.
Characteristics and Risks of the Securities in which the Funds
may invest
Subject to the percentage limitations on investment to which each
Fund is subject based on their investment objective, and unless stated
otherwise, each of the Funds may invest in the following types of
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.) Mortgage-backed securities are explained more fully
below.
18<PAGE>
Corporate Debt Securities. All of the Funds, with the exception of
the Short and Intermediate Funds, may invest in corporate debt
securities. Corporate Debt Securities are subject to the risk of an
issuer's inability to meet principal and interest payments on the
obligation (credit risk) and may also be subject to price volatility due to
such factors as interest rate sensitivity, market perception of the credit-
worthiness of the issuer and general market liquidity. Debt securities
issued by smaller and medium sized issuers may be less actively traded
than those of larger issuers and may experience greater fluctuations in
price. Smaller and medium sized issuers may be less seasoned, have
more limited product lines, markets, financial resources and
management depth, and therefore be more susceptible to adverse market
conditions than larger issuers.
Convertible Securities. All of the Funds, with the exception of the
Short and Intermediate Funds, may invest in convertible securities. A
convertible security is a fixed income equity security that may be
converted into a prescribed amount of common stock at a specified
formula. A convertible security entitles the owner to receive interest
until the security matures or is converted. Convertibles have several
unique investment characteristics such as: (a) higher yields than
common stocks but lower yields than straight debt securities; (b) lesser
degree of fluctuation in value than the underlying stock since they have
fixed income characteristics; and (c) potential for capital appreciation if
the market price of the underlying securities increases.
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. 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.
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. Not all securities issued by the U.S. Government or
its agencies are backed by the full faith and credit of the United States;
some may be backed only the assets of the particular instrumentality or
the ability of the agency to borrow.
19<PAGE>
The Short and Intermediate Funds may only invest in mortgage-backed
securities issued by private originators of, or investors in, mortgage
loans issued by private entities that are rated AAA by S&P or Aaa by
Moody's Investors Service ("Moody's"), or, if unrated, determined by the
Adviser to be of comparable quality. The Short and Intermediate Funds
will not pay any additional fees for credit support and will not invest in
private mortgage pass-through securities unless they are rated AAA by
S&P or Aaa by Moody's, or are unrated but deemed to be of comparable
credit quality by the Adviser. In addition, the Short and Intermediate
Funds will only purchase mortgage-backed securities which constitute
"Mortgage Related Securities" for purposes of the Secondary Mortgage
Market Enhancement Act of 1984.
The Funds will not purchase privately-issued mortgage-backed
securities or Collateralized Mortgage Backed Obligations ("CMOs")
collateralized by interests in whole mortgage loans (not guaranteed by
GNMA, FNMA or FHLMC) if the securities of any one issuer would
exceed 10% of any Fund's assets at the time of purchase. The Funds will
not purchase privately-issued mortgage-backed securities or CMOs
collateralized by U.S. Government agency mortgage-backed securities if
the securities of any one issuer would exceed 20% of any Fund's assets
at the time or purchase.
The U.S. Equity Market Plus, Europe and Asia/Pacific Funds'
investments in mortgage-backed and other asset-backed securities will
be rated at least A by Moody's or S&P.
Mortgage-backed and asset-backed securities have yield and maturity
characteristics corresponding to their underlying assets. Unlike
traditional debt securities, which may pay a fixed rate of interest until
maturity when the entire principal amount comes due, payments on
certain mortgage-backed and asset-backed securities include both
interest and a partial payment of principal. This partial payment of
principal may be comprised of a scheduled principal payment as well as
an unscheduled payment from the voluntary prepayment, refinancing, or
foreclosure of the underlying loans. As a result of these unscheduled
payments of principal, or prepayments on the underlying securities, the
price and yield of mortgage-backed securities can be adversely affected.
For example, during periods of declining interest rates, prepayments can
be expected to accelerate, and the Funds would be required to reinvest
the proceeds at the lower interest rates then available. Prepayments of
mortgages which underlie securities purchased at a premium could result
in capital losses because the premium may not have been fully
amortized at the time the obligation is prepaid. In addition, like other
interest-bearing securities, the values of mortgage-backed securities
generally fall when interest rates rise, but when interest rates fall, their
potential for capital appreciation is limited due to the existence of the
prepayment feature. In order to hedge against possible prepayment, the
Funds may purchase certain options and options on futures contracts as
described more fully in "Other Investment Practices and Risk
Considerations" and the Statements of Additional Information.
20<PAGE>
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 Segments of
the U.S. Equity Market Plus, Asia/Pacific, and Europe Funds may also
invest in adjustable-rate securities backed by assets other than mortgage
pools.
Although the rate adjustment feature may act as a buffer to reduce large
changes in the value of adjustable-rate securities, these securities are still
subject to changes in value based on changes in market interest rates or
changes in the issuer's creditworthiness. Because the interest rate is reset
only periodically, changes in the interest rate on adjustable-rate
securities may lag changes in prevailing market interest rates. Also,
some adjustable-rate securities (or the underlying mortgages or other
underlying loans or receivables) are subject to caps or floors that limit
the maximum change in interest rate during a specified period or over
the life of the security. Because of the resetting of interest rates,
adjustable-rate securities are less likely than non-adjustable-rate
securities of comparable quality and maturity to increase significantly in
value when market interest rates fall. Adjustable-rate securities are also
subject to the prepayment risks associated generally with mortgage-
backed securities.
Credit Risk. While certain U.S. Government securities such as U.S.
Treasury obligations and GNMAs are backed by the full faith and credit
of the U.S. Government, other fixed-income 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, while the U.S. Equity Market
Plus, Europe and Asia/Pacific Funds will seek to minimize this risk of
default by investing in securities of at least investment grade, except that
its investment in mortgage-backed securities will be rated at least A.
The High Yield Bond Fund will invest in securities of below investment
grade.
Debt obligations that are deemed investment grade carry a rating of
at least Baa from Moody's or BBB from Standard and Poor's, or a
comparable rating agency from another rating agency or, if not rated by
an agency, are determined by the Adviser to be of comparable quality.
Bonds rated BBB or Baa or below (and unrated bonds of comparable
quality) have speculative characteristics and changes in economic
circumstances are more likely to lead to a weakened capacity of the
issuer to make interest and principal payments.
21<PAGE>
Other Mortgage Backed Securities and Fixed Income
Investments. The Funds may also invest in other types of mortgage-
backed and fixed income securities including Collateralized Mortgage
Obligations, Stripped Securities, and zero coupon bonds. These types of
securities, including their risks, are described in detail in the Statements
of Additional Information. New financial instruments and securities
continue to be developed. The Funds may invest in any such instruments
or variations to the extent consistent with their investment objectives
and policies and applicable regulatory requirements.
OTHER INVESTMENT PRACTICES AND RISK
CONSIDERATIONS
The Statement of Additional Information for each Fund contains
more detailed information about the following practices, including
limitations designed to reduce the related risks.
Adjusting Investment and Interest Rate Risk Exposure. A Fund
can use various techniques to increase or decrease its exposure to
changing security prices and indices, currency exchange rates, interest
rates or other factors that affect security value, or to employ temporary
substitutes for anticipated future transactions. These techniques include
buying or selling financial futures contracts, purchasing call or put
options, or selling covered call options on such futures or entering into
currency exchange contracts or swap agreements. Any or all of these
techniques may be used at one time, except that only the Asia/Pacific,
Europe, and Financial Services Funds may enter into currency exchange
futures, forward or swap contracts. Use of any particular transaction is a
function of market conditions. There is no overall limitation on the
percentage of a Fund's assets which may be subject to a hedge
position.
Swap agreements are two-party contracts entered into primarily by
institutional investors for periods ranging from a few weeks to more
than one year. In a standard swap transaction, two parties agree to
exchange the returns (or differentials in rates of return) earned or
realized on particular predetermined investments or instruments, which
may be adjusted for an interest factor. The gross returns to be exchanged
or "swapped" between the two parties are generally calculated with
respect to a "notional amount", i.e., the return on or increase in value of
a particular dollar amount invested at a particular interest rate, in a
particular foreign currency, or in a "basket" of securities representing a
particular index. Whether a Fund's use of swap agreements will be
successful in furthering its investment objective will depend on the
Adviser's ability to predict correctly whether certain types of
investments are likely to produce greater returns than other investments.
Because they are two-party contracts and because they may have terms
of greater than seven days, swap agreements are currently considered
illiquid investments. Moreover, a Fund bears the risk of loss of the
amount expected to be received under a swap agreement in the event of
the default or bankruptcy of a swap agreement counterparty. The Funds
will enter into swap agreements only with counterparties that meet
certain standards for creditworthiness (generally such counterparties
would have to be eligible counterparties under the terms of the Funds'
repurchase agreement guidelines). Certain restrictions imposed on the
Funds by the Internal Revenue Code may limit the Funds' ability to use
22<PAGE>
swap agreements. The swaps market is a relatively new market and is
largely unregulated. It is possible that developments in the swaps
market, including potential government regulation, could adversely
affect a Fund's ability to terminate existing swap agreements or to
realize amounts to be received under such agreements.
Options and futures transactions involve costs and may result in losses.
The losses from investing in futures transactions are potentially
unlimited. In addition, the effective use of options and futures strategies
depends on a Fund's ability to terminate options and futures positions at
times when the Adviser deems it desirable to do so. This ability to
terminate positions when the Adviser deems it desirable to do so may be
hindered by the lack of a liquid secondary market. Although a Fund will
take an options or futures contract position only if the Adviser believes
there is a liquid secondary market for the option or futures contract,
there is no assurance that a Fund will be able to effect closing
transactions at any particular time or at an acceptable price.
The use of options and futures strategies also involves the risk of
imperfect correlation between movements in the values of the securities
underlying the futures and options purchased and sold by a Fund, of the
option and futures contract itself, and of the securities which are the
subject of a hedge. For example, a Fund bears the risk that prices of
hedged securities will not move to the same degree as the hedging
instrument, or that price movements in the hedging instrument will not
accurately reflect price movements in the security underlying the
hedging instrument. It is also possible for a Fund to incur a loss on both
the hedged securities and the hedging instrument. In the case of the
Funds other than the Financial Services Fund, this means that a Fund
may not achieve, and may at times exceed, its targeted option-adjusted
duration or the return of the market it tracks.
Option-adjusted duration is a measure of the price sensitivity of a
portfolio to changes in interest rates. The maturity of a security, another
commonly used measure of price sensitivity, measures only the time
until final payment is due, whereas option-adjusted duration takes into
account the pattern of all payments of interest and principal on a security
over time, including how these payments are affected by prepayments
and by changes in interest rates. In computing the duration of a Fund's
portfolio, the Adviser will estimate the duration of obligations that are
subject to prepayment or redemption by the issuer, taking into account
the influence of changes in interest rates on prepayments and coupon
flows.
At times, a Fund may sell interest rate futures in a different dollar
amount than the dollar amount of securities being hedged, depending on
the expected relationship between the volatility of the prices of such
securities and the volatility of the futures contracts, based on duration
calculations by the Adviser. If the actual price movements of the
securities and futures are inconsistent with the Adviser's estimates of
their durations, the hedge may not be effective.
23<PAGE>
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 fixed income
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 Short and Intermediate Funds will not purchase a put or call option
on U.S. Government Securities or mortgage-backed securities if, as a
result of such purchase, more than 10% of its total assets would be
invested in such options. The Short and Intermediate Funds will engage
in OTC option transactions only with primary U.S. Government
Securities dealers recognized by the Federal Reserve Bank of New York.
The Short and Intermediate Funds will also not sell options which are
not covered.
In accordance with regulations established by the Commodity
Futures Trading Commission, each Funds' aggregate initial margin and
premiums on all futures and options contract positions not held for bona
fide hedging purposes, will not exceed 5% of a Fund's net assets, after
taking into account unrealized profits and losses on such contracts. In
addition to margin deposits, when the Fund purchases a futures contract,
it is required to maintain at all times liquid securities in a segregated
account with its Custodian, in an amount which, together with the initial
margin deposit on the futures contract, is equal to the current delivery or
cash settlement value of the futures contract. The Funds' ability to
engage in options and futures transactions and to sell related securities
might also be limited by tax considerations and by certain regulatory
requirements. See "Taxes" in the relevant Statement of Additional
Information.
Securities Lending, Repurchase Agreements and Forward
Commitments. The Funds may lend portfolio securities to broker-
dealers and may enter into repurchase agreements. These transactions
must be fully collateralized at all times but involve some risk to the
Funds if the other party should default on its obligations and a Fund is
delayed in or prevented from recovering the collateral. None of the
Funds will lend portfolio securities if, as a result, the aggregate of such
loans exceeds 33 1/3% of the total asset value (including such loans).
The Funds will only enter into repurchase agreements with or lend
securities to (i) member banks of the Federal Reserve System having
total assets in excess of $500 million and (ii) securities dealers, provided
such banks or dealers meet the creditworthiness standards established by
the Board of Trustees ("Qualified Institutions"). The Adviser will
monitor the continued creditworthiness of Qualified Institutions, subject
to the oversight of the Board of Trustees.
The Funds may also purchase securities for future delivery, which may
increase overall investment exposure and involves a risk of loss if the
value of the securities declines prior to the settlement date. At the time a
Fund enters into a transaction on a when-issued or forward commitment
basis, a segregated account consisting of liquid securities equal to at
least 100% of the value of the when-issued or forward commitment
securities will be established and maintained with the Funds' custodian.
Subject to this requirement, the Funds may purchase securities on such
basis without limit. Settlements in the ordinary course, which may be
23<PAGE>
substantially more than three business days for mortgage-backed
securities, are not treated as when-issued or forward commitment
transactions, and are not subject to the foregoing limitations, although
some of the risks described above may exist.
Reverse Repurchase Agreements, Dollar Roll Agreements and
Borrowing. The Funds may enter into reverse repurchase agreements or
dollar roll agreements with commercial banks and registered broker-
dealers in amounts up to 33 1/3% of their assets. The Short and
Intermediate Funds may only enter into these transactions with
commercial banks and registered broker-dealers which are also
Qualified Institutions. The Statement of Additional Information for each
Trust contains a more detailed explanation of these practices. Reverse
repurchase agreements and dollar rolls are considered borrowings by a
Fund and require segregation of assets with a Fund's custodian in an
amount equal to the Fund's obligations pending completion of such
transactions. Each Fund may also borrow money from banks in an
amount up to 33 1/3% of a Fund's total assets to realize investment
opportunities, for extraordinary or emergency purposes, or for the
clearance of transactions. Borrowing from banks usually involves
certain transaction and ongoing costs and may require a Fund to
maintain minimum bank account balances. Use of these borrowing
techniques to purchase securities is a speculative practice known as
"leverage." Depending on whether the performance of the investments
purchased with borrowed funds is sufficient to meet the costs of
borrowing, a Fund's net asset value per share will increase or decrease,
as the case may be, more rapidly than if the Fund did not employ
leverage.
Short Sales. The Funds may make short sales of securities. A short
sale is a transaction in which the Fund sells a security it does not own in
anticipation that the market price of that security will decline. All of the
Funds, except the Financial Services Fund, expect to engage in short
sales as a form of hedging in order to shorten the overall duration of the
portfolio and maintain portfolio flexibility. The Financial Services Fund
may make short sales of securities to reduce the risk of the portfolio to
the market or to increase return. While a short sale may act as effective
hedge to reduce the market or interest rate risk of a portfolio, it may also
result in losses which can reduce the portfolio's total return.
When a Fund makes a short sale, it must borrow the security sold short
and deliver it to the broker-dealer through which it made the short sale
as collateral for its obligation to deliver the security upon completion of
the transaction. A Fund may have to pay a fee to borrow particular
securities, and is often obligated to relinquish any payments received on
such borrowed securities.
Until a Fund replaces a borrowed security, it will maintain daily a
segregated account with its custodian into which it will deposit liquid
securities such that the amount deposited in the account plus any amount
deposited with the broker as collateral will equal the current value of the
security sold short. Depending on arrangements made with the broker, a
Fund may not receive any payments (including interest) on collateral
deposited with the broker. If the price of the security sold short increases
between the time of the short sale and the time a Fund replaces the
borrowed security, the Fund will incur a loss; conversely, if the price
24<PAGE>
declines, the Fund will realize a gain. Although a Fund's gain is limited
to the amount at which it sold the security short, its potential loss is
limited only by the maximum attainable price of the security less the
price at which the security was sold.
A Fund will not make a short sale if, after giving effect to such sale, the
market value of all securities sold exceeds 25% of the value of the
Fund's total net assets. A Fund may also effect short sales where the
Fund owns, or has the right to acquire at no additional cost, the identical
security (a technique known as a short sale "against the box"). Such
transactions might accelerate the recognition of gain. See "Taxes" in the
relevant Statement of Additional Information.
Illiquid Securities. A Fund may invest up to 15% of its net assets in
illiquid securities. The term illiquid securities for this purpose means
securities that cannot be disposed of within seven days in the ordinary
course of business. The SEC staff takes the position that this includes
non-terminable repurchase agreements having maturities of more than
seven days.
The High Yield Bond, U.S. Equity Market Plus Fund, Asia/Pacific,
Europe, and Financial Services Funds may invest in restricted securities,
which represent securities that can be sold in privately negotiated
transactions, pursuant to an exemption from registration under the
Securities Act of 1933, or in registered public offering. Restricted
securities deemed to be liquid under procedures established by the Board
are not subject to the limitations on illiquid securities.
The determination of whether certain IO/PO Strips issued by the U.S.
Government and backed by fixed-rate mortgages or any other securities
in which a Fund desires to invest are liquid shall be made by the Adviser
under guidelines established by the Trustees in accordance with
applicable pronouncements of the SEC. At present, all other IO/PO
Strips, other residual interests of CMOs and OTC options are treated as
illiquid securities. The SEC staff also currently takes the position that
the interest rate swaps, caps and floors discussed in the Statements of
Additional Information, as well as equity swap contracts and reverse
equity swap contracts, are illiquid.
Portfolio Turnover. The Adviser buys and sells securities for a Fund
whenever it believes it is appropriate to do so. Portfolio turnover
generally involves some expense to a Fund, including brokerage
commissions or dealer mark-ups and other transaction costs on the sale
of securities and reinvestment in other securities. Such transactions may
result in realization of taxable capital gains. The portfolio turnover rate
for each Fund's previous fiscal periods is shown in the table under the
heading "Financial Highlights". The Adviser expects that for the High
Yield Bond, Asia/Pacific and Europe Funds, the portfolio turnover rate
will not exceed 500% for the fiscal year.
25<PAGE>
The portfolio turnover rates reported in the "Financial Highlights"
for the Short, Intermediate, and U.S. Equity Market Plus Funds for the
fiscal year ended March 31, 1998 were relatively high. In addition, the
Adviser anticipates that the portfolio turnover rate for the High Yield
Bond, Asia/Pacific, and Europe Funds will also be relatively high. Since
the Funds' fixed-income holdings are relatively liquid, the Funds may
reposition their holdings between different sectors and coupons
relatively frequently. The mortgage securities in which the Funds may
invest are generally traded on a "net" basis with dealers acting as
principals for their own account without a stated commission.
.
The Funds will pay commissions in connection with options and
future transactions and, for the High Yield Bond, U.S. Equity Market
Plus, Asia/Pacific, Europe and Financial Services Funds, in relation to
any purchase of any common stocks or other equity securities.
MANAGEMENT OF THE FUNDS
Its Board of Trustees manages the business affairs of the Funds. Each of
the Funds has entered into an investment advisory agreement with Smith
Breeden Associates, Inc., 100 Europa Drive, Chapel Hill, North
Carolina, 27514 (the "Investment Advisory Agreements"). Pursuant to
such investment advisory agreements, the Adviser furnishes continuous
investment advisory services to each of the Funds.
Trustees and Officers
The following is a listing of the Trustees and officers of the Series Fund
and Trust, the legal entities that have issued shares in the Funds. Unless
otherwise indicated, all of the named individuals serve in their capacities
for both the Series Fund and Trust.
Douglas T. Breeden* Trustee and Chairman
Portfolio Manager, Financial Services Fund
Portfolio Manager, High Yield Bond Fund
Dr. Breeden, the Chairman of the Board of Smith Breeden Associates,
co-founded the firm in 1982. In conjunction with Michael J. Giarla and
Robert B. Perry, he is responsible for the day-to-day operations of the
Financial Services Fund, and in conjunction with David A. Tiberii, he is
responsible for the day-to-day operations of the High Yield Bond Fund.
Dr. Breeden has served on business school faculties at Duke University,
Stanford University and the University of Chicago, and as a visiting
professor at Yale University and at the Massachusetts Institute of
Technology. He is the Editor of The Journal of Fixed Income. Dr.
Breeden served as Associate Editor for five journals in financial
economics, and was elected to the Board of Directors of the American
Finance Association. He has published several well-cited articles in
finance and economics journals. He holds 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.
26<PAGE>
Michael J. Giarla* Trustee and President
Portfolio Manager, Financial Services Fund
Mr. Giarla is Chief Operating Officer, President and Director of Smith
Breeden Associates. In conjunction with Douglas T. Breeden and Robert
B. Perry, he is responsible for the day-to-day operations of the Financial
Services Fund. He also serves as a Director of Harrington Financial
Group, the holding company for Harrington Bank, F.S.B., of Richmond,
Indiana. Formerly Smith Breeden's Director of Research, he was
involved in research and programming, particularly in the development
and implementation of models to evaluate and hedge mortgage
securities. He also consults with institutional clients and conducts
special projects. Before joining Smith Breeden Associates, Mr. Giarla
was a Summer Associate in Goldman Sachs & Company's Equity
Strategy Group in New York. Mr. Giarla has published a number of
articles and book chapters regarding MBS investment, risk management
and hedging. He served as an Associate Editor of The Journal of Fixed
Income from 1991-1993. Mr. Giarla holds a Master of Business
Administration with Concentration in Finance from the Stanford
University Graduate School of Business, where he was an Arjay Miller
Scholar. He earned a Bachelor of Arts in Statistics, summa cum laude,
from Harvard University, where he was elected to Phi Beta Kappa and
was a Harvard Club of Boston Scholar. Mr. Giarla is a Trustee of the
Roxbury Latin School, West Roxbury, Massachusetts.
Stephen M. Schaefer Trustee
Stephen M. Schaefer is the Tokai Bank Professor 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, including the Adviser, and is a
former Independent Board Member of the Securities and Futures
Authority of Great Britain.
Myron S. Scholes Trustee
Myron S. Scholes is a Principal in the money management firm Long-
Term Capital Management Co. (since 1993). He is the Frank E. Buck
Professor of Finance Emeritus at the Graduate School of Business at
Stanford University (since 1983). He is a member of the Econometric
Society. Professor Scholes was also a Managing Director and co-head of
the fixed income derivatives group at Salomon Brothers between 1991-
1993. Prior to coming to Stanford University in 1983, Professor Scholes
was the Edward Eagle Brown Professor of Finance at the Graduate
School of Business, University of Chicago (1974-1983). He served as
the Director of the University of Chicago's Center for Research in
Security Prices from 1974-1980. Prior to coming to the University of
Chicago, Professor Scholes was first an Assistant Professor then an
Associate Professor at the Sloan School of Management at M.I.T. from
1968 to 1973. He received his Ph.D. in 1969 from the Graduate School
of Business, University of Chicago. He has honorary Doctor of Law
degrees from the University of Paris and McMaster University. He is a
past president of the American Finance Association (1990).
26<PAGE>
Dr. Scholes has published numerous articles in academic journals and in
professional volumes. He is most noted as the co-originator of the
Black-Scholes Options Pricing Model as described in the paper, "The
Pricing of Options and Corporate Liabilities," published in the Journal
of Political Economy (with Fischer Black, May 1973), for which he was
awarded the Nobel Prize in Economic Sciences in 1997. His other papers
include such topics as risk-return relationships, the effects of dividend
policy on stock prices, and the effects of taxes and tax policy on
corporate decision making. His book with Mark Wolfson (Stanford
University) Taxes and Business Strategy: A Planning Approach was
published by Prentice Hall in 1991.
William F. Sharpe Trustee
William F. Sharpe is the STANCO 25 Professor of Finance at Stanford
University's Graduate School of Business. He is best known as one of
the developers of the Capital Asset Pricing Model, including the beta
and alpha concepts used in risk analysis and performance measurement.
He developed the widely used binomial method for the valuation of
options and other contingent claims. He also developed the computer
algorithm used in many asset allocation procedures, a procedure for
estimating the style of an investment manager from its historic returns,
and the Sharpe ratio for measuring investment performance. Dr. Sharpe
has published articles in a number of professional journals. He has also
written six books, including Portfolio Theory and Capital Markets,
(McGraw-Hill, 1970), Asset Allocation Tools, (Scientific Press, 1987),
Fundamentals of Investments (with Gordon J. Alexander and Jeffery
Bailey, Prentice-Hall, 1993) and Investments (with Gordon J. Alexander
and Jeffrey Bailey, Prentice-Hall, 1990). Dr. Sharpe is a past President
of the American Finance Association. He also served as consultant to a
number of corporations and investment organizations. He is Trustee of
the Barr Rosenberg mutual funds, a director of Stanford Management
Company and the Chairman of the Board of Financial Engines, a
company providing electronic portfolio advice. He received the Nobel
Prize in Economic Sciences in 1990.
Daniel C. Dektar Vice President, Smith Breeden Series Fund
Portfolio Manager, Short and Intermediate Funds
Daniel C. Dektar is a Principal, Executive Vice President, Director of
Portfolio Management, and Director of Smith Breeden Associates. Mr.
Dektar has been primarily responsible for the day-to-day management of
the Short and Intermediate Funds since their commencement of
operations in 1992. In December 1997, Timothy D. Rowe joined Mr.
Dektar as co-Portfolio Manager of the Intermediate Fund, and shares
responsibility for the day-to-day management of that Fund. As head of
Smith Breeden Associates' portfolio management group, Mr. Dektar is
constantly in touch with developments on Wall Street. He serves as a
liaison among the portfolio management, client service, and research
groups to ensure accurate analysis and timely execution of portfolio
management opportunities. Mr. Dektar consults with institutional clients
in the areas of investments and risk management. He made several
presentations on mortgage investments and risk management at seminars
for institutional investors. Mr. Dektar was an Associate in the Mergers
and Acquisitions Group of Montgomery Securities in San Francisco,
California and a Financial Analyst in the Investment Banking Division
of Morgan Stanley & Co., Incorporated, New York before joining Smith
Breeden Associates. He holds a Master of Business Administration with
Concentration in Finance from Stanford University Graduate School of
27<PAGE>
Business, where he was an Arjay Miller Scholar. Mr. Dektar received a
Bachelor of Science in Business Administration, summa cum laude,
from the University of California at Berkeley, where he was University
of California Regent's Scholar, was elected to Phi Beta Kappa and Phi
Eta Sigma, and won the White Award as the top student in finance.
Timothy D. Rowe Vice President, Smith Breeden Series Fund
Portfolio Manager, Intermediate Fund
Timothy D. Rowe is a Principal, Director, and Vice President of Smith
Breeden Associates. Mr. Rowe, in conjunction with Daniel C. Dektar, is
responsible for the day-to-day management of the Intermediate Fund.
Mr. Rowe is a senior portfolio manager working primarily with
discretionary separate account clients. He implements investment
strategies designed to generate portfolio returns superior to the broad
investment grade and mortgage market indices. Mr. Rowe joined Smith
Breeden in 1988. His prior experience includes three years as Assistant
Economist at the Federal Reserve Bank of Richmond, Virginia. While at
the Bank, he co-edited the sixth edition of Instruments of the Money
Market, and produced research papers for publication in the Bank's
Economic Review magazine. He holds a Master of Business
Administration with specialization in Finance from the University of
Chicago Graduate School of Business, and a Bachelor of Arts in
Economics and History from Duke University. He graduated from Duke
magna cum laude, earned Class Honors and was a National Merit
Scholar.
John B. Sprow Vice President, Smith Breeden Trust
Portfolio Manager, U.S. Equity Market Plus Fund
John B. Sprow is a Principal, Director and Executive Vice President
of Smith Breeden Associates. Mr. Sprow has been primarily responsible
for the day-to-day management of the U.S. Equity Market Plus Fund
from the commencement of its operations in 1992. Mr. Sprow is a senior
portfolio manager who works primarily with discretionary pension
accounts. In addition to traditional mortgage accounts, he also manages
S&P 500 indexed accounts. Prior to directly managing discretionary
accounts, Mr. Sprow assisted in the development of the Adviser's
models for pricing and hedging mortgage-related securities, risky
commercial debt, and forecasting mortgage prepayment behavior. Mr.
Sprow came to Smith Breeden Associates from the Fuqua School of
Business, Duke University, where he was Research Assistant.
Previously, Mr. Sprow was a Research Assistant to the Department Head
of the Materials Science Department, Cornell University. He received a
Master of Business Administration with Emphasis in Finance from the
Fuqua School of Business, Duke University. Mr. Sprow holds a
Bachelor of Science in Materials Science and Engineering from Cornell
University, where he was awarded the Carpenter Technology
Scholarship three successive years.
28<PAGE>
Robert B. Perry Vice President, Smith Breeden Trust
Portfolio Manager, Financial Services Fund
Robert B. Perry is a Principal at Smith Breeden Associates, providing
hedging and investment advice to Smith Breeden's financial services
clients. He is also responsible for calculating marked-to-market values
and projected income of institutions, and assesses the effects of interest
rate and economic changes. In conjunction with Douglas T. Breeden and
Michael J. Giarla, Mr. Perry is responsible for the day-to-day operations
of the Financial Services Fund. Prior to joining Smith Breeden, Mr.
Perry served as an interest rate risk analyst for Centura Bank, and
secretary to the ALCO committee. He has also served as a Director for
Community First Financial Group, a multi-bank holding company
located in Indianapolis, Indiana. Mr. Perry earned his Bachelor of Arts
in Business Administration from North Carolina State University.
David A. Tiberii Vice President, Smith Breeden Trust
Portfolio Manager, High Yield Bond Fund
David A. Tiberii is an Associate at Smith Breeden Associates. As a
member of Smith Breeden's Research Group, he assists in the creation of
new security pricing models. In conjunction with Douglas T. Breeden,
Mr. Tiberii is responsible for the day-to-day operations of the High
Yield Bond Fund. Before joining Smith Breeden Associates, he was an
engineering consultant specializing in operational and maintenance
issues at nuclear power plants and a submarine officer in the US Navy.
He received his Masters of Business Administration with a
concentration in Finance from the Fuqua School of Business, Duke
University, where he was a Fuqua Scholar. Mr. Tiberii holds a Bachelor
of Arts degree in Physics from Holy Cross College and a Chief Nuclear
Engineer certification from the US Navy.
William F. Quinn Vice President, Smith Breeden Trust
Portfolio Manager, Asia/Pacific and Europe Funds
William F. Quinn is an Executive Vice President and a Director of Smith
Breeden Associates. He is a Senior Portfolio Manager, a member of
Smith Breeden's Portfolio Management Group (PMG), and the portfolio
manager for several discretionary accounts as well as the primary Smith
Breeden consultant to Harrington Bank. Mr. Quinn is also involved in
the formulation and implementation of investment and risk management
policies and procedures as well as clients' strategic plans and business
plans. He has completed a number of special projects for both
institutional clients and government regulators regarding complex
mortgage securities. Mr. Quinn is primarily responsible for the day-to-
day operations of the Asia/Pacific and Europe Funds. Mr. Quinn joined
Smith Breeden after completing his Masters of Science in Management
with Concentrations in Finance, MIS and System Dynamics from the
Sloan School of Management, Massachusetts Institute of Technology.
He earned a Bachelor of Science in Management Science from the
Massachusetts Institute of Technology.
29<PAGE>
Marianthe S. Mewkill Vice President, Secretary,
Treasurer, and Chief Accounting Officer
Marianthe S. Mewkill is a Principal, Vice President and Chief Financial
Officer of Smith Breeden Associates. Ms. Mewkill handles financial
reporting, budgeting, tax research and planning for the Smith Breeden
Mutual Funds and for Smith Breeden Associates, Inc. She ensures
compliance with agency regulations and administers the Adviser's
internal trading and other policies. She was previously employed as a
Controller for the Hunt Alternatives Fund, as an Associate at Goldman
Sachs & Co., and as a Senior Auditor at Arthur Andersen & Co. She
earned a Master of Business Administration with Concentrations in
Finance and Accounting from New York University and graduated from
Wellesley College, magna cum laude with a Bachelor of Arts degree in
History and French and a Minor in Economics.
St. John M. Kelliher Assistant Treasurer
St. John M. Kelliher assists in financial administration and portfolio
analysis for Smith Breeden Associates and Smith Breeden Mutual
Funds. He holds a Bachelor of Arts degree from Trinity College,
Dublin, Ireland, and a Master of Arts degree in Philosophy from the
University of Illinois at Chicago. He passed the Uniform C.P.A.
examination in 1993, and currently is studying for the Chartered
Financial Analyst (C.F.A.) designation.
Investment Adviser
Smith Breeden Associates, Inc., a registered investment adviser,
acts as investment adviser to the Funds. Approximately 62% of the
Adviser's voting stock on a fully diluted basis 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 each of the Short, Intermediate, High Yield
Bond, U.S. Equity Market Plus, Asia/Pacific, and Europe Funds' average
daily net assets. The Adviser receives a fee at the rate of 1.50% for its
management of the Financial Services Fund. Until August 1, 1999, 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 and other
investment related expenses, investment transaction taxes and
extraordinary expenses) do not exceed 0.78% of the average net assets
of the Short Fund, 0.88% of the average net assets for each of the
Intermediate Fund and U.S. Equity Market Plus Fund, 0.98% of the net
assets for each of the High Yield Bond Fund, Asia/Pacific Fund, and
Europe Fund, and 1.48% of the average net assets for the Financial
Services 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.
30<PAGE>
Distribution
FPS Broker Services, Inc. (the "Principal Underwriter") acts as
distributor for the Funds. Effective on or about January 1, 1999, First
Data Broker Services, Inc. (also, the "Principal Underwriter") is
expected to become the distributor for the Funds. Shares may also be
sold by authorized dealers who have entered into dealer agreements with
the Principal Underwriter or the Adviser.
Expenses
Subject to any expense waivers or reimbursements, the Funds pay all of
their own expenses, including, without limitation, the cost of preparing
and printing their registration statements required under the Securities
Act of 1933 and the 1940 Act and any amendments thereto, the expense
of registering their shares with the Securities and Exchange Commission
and the various states, the printing and distribution costs of prospectuses
mailed to existing investors, reports to investors, reports to government
authorities and proxy statements, fees paid to directors who are not
interested persons of the Adviser, interest charges, taxes, legal expenses,
association membership dues, auditing services, insurance premiums,
brokerage commissions and expenses in connection with portfolio
transactions, fees and expenses of the custodian of their assets, printing
and mailing expenses and charges and expenses of dividend disbursing
agents, accounting services agents, registrars and stock transfer agents.
PRICING OF FUND SHARES
The price you pay when buying a Fund's shares, and the price you
receive when selling (redeeming) a Fund's shares, is the net asset value
of the shares next determined after receipt of a purchase or redemption
request in proper form. No front-end sales charge or commission of any
kind is added by the Fund upon a purchase, and no charge is deducted
upon redemption. These charges may apply if you purchase or sell
shares through certain broker-dealers. The Funds currently charge a $9
fee for each redemption made by wire. See "How to Redeem Shares."
The per share net asset value of a Fund is determined by dividing the
total value of its assets, less its liabilities, by the total number of its
shares outstanding at that time. The net asset value is determined as of
the close of regular trading (usually at 4:00 p.m. Eastern time) each day
that the Adviser and Transfer Agent are open for business and on which
there is a sufficient degree of trading in a Fund's securities such that the
net asset value of a Fund's shares might be affected. Accordingly,
Purchase Applications accepted or redemption requests received in
proper form by the Transfer Agent, or other agent designated by the
Funds, prior to the close of regular trading each day that the Adviser and
Transfer Agent are open for business, will be confirmed at that day's net
asset value. Purchase Applications accepted or redemption requests
received in proper form after the close of regular trading by the Transfer
Agent, or other agent designated by the Funds, will be confirmed at the
net asset value of the following business day.
31<PAGE>
Foreign securities, futures and options are valued at the last quoted
sales price, according to the broadest and most representative market,
available at the time a Fund is valued. If events which materially affect
the value of an investment occur after the close of the securities and
futures markets on which such securities are primarily traded, those
investments may be valued by such methods as the Board of Trustees
deems in good faith to reflect fair value.
Current holiday schedules indicate that the Funds' net asset values will
not be calculated on New Year's Day, Martin Luther King Day,
President's Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving Day, the day following Thanksgiving, Christmas Eve
and Christmas Day. The Short and Intermediate Funds will also not be
priced on Columbus Day and Veterans' Day.
Under procedures approved by the Board of Trustees, a Fund's securities
for which market quotations are readily available are valued at current
market value provided by a pricing service, bank or broker-dealer
experienced in such matters. Short-term investments that will mature in
60 days or less are generally valued at amortized cost, which
approximates market value. All other securities and assets are valued at
fair market value as determined by following procedures approved by
the Board of Trustees.
HOW TO PURCHASE SHARES
All of the Funds are no-load, so you may purchase, redeem or exchange
shares directly at net asset value without paying a sales charge. Because
the Funds' net asset value changes daily, your purchase price will be the
next net asset value determined after the Funds' Transfer Agent, or other
agent designated by the Funds, receives and accepts your purchase
order. See "Pricing of Fund Shares."
Initial Minimum Additional Minimum
Type of Account Investment Investment
Regular $1000 $50
Automatic Investment Plan None $50
Individual Retirement Account $ 250 $50
Gift to Minors $ 250 $50
Each Fund reserves the right to reject any orders for the purchase of its
shares or to limit or suspend, without prior notice, the offering of its
shares. The required minimum investments may be waived in the case of
qualified retirement plans.
How to Open Your Account by Mail. Please complete the Purchase
Application. You can obtain additional copies of the Purchase
Application and a copy of the IRA Purchase Application from the Funds
by calling 1-800-221-3138.
Your completed Purchase Application should be mailed directly to:
Smith Breeden Mutual Funds
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA 19406-0903
32<PAGE>
All applications must be accompanied by payment in the form of a
check or money order made payable to "Smith Breeden Mutual Funds."
All purchases must be made in U.S. dollars, and checks must be drawn
on U.S. banks. No cash, credit cards or third party checks will be
accepted. When a purchase is made by check and a redemption is made
shortly thereafter, the Funds will delay the mailing of a redemption
check until the purchase check has cleared your bank, which may take
up to 15 calendar days from the purchase date. If you contemplate
needing access to your investment shortly after purchase, you should
purchase the shares by wire as discussed below.
How to Open Your Account by Wire. You may make purchases by
direct wire transfers. To ensure proper credit to your account, please call
the Funds at 1-800-221-3137 for instructions prior to wiring funds.
Funds should be wired through the Federal Reserve System as follows:
United Missouri Bank
A.B.A. Number 10-10-00695
For the account of First Data Investor Services Group, Inc.
Account Number 98-7037-071-9
For credit to (identify which Fund to purchase)
For further credit to: (investor account number)
(name or account registration)
(Social Security or Tax Identification Number)
Following such wire transfer, you must promptly complete a Purchase
Application and mail it to the Funds at the following address: Smith
Breeden Mutual Funds, 3200 Horizon Drive, P.O. Box 61503, King of
Prussia, PA 19406-0903. Shares will be redeemed with Federal tax
withheld if the Funds do not receive a properly completed and executed
Purchase Application.
Telephone Transactions. The privilege to initiate redemption or
exchange transactions by telephone is made automatically available to
shareholders when opening an account, unless they indicate otherwise
by 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.
33<PAGE>
Automatic Investment Plan. You may make purchases of shares of
each Fund automatically on a regular basis ($50 minimum per
transaction). You have two options under the Plan to make investments.
One is by automatic payroll deduction. Under this method, you authorize
your employer to direct a portion of each paycheck to be invested in the
Fund of your choice. Your employer must be using direct deposit to
process its payroll in order for you to elect this method. Under the other
method, your bank debits a pre-authorized amount from your checking
or savings account each month and applies the amount to your
investment in Fund shares. In order to have your bank account debited
automatically for investment into the Funds, your financial institution
must be a member of the Automated Clearing House. No service fee is
currently charged by the Funds for participation in either method under
the Plan. A $20 fee will be imposed by the Funds if sufficient funds are
not available in your bank account, or if your bank account has been
closed at the time of the automatic transaction. You may adopt either
method under the Plan at the time an account is opened by completing
the appropriate section of the Purchase Application. Enclosed with the
application are the necessary forms to deliver to your employer to set up
the payroll deduction. You may obtain an application to establish the
Automatic Investment Plan after an account is opened by calling the
Funds at 1-800-221-3138. In the event you discontinue participation in
the Plan, the Funds reserve the right to redeem your Fund account
involuntarily, upon sixty days' written notice, if the account's net asset
value is $1000 or less.
Purchasing Shares Through Other Institutions. The Funds have
authorized dealers besides the Principal Underwriter to accept on its
behalf purchase and redemption orders. If you purchase shares through a
program of services offered or administered by one of these broker-
dealers, financial institutions, or other service provider, you should read
the program materials, including information relating to fees, in addition
to this Prospectus. Certain services of a Fund may not be available or
may be modified in connection with the program of services provided,
and service providers may establish higher minimum investment
amounts. The Funds may only accept requests to purchase additional
shares into a broker-dealer street name account from the broker- dealer.
Certain broker-dealers, financial institutions, or other service providers
that have entered into an agreement with the Adviser or Principal
Underwriter may enter purchase and redemption orders on behalf of
their customers by phone, with payment to follow within several days as
specified in the agreement. These broker-dealers and service providers
may designate other intermediaries to accept purchase and redemption
orders on the Funds' behalf. The Funds will be deemed to have effected
such purchase or redemption orders at the net asset value next
determined after acceptance of the telephone purchase order by the
authorized broker or the authorized broker's designee. It is the
responsibility of the broker-dealer, financial institution, or other service
provider to place the order with the Funds on a timely basis. If payment
is not received within the time specified in the agreement, the broker-
dealer, financial institution, or other service provider could be held
liable for any resulting fees or losses.
Miscellaneous. The Funds will charge a $20 service fee against your
account for any check or electronic funds transfer that is returned
unpaid. You will also be responsible for any losses suffered by the
Funds as a result. In order to relieve you of responsibility for the safekeeping
and delivery of stock certificates, the Funds do not currently issue
certificates.
34<PAGE>
HOW TO EXCHANGE SHARES
Shares of any Fund may be exchanged for shares of another Fund at any
time. This exchange offer is available only in states where shares of such
other Fund may be legally sold. You may open a new account, or
purchase additional shares in an existing account, by making an
exchange from an identically registered Smith Breeden Fund account. A
new account will have the same registration as the existing account from
which the exchange was made, and is subject to the same initial
investment minimums.
Exchanges may be made either in writing or by telephone. Written
instructions should be mailed to 3200 Horizon Drive, P.O. Box 61503,
King of Prussia, PA 19406 and must be signed by all account owners,
and accompanied by any properly endorsed outstanding share
certificates, if applicable. The telephone exchange is automatically
accepted unless checked otherwise. The telephone exchange privilege is
available only for uncertificated shares. During periods of drastic
economic or market changes, it is possible that exchanges by telephone
may be difficult to implement. In this event, shareholders should follow
the written exchange procedures. The telephone exchange privilege may
be modified or discontinued by the Funds at any time upon a 60-day
notice to the shareholders. To exchange by telephone, you must follow
the instructions below under "How to Redeem by Telephone."
The Funds will accept exchange orders by telephone or other means of
electronic transmission from broker- dealers, financial institutions or
other service providers who execute an agreement with the Adviser or
Principal Underwriter. It is the responsibility of the broker-dealer,
financial institution or other service provider to place the exchange order
on a timely basis.
Exchanges are made on the basis of the Funds' relative net asset values.
Because the exchange is considered a redemption and purchase of
shares, the shareholder may recognize a gain or loss for federal income
tax purposes. Backup withholding and information reporting may also
apply. Additional information regarding the possible tax consequences
of such an exchange is included under the caption "Taxes" in the Funds'
Statements of Additional Information.
There are differences among the Funds. When exchanging shares,
shareholders should be aware that the Funds might have different
dividend payment dates. The dividend payment schedules should be
checked before exchanging shares. The amount of any accumulated, but
unpaid, dividend is included in the net asset value per share.
If you buy shares by check, you may not exchange those shares for up to
15 calendar days to ensure your check has cleared. If you intend to
exchange shares soon after their purchase, you should purchase the
shares by wire or contact the Funds at 1-800-221-3137 for further
information.
The Funds reserve the right to temporarily or permanently terminate,
with or without advance notice, the exchange privilege of any investor
who makes excessive use of the exchange privilege (e.g., more than four
exchanges per calendar year).
35<PAGE>
Additional documentation may be required for exchange requests if
shares are registered in the name of a corporation, partnership or
fiduciary. Please contact the Funds for additional information
concerning the exchange privilege.
HOW TO REDEEM SHARES
You may redeem shares of the Funds at any time. The price at which the
shares will be redeemed is the net asset value per share next determined
after proper redemption instructions are received by the Transfer Agent
or other agent designated by the Funds. See "Pricing of Fund Shares."
There are no charges for the redemption of shares, except that a fee of $9
is charged for each wire redemption. Depending upon the redemption
price you receive, you may realize a capital gain or loss for federal
income tax purposes.
How to Redeem by Mail to Receive Proceeds by Check. To redeem
shares by mail, simply send an unconditional written request to the
Funds specifying the number of shares or dollar amount to be redeemed,
the name of the Fund, the name(s) on the account registration and the
account number. A request for redemption must be signed exactly as the
shares are registered. If the amount requested is greater than $25,000, or
the proceeds are to be sent to a person other than the recordholder or to a
location other than the address of record, each signature must be
guaranteed by a commercial bank or trust company in the United States,
a member firm of the National Association of Securities Dealers, Inc. or
other eligible guarantor institution. A notary public is not an
acceptable guarantor. Guarantees must be signed by an authorized
signatory of the bank, trust company, or member firm, and "Signature
Guaranteed" must appear with the signature. Additional documentation
may be required for the redemption of shares held in corporate,
partnership or fiduciary accounts. In case of any questions, please
contact the Funds in advance.
A Fund will mail payment for redemption within seven days after
receiving proper instructions for redemption. However, the Funds will
delay payment for 15 calendar days on redemptions of recent purchases
made by check. This allows the Funds to verify that the check used to
purchase Fund shares will not be returned due to insufficient funds and
is intended to protect the remaining investors from loss.
How to Redeem by Telephone. The redemption of shares by telephone
is available automatically unless you elected to refuse this redemption
privilege on your Purchase Application. Shares may be redeemed by
calling the Funds at 1-800-221-3137. Proceeds redeemed by telephone
will be mailed to your address, or wired or credited to your pre-
authorized bank account. To establish wire redemption privileges, you
must select the appropriate box on the Purchase Application and enclose
a voided check.
36<PAGE>
In order to arrange for telephone redemptions after your account has
been opened, or to change the bank account or address designated to
receive redemption proceeds, you must send a written request to your
Fund. The request must be signed by each registered holder of the
account with the signatures guaranteed by a commercial bank or trust
company in the United States, a member firm of the National
Association of Securities Dealers, Inc. or other eligible guarantor
institution. A notary public is not an acceptable guarantor. Further
documentation as provided above may be requested from corporations,
executors, administrators, trustees and guardians.
Payment of the redemption proceeds for Fund shares redeemed by
telephone where you request wire payment will normally be made in
federal funds on the next business day. The Funds reserve the right to
delay payment for a period of up to seven days after receipt of the
redemption request. There is currently a $9 fee for each wire
redemption, which will be deducted from your account.
The Funds reserve the right to refuse a telephone redemption or
exchange transaction if they believe it is advisable to do so. Procedures
for redeeming or exchanging shares of the Funds by telephone may be
modified or terminated by the Funds at any time. In an effort to prevent
unauthorized or fraudulent redemption or exchange requests by
telephone, the Funds have implemented procedures designed to
reasonably assure that telephone instructions are genuine. These
procedures include: requesting verification of certain personal
information; recording telephone transactions; confirming transactions
in writing; and restricting transmittal of redemption proceeds only to
pre-authorized designations. Other procedures may be implemented
from time to time. If reasonable procedures are not implemented, the
Funds may be liable for any loss due to unauthorized or fraudulent
transactions. In all other cases, you are liable for any loss for
unauthorized transactions.
You should be aware that during periods of substantial economic or
market change, telephone or wire redemptions may be difficult to
implement. If you are unable to contact the Funds by telephone, you
may also redeem shares by delivering or mailing the redemption request
to: Smith Breeden Mutual Funds, 3200 Horizon Drive, P.O. Box 61503,
King of Prussia, PA 19406-0903.
The Funds reserve the right to suspend or postpone redemptions during
any period when trading on the New York Stock Exchange
("Exchange") is restricted as determined by the Securities and Exchange
Commission ("SEC"), or the Exchange is closed for other than
customary weekend and holiday closing; the SEC has by order permitted
such suspension; or an emergency, as determined by the SEC, exists,
making disposal of portfolio securities or valuation of net assets of a
Fund not reasonably practicable.
Due to the relatively high cost of maintaining small accounts, if your
account balance falls below $1000 as a result of a redemption or
exchange, or if you discontinue the Automatic Investment Plan before
your account balance reaches $1000, you may be given a 60-day notice
to bring your balance to $1000 or reactivate an Automatic Investment
Plan. If this requirement is not met, your account may be closed and the
proceeds sent to you.
37<PAGE>
Check Writing. In addition to telephone and written redemption
requests, the Short Fund offers redemption through check writing.
Shareholders electing this option will receive checks that may be used
like personal or business checks. Checks are not ordered to be mailed to
the shareholder until 15 days after the account is opened, if the account
is opened by check by the shareholder. This allows the Fund to verify
that the check used to open the account will not be returned due to
insufficient funds. There is no limit on the number of checks you may
write. Checks must be written for at least $100. There is a $30 fee for
returned checks. Because dividends declared on shares held in a
shareholder's account, prior redemptions, and possible changes in net
asset value may cause the value of the account to change, shareholders
should not write a check for the entire value of the account or close the
account by writing a check.
In using the check writing privilege, shareholders bear the responsibility
of ensuring that the check amount does not exceed the value of their
account on the day the check is presented to the Transfer Agent for
payment. The day the check is presented for payment is the day the
redemption of Fund shares takes place. If insufficient shares are in the
account, the check will be returned and no shares will be redeemed. The
clearing agent for the check writing facility is United Missouri Bank.
Shareholders utilizing check writing are subject to United Missouri
Bank's rules governing checking accounts. However, this check writing
facility is purely a means to redeem Fund shares. No facilities
characteristic of bank accounts, such as deposit insurance, are provided
along with the check writing option. Cancelled checks will not be
returned to the shareholder. If you need to request a copy of a cancelled
check, please contact Shareholder Services for procedures and
applicable fees.
If you would like to initiate check writing, please call Shareholder
Services at 1-800-221-3137 or check the appropriate box on the
Purchase Application.
Systematic Withdrawal Plan. A shareholder may establish a
Systematic Withdrawal Plan to receive regular periodic payments from
the account. An initial balance of $10,000 is required to establish a
Systematic Withdrawal Plan. There are no service charges for
establishing or maintaining a Systematic Withdrawal Plan. The
minimum amount which the shareholder may withdraw periodically is
$100. Capital gain distributions and income dividends to the
shareholder's account are received in additional shares at net asset value.
Payments are then made from the liquidation of shares at net asset value
to meet the specified withdrawals. Liquidation of shares may reduce or
possibly exhaust the shares in the shareholder's account, to the extent
withdrawals exceed shares earned through dividends and distributions,
particularly in the event of a market decline. No payment pursuant to a
Systematic Withdrawal Plan will be made if there are insufficient shares
on deposit on the date of the scheduled distribution. A subsequent
deposit of shares will not result in a payment under the plan retroactive
to the distribution date. As with other redemptions, a liquidation to make
a withdrawal payment is a sale for federal income tax purposes. The
entire Systematic Withdrawal Plan payment cannot be considered as
actual yield or income since part of the Plan's payment may be a return
of capital.
38<PAGE>
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, Intermediate and High Yield Bond Funds intend to pay
monthly distributions to their shareholders of net investment income.
The U.S. Equity Market Plus, Asia/Pacific, and Europe Funds each
intend to make quarterly distributions of net investment income. All
Funds will distribute net realized gains at least annually. The Financial
Services Fund will most likely make only this annual distribution of net
realized gains, and at this time, will also distribute any net investment
income. Each Fund may make additional distributions if necessary to
avoid imposition of a 4% excise tax or other tax on undistributed income
and gains.
The monthly distributions for the Short Fund's shares are quoted ex-
dividend on the business day after record date (the "ex-date"). Record
date is usually the first or second business day of the month. If a
shareholder elects to reinvest dividends, the date the dividends are
reinvested is also the ex-date. Dividends are paid in cash by the Short
Fund generally one week after the ex-date.
The Intermediate and High Yield Bond Funds will declare daily
dividends for shareholders of record. The Intermediate and High Yield
Bond Funds' dividend payable date, and the day that dividends are
reinvested for shareholders who have made this election, is the last
business day of the month. Shares begin accruing dividends on the
business day after federal funds (funds credited to a member bank's
account at the Federal Reserve Bank) are available from the purchase
payment for such shares, and continue to accrue dividends through and
including the day the redemption order for the shares is executed. If an
investor closes his account, any accrued dividends through and including
the day of redemption will be paid as part of the redemption
proceeds.
39<PAGE>
Dividends and capital gains distributions may be declared more or less
frequently at the direction of the Trustees. In order to be entitled to a
dividend or a distribution, an investor must acquire a Fund's shares on or
before the record date. Caution should be exercised, however, before
purchasing shares immediately prior to a distribution record date. Since
the value of a Fund's shares is based directly on the amount of its net
assets, rather than on the principle of supply and demand, any
distribution of income or capital gain will result in a decrease in the
value of its shares equal to the amount of the distribution. While a
dividend or capital gain distribution received shortly after purchasing
shares represents, in effect, a return of the shareholder's investment, it
may be taxable as dividend income or capital gain. You may separately
elect to reinvest income dividends and capital gains distributions in
shares of a Fund or receive cash as designated on the Purchase
Application. You may change your election at any time by sending
written notification to your Fund. The election is effective for
distributions with a dividend record date on or after the date that the
Funds receive notice of the election. If you do not specify an election, all
income dividends and capital gains distributions will automatically be
reinvested in full and fractional shares of the Fund from which they were
paid. Shareholders may also elect to have dividends automatically
reinvested in a fund different than the one from which the dividends
were paid. A shareholder may write the transfer agent, or complete the
appropriate section of the Purchase Application, to designate such an
election, but must have already established an account in the other fund.
The transfer agent's address is on the back of the Prospectus. Reinvested
dividends and distributions receive the same tax treatment as those paid
in cash.
SHAREHOLDER REPORTS AND INFORMATION
The Funds will provide the following statements and reports:
Confirmation and Account Statements. After each transaction that
affects the account balance or account registration, including the
payment of dividends, you will receive a confirmation statement.
Form 1099. By January 31 of each year, all shareholders will receive
Form 1099, which will report the amount and tax status of distributions
paid to you by the Funds for the preceding calendar year.
Financial Reports. Financial reports are provided to shareholders
semiannually. Annual reports will include audited financial statements.
To reduce the Funds' expenses, one copy of each report will be mailed to
each Taxpayer Identification Number even though the investor may have
more than one account in a Fund.
Reports to Depository Institutions. Shareholders of the Short or
Intermediate Funds who are financial institutions may request receipt of
monthly or quarterly reports which provide information about the Short
or Intermediate Fund's investments considering regulatory risk-based
asset categories.
If you need additional copies of previous statements, you may order
statements for the current and preceding year at no charge. Call 1-800-
221-3137 to order past statements. If you need information on your
account 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. 41<PAGE>
RETIREMENT PLANS
The Funds have a program under which you may establish an Individual
Retirement Account ("IRA") with the Funds and purchase shares
through such account. Shareholders wishing to establish an IRA should
consult their tax adviser regarding (1) their individual qualifying status
and (2) the tax regulations governing these accounts. The minimum
initial investment in each Fund for an IRA is $250. There is a $12 annual
maintenance fee charged to process an account. This fee is waived for
accounts greater than $10,000. You may obtain additional information
regarding establishing such an account by calling the Funds at 1-800-
221-3138.
The Funds may be used as investment vehicles for established defined
contribution plans, including simplified employee, 401(k), 403(b),
profit-sharing, money purchase, and simple pension plans ("Retirement
Plans"). For details concerning Retirement Plans, please call 1-800-221-
3138.
SERVICE AND DISTRIBUTION PLANS
Each Fund has adopted a Distribution and Services Plan (the "Plans").
The purpose of the Plans is to permit the Adviser to compensate
investment dealers and other persons involved in servicing shareholder
accounts for services provided and expenses incurred in promoting the
sale of shares of the Funds, reducing redemptions, or otherwise
maintaining or improving services provided to shareholders by such
dealers or other persons. The Plans provide for payments by the Adviser
out of its advisory fee to dealers and other persons at an annual rate of
up to 0.25% of a Fund's average net assets, subject to the authority of the
Trustees to reduce the amount of payments permitted under the Plan or
to suspend the Plan for such periods as they may determine. Subject to
these limitations, the Adviser shall determine the amount of such
payments and the purposes for which they are made.
Any distribution and service related payments made by the Adviser to
investment dealers or other persons are subject to the continuation of the
Plans, the terms of any related service agreements, and any applicable
limits imposed by the National Association of Securities Dealers, Inc.
TAXES
Each Fund intends to qualify as a regulated investment company under
the Internal Revenue Code. In each taxable year that a Fund so qualifies,
such Fund (but not its shareholders) will be relieved of federal income
tax on the part of its net investment income and net capital gain that is
distributed to shareholders. Each Fund will distribute at least annually
substantially all of the sum of its taxable net investment income, its net
tax-exempt income and the excess, if any, of net short-term capital gains
over the net long-term capital losses for such year.
All Fund distributions from net investment income (whether paid in cash
or reinvested in additional shares) will be taxable to its shareholders as
ordinary income, except that any distributions of a Fund's net long-term
capital gain will be taxable to its shareholders as long-term capital gain,
regardless of how long they have held their Fund shares. Pursuant to the
Taxpayer Relief Act of 1997, long-term capital gains are taxed at a
maximum of 28% or 20%, depending on the Fund's holding period in the
portfolio investments. Each Fund provides federal tax information to its
shareholders annually about distributions paid during the preceding year.
It is not anticipated that any of the Funds' distributions will qualify for
either the corporate dividends-received deduction or tax-exempt interest
income. Distributions will also probably be subject to state and local
taxes, depending on each shareholder's tax situation. While many states
grant tax-free status to mutual fund distributions paid from interest
income earned from direct obligations of the U.S. Government, none of
the Short or Intermediate Fund's distributions are expected to qualify for
such tax-free treatment, and only an insignificant amount of the U.S.
Equity Market 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 each of the Series Fund or
Trust, as the case may be, will vote together in electing the relevant
trustees and in certain other matters. Shareholders should be aware that
the outcome of the election of trustees and of certain other matters for
their trust could be controlled by the shareholders of another fund. The
shares have non-cumulative voting rights, which means that holders of
more than 50% of the shares voting for the election of the trustees can
elect 100% of the trustees if they choose to do so.
42<PAGE>
Neither the Series Fund nor the Trust is required to hold annual
meetings of its shareholders. However, shareholders of the Series Fund
have the right to call a meeting to take certain actions as provided in the
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 such actions,
the Series Fund has undertaken to provide a list of shareholders or to
disseminate appropriate materials (at the expense of the requesting
shareholders).
Under Massachusetts law, shareholders of a business trust may, under
certain circumstances, be held personally liable as partners for its
obligations. However, the risk of a shareholder incurring financial loss
on account of shareholder liability is limited to circumstances in which
both (i) any liability was greater than 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
First Data Investor Services Group, Inc. (the "Transfer Agent"), 3200
Horizon Drive, P.O. Box 61503, King of Prussia, PA 19406, a wholly
owned subsidiary of First Data Corporation, which has its principal
place of business at 4400 Computer Drive, Westboro, MA, 01581, 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.
FUND PERFORMANCE
Each Fund may quote the Fund's average annual total and/or aggregate
total return for various time periods in advertisements or
communications to shareholders. An average annual total return refers to
the rate of return which, if applied to an initial investment at the
beginning of a stated period and compounded over that period, would
result in the redeemable value of the investment at the end of the period
assuming reinvestment of all dividends and distributions and reflecting
the effect of all recurring fees. An investor's principal in each Fund and
the Fund's return are not guaranteed and will fluctuate according to
market conditions. When considering "average" total return figures for
periods longer than one year, you should note that a Fund's annual total
return for any one year in the period might have been greater or less than
the average for the entire period. Each Fund also may use "aggregate"
total return figures for various periods, representing the cumulative
change in value of an investment in the Fund for a specific period (again
reflecting changes in the Fund's share price and assuming reinvestment
of dividends and distributions).
43<PAGE>
The Short, Intermediate, and High Yield Bond Funds may also
advertise current yield and distribution rate information. Current yield
reflects the income per share earned by a Fund's portfolio investments,
and is calculated by dividing a Fund's net investment income per share
during a recent 30-day period by a Fund's net asset value on the last day
of that period and annualizing the result. The current yield (or "SEC
Yield"), which is calculated according to a formula prescribed by the
SEC (see the relevant Statement of Additional Information), is not
indicative of the dividends or distributions which were or will be paid to
a Fund's shareholders. SEC regulations require that net investment
income be calculated on a "yield-to-maturity" basis, which has the effect
of amortizing any premiums or discounts in the current market value of
fixed income securities. Dividends or distributions paid to shareholders
are reflected in the current distribution rate which may be quoted to
shareholders, and may not reflect amortization in the same manner.
A Fund may also compare its performance to that of other mutual funds
and to stock and other relevant indices, or to rankings prepared by
independent services or industry publications. For example, a Fund's
total return may be compared to data prepared by Lipper Analytical
Services, Inc., Morningstar, Inc., Value Line Mutual Fund Survey and
CDA Investment Technologies, Inc. Total return data as reported in such
national financial publications as The Wall Street Journal, The New York
Times, Investor's Business Daily, USA Today, Barron's, Money and
Forbes, as well as in publications of a local or regional nature, may be
used in comparing Fund performance.
The Short Fund's total return may also be compared to that of
taxable money funds as quoted in Donaghue's Money Fund Report and
other suppliers, and to total returns for the six month U.S. Treasury as
published by Merrill Lynch or others. The Intermediate Fund's return
may be compared to the total return of the Salomon Brothers Mortgage
Index, or the total return of intermediate U.S. Treasury Notes as
published by various brokerage firms and others. The High Yield Bond
Fund's return may be compared to the Merrill Lynch High Yield Master
Index or some other high yield bond index as published by a brokerage
firm or others. The High Yield Bond Fund's performance may also be
compared to the competitive funds average as published by Lipper
Analytical Services, Inc.
The U.S. Equity Market Plus Fund's total return may also be
compared to the return of the Standard & Poor's 500 Composite Stock
Price Index. For purposes of showing the returns of large company
stocks versus small company stocks, or to compare returns versus
inflation, the U.S. Equity Market Plus Fund's total return may also be
compared to the total return of the Nasdaq Composite OTC Index,
Nasdaq Industrials Index, Russell 2000 Index, or the Consumer Price
Index. The Asia/Pacific Fund's total return may be compared to the
return of the Morgan Stanley Capital International (MSCI) - Pacific
(Free) Index, which consists of common stocks of companies located in
Australia, Hong Kong, Japan, Malaysia, New Zealand, and Singapore.
The Europe Fund's total return may be compared to the return of the
Morgan Stanley Capital International (MSCI) - Europe Index, which is
comprised of common stocks of companies located in 15 European
countries (Austria, Belgium, Denmark, Finland,, France, Germany,
Ireland, Italy, the Netherlands, Norway, Portugal, Spain, Sweden,
43<PAGE>
Switzerland, and the United Kingdom). The Financial Services Fund's
return may be compared to the S&P 500 Index return, an investment of
80% in the S&P Financial Composite Index and 20% in money market
funds, the Keefe, Bruyette & Woods Index, or the average of the mutual
funds in the Morningstar Specialty Financial Category. Further
information on performance measurement may be found in the relevant
Statement of Additional Information.
Performance quotations of a Fund represent the Fund's past performance
and should not be considered representative of future results. The
investment return and principal value of an investment in a Fund will
fluctuate so that an investor's shares, when redeemed, may be worth
more or less than their original cost. The methods used to compute a
Fund's total return and yield are described in more detail in the relevant
Statement of Additional Information.
44<PAGE>
APPENDIX
Corporate Bond Ratings
Moody's Investors Service, Inc.'s Corporate Bond Ratings. Moody's
rating for obligations with an original remaining maturity in excess of
one year fall into nine categories. They range from Aaa (highest
quality) to C (lowest quality). Moody applies numerical modifiers of 1,
2, or 3 to each generic rating classification from Aa through B. The
modifier 1 indicates that the security ranks in the higher end of its
generic rating category; the modifier 2 indicates a mid-range ranking;
and the modifier 3 indicates that the issue ranks in the lower end of its
generic rating category.
Aaa - Bonds which are rated Aaa are judged to be of the best
quality. They carry the smallest degree of investment
risk and are generally referred to as "gilt edged."
Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure.
While the various protective elements are likely to
change, such changes as can be visualized are most
unlikely to impair the fundamentally strong position of
such issues.
Aa - Bonds which are rated Aa are judged to be of high
quality by all standards. Together with the Aaa group
they comprise what are generally known as high grade
bonds. They are rated lower than the best bonds because
margins of protection may not be as large as in Aaa
securities, or fluctuation of protective elements may be
of greater amplitude,or there may be other elements
present which make the long-term risks appear
somewhat larger than in Aaa securities.
A - Bonds which are rated A possess many favorable
investment attributes and are to be considered as upper
medium grade obligations. Factors giving security to
principal and interest are considered adequate but
elements may be present which suggest a susceptibility
to impairment sometime in the future.
Baa - Bonds which are rated Baa are considered as medium
grade obligations, i.e., they are neither highly protected
nor poorly secured. Interest payments and principal
security appear adequate for the present, but certain
protective elements may be lacking or may be
characteristically unreliable over any great length of
time. Such bonds lack outstanding investment
characteristics and in fact, have speculative
characteristics as well.
Ba - Bonds which are rated Ba are judged to have speculative
elements; their future cannot be considered as well
assured. Often the protection of interest and principal
payments may be very moderate and thereby not well
safeguarded during both good and bad times over the
future. Uncertainty of position characterizes bonds in
this class.
B - Bonds which are rated B generally lack characteristics
of the desirable investment. Assurance of interest and
principal payments or of maintenance of other terms of
the contract over any long period of time may be small.
Caa - Bonds which are rated Caa are of poor standing. Such
issues may be in default, or there may be present
elements of danger with respect to principal or interest.
Ca - Bonds which are rated Ca represent obligations which
are speculative in a high degree. Such issues are often
in default or have other marked shortcomings.
C - Bonds that are rated C are the lowest-rated class of
bonds, and issues so rated can be regarded as having
extremely poor prospects of ever attaining any real
investment standing.
Standard & Poor's Corporation's Corporate Bond Ratings. Debt
issues may be designated by Standard & Poor's as either investment
grade ("AAA" through "BBB") or speculative grade ("BB through "D").
While speculative grade will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major
exposures to adverse conditions. Ratings from AA to CCC may be
modified by the addition of a plus sign (+) or a minus sign (-) to show
relative standing within the major rating categories.
AAA - Debt rated AAA has the highest rating assigned by
Standard & Poor's to a debt obligation. Capacity to pay
interest and repay principal is extremely strong.
AA - Debt rated AA has a very strong capacity to pay interest
and repay principal, and differs from AAA issues only
in small degree.
A - Debt rated A has a strong capacity to pay interest and
repay principal, although it is somewhat more
susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in
higher-rated categories.
BBB - Debt rated BBB is regarded as having an adequate
capacity to pay interest and repay principal. Whereas it
normally exhibits adequate protection parameters,
adverse economic conditions or changing circumstances
are more likely to lead to a weakened capacity to pay
principal interest and repay principal for debt in this
capacity than in higher-rated categories.
BB - Debt rated BB has less near-term vulnerability to default
than other speculative issues. However, it faces major
ongoing uncertainties or exposure to adverse business,
financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal
payments. The BB rating category is also used for debt
subordinated to senior debt that is assigned and actual or
implied BBB- rating.
B - Debt rated B has a greater vulnerability to default but
currently has the capacity to meet interest payments and
principal repayments. Adverse business, financial, or
economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The B
rating category is also used for debt subordinated to
senior debt that is assigned an actual or implied BB or
BB- rating.
CCC - Debt rated CCC has a currently identifiable
vulnerability to default, and is dependent upon favorable
business, financial, and economic conditions to meet
timely payment of interest and repayment of principal.
In the even of adverse business, financial, or economic
conditions, it is not likely to have the capacity to pay
interest and repay principal. The CCC rating is also
used for debt subordinated to senior debt that is assigned
an actual or implied B or B- rating.
CC - Debt rated CC is typically applied to debt subordinated
to senior debt that is assigned an actual or implied CCC
debt rating.
C - The rating C is typically applied to debt subordinated to
senior debt that is assigned an actual or implied CCC-
rating. The C rating may be used to cover a situation
where a bankruptcy petition has been filed but debt
service payments are continued.
CI - The rating CI is reserved for income bonds on which no
interest is being paid.
D - Debt rated D is in payment default. The D rating
category is used when interest payments or principal
payments are not made on the date due even if the
applicable grace period has not expired, unless Standard
& Poor's believes that such payments will be made
during such grace period. The D rating will also be used
upon the filing of a bankruptcy petition if debt service
payments are jeopardized.
*Interested Person
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 Contents
12. General Information
and History See Part A Item 4.
13. Investment Objective Miscellaneous
and Policies Investment Practices and
Risk Considerations;
Investment Restrictions
of the Funds; Hedging
and Other Strategies
Using Derivative Contracts
14. Management of the Management of the
Registrant Funds
15. Control Persons and Principal Holders of
Principal Holders of Securities and
Securities 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
and Redemptions of Fund
Shares
22. Calculation of Standard Performance
Performance Data Measures
23. Financial Statements Experts; Financial
Statements
SMITH BREEDEN TRUST
SMITH BREEDEN HIGH YIELD BOND FUND
SMITH BREEDEN U.S. EQUITY MARKET PLUS FUND
SMITH BREEDEN ASIA/PACIFIC FUND
SMITH BREEDEN EUROPE FUND
SMITH BREEDEN FINANCIAL SERVICES FUND
(the "Funds")
STATEMENT OF ADDITIONAL INFORMATION
OCTOBER 15, 1998
100 Europa Drive, Suite 200
Chapel Hill, North Carolina 27514-2310
(919) 967-7221
This Statement of Additional Information contains information pertaining
to the Funds, which may be useful to investors and is not included in the
Prospectus of the Smith Breeden Mutual Funds. This Statement is not a
Prospectus and is only authorized for distribution when accompanied or
preceded by the Prospectus of the Smith Breeden Mutual Funds dated October
15, 1998, 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 FUNDS 3
MISCELLANEOUS INVESTMENT PRACTICES AND RISK
CONSIDERATIONS 5
HEDGING AND OTHER STRATEGIES USING DERIVATIVE CONTRACTS 12
TAXES 16
FUND CHARGES AND EXPENSES 18
MANAGEMENT OF THE FUNDS 19
THE INVESTMENT ADVISORY AGREEMENT AND OTHER SERVICES 21
PRINCIPAL HOLDERS OF SECURITIES AND CONTROLLING PERSONS 24
DETERMINATION OF NET ASSET VALUE 25
ADDITIONAL INFORMATION REGARDING PURCHASES
AND REDEMPTIONS OF FUND SHARES 26
SHAREHOLDER INFORMATION 27
SUSPENSION OF REDEMPTIONS 27
SHAREHOLDER LIABILITY 28
STANDARD PERFORMANCE MEASURES 28
EXPERTS 31
FINANCIAL STATEMENTS 31
2<PAGE>
SMITH BREEDEN TRUST
SMITH BREEDEN HIGH YIELD BOND FUND
SMITH BREEDEN U.S. EQUITY MARKET PLUS FUND
SMITH BREEDEN ASIA/PACIFIC FUND
SMITH BREEDEN EUROPE FUND
SMITH BREEDEN FINANCIAL SERVICES FUND
(the "Funds")
Statement of Additional Information
DEFINITIONS
The "Trust": Smith Breeden Trust
The "Adviser": Smith Breeden Associates, Inc., the Funds' investment
adviser.
The "Custodian": The Bank of New York, the Funds' custodian.
"First Data Investor Services": First Data Investor Services, Inc., the
Funds' investor servicing agent
The "Principal Underwriter": Until December 31, 1998: FPS Broker
Services, Inc.
Effective on or about January 1, 1999, First
Data Broker Services, Inc. is expected to
become distributor for the Funds.
INVESTMENT RESTRICTIONS OF THE FUNDS
As fundamental investment restrictions, which may not be changed without
a vote of a majority of the outstanding voting securities, a Fund may not and
will not engage in the following activities except that only the U.S. Equity
Market Plus Fund has adopted item 7 as a fundamental policy. ( The Investment
Company Act of 1940 (the "Investment Company Act") provides that a "vote of a
majority of the outstanding voting securities" of a Fund means the affirmative
of the lesser of (1) more than 50% of the outstanding shares of the Fund, or
(2) 67% or more of the shares present at a meeting if more than 50% of the
outstanding shares are represented at the meeting in person or by proxy.)
1. Issue senior securities, borrow money or pledge its assets, except that
the Fund may borrow from banks or through reverse repurchase
agreements or dollar rolls up to 33 1/3% of the value of its respective
total assets (calculated when the loan is made) for temporary,
extraordinary or emergency purposes and to take advantage of
investment opportunities and may pledge up to 33 1/3% of the value of
its total assets to secure such borrowings. For purposes of this
restriction, the purchase or sale of securities on a "when-issued" or
delayed delivery basis, the purchase and sale of futures contracts, the
entry into forward contracts, reverse repurchase agreements and dollar
roll transactions, short sales, interest rate caps, floors and swaps,
mortgage swaps, and collateral arrangements with respect thereto and
such other practices as may be determined by counsel to the Fund
(consistent with pronouncements of the Securities and Exchange
Commission (the "SEC")) 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.
3<PAGE>
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. Acquire, sell, lease or hold real estate or real estate limited
partnerships, except that it may invest in securities of companies which
deal in real estate and in securities collateralized by real estate or
interests therein and it may acquire, sell, lease or hold real estate in
connection with protecting its rights as a creditor.
4. Purchase or sell commodities or commodity contracts, except that
the Fund may purchase and sell financial futures contracts and options
thereon. (For purposes of this restriction, "commodity contracts" do
not include caps, floors, collars or swaps.)
5. Invest in interests in oil, gas, mineral leases or other mineral
exploration or development program.
6. Invest in companies for the purpose of exercising control or
management.
7. Purchase securities of other investment companies.
8. Make loans of money or property to any person, except through loans
of portfolio securities to qualified institutions, the purchase of debt
obligations in which the Fund may invest consistently with its
investment objectives and policies and investment limitations or the
investment in repurchase agreements with qualified institutions. The
Fund will not lend portfolio securities if, as a result, the aggregate of
such loans exceeds 33 1/3% of the value of the Fund's total assets
(including such loans).
9. Purchase securities on margin (but the Fund may obtain such short-
term credits as may be necessary for the clearance of transactions);
provided that the deposit or payment by the Fund of initial or variation
margin in connection with options or futures contracts is not considered
the purchase of a security on margin.
10. Make short sales of securities or maintain a short position if, when
added together, more than 25% of the value of the Fund's net assets
would be (i) deposited as collateral for the obligation to replace
securities borrowed to effect short sales, and (ii) allocated to segregated
accounts in connection with short sales. Short sales "against the box"
are not subject to this limitation.
In addition to the items listed above, the U.S. Equity Market Plus Fund will
not, as a matter of fundamental policy:
1. Purchase any security (other than obligations of the U.S.
Government, its agencies and instrumentalities and shares of other
investment companies as permitted pursuant to exemptive relief
granted by the SEC) 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<PAGE>
2. Purchase any security, other than mortgage-backed securities,
obligations of the U.S. Government, its agencies or instrumentalities,
collateralized mortgage obligations, and shares of other investment
companies as permitted pursuant to exemptive relief granted by the
SEC, if as a result the Fund would have invested more than 5% of its
respective total assets in securities of issuers (including predecessors)
having a record of less than three years of continuous operation.
It is contrary to each 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.
All percentage limitations on investments will apply at the time of the making
of an investment and shall not be considered violated unless an excess or
deficiency exist immediately after and as a result of such investment.
MISCELLANEOUS INVESTMENT PRACTICES AND RISK
CONSIDERATIONS
Unless so indicated, each Fund may engage in each of the following investment
practices or make the following investments. However, the fact that a Fund may
engage in a particular practice does not necessarily mean that it will actually
do so.
Repurchase Agreements. A repurchase agreement is a contract under which
the Fund acquires a security for a relatively short period (usually not more
than one week) subject to the obligation of the seller to repurchase and the
Fund to resell such security at a fixed time and price (representing the Fund's
cost plus interest). It is the Funds' present intention to enter into
repurchase agreements only with commercial banks and registered broker-dealers.
Repurchase agreements may also be viewed as loans made by a Fund which are
collateralized by the securities subject to repurchase. The Adviser will
monitor such transactions to determine that the value of the underlying
securities is at least equal at all times to the total amount of the
repurchase obligation, including the interest factor. If the seller
defaults, a Fund could realize a loss on the sale of the underlying security
to the extent that the proceeds of sale including accrued interest are less
than the resale price provided in the agreement including interest.
In addition, if the seller should be involved in bankruptcy or insolvency
proceedings, a Fund may incur delay and costs in selling the underlying
security or may suffer a loss of principal and interest if a Fund is treated
as an unsecured creditor and required to return the underlying collateral to
the seller's estate.
5<PAGE>
Forward Commitments. A forward commitment represents a contract to
purchase securities for a fixed price at a future date beyond customary
settlement time (referred to as "forward commitments" or "when issued" or
"delayed delivery" securities) if, when entering into a forward commitment, a
Fund will hold until the settlement date, in a segregated account, liquid
securities in an amount sufficient to meet the purchase price, or the Fund will
enter into offsetting contracts for the forward sale of other securities it
owns. Forward commitments may be considered securities in themselves, and
involve a risk of loss if the value of the security to be purchased declines
prior to the settlement date. Where such purchases are made through dealers, a
Fund relies on the dealer to consummate the sale. The dealer's failure to do
so may result in the loss to the Fund of an advantageous return or price.
Although a Fund will generally enter into forward commitments with the intention
of acquiring securities for its portfolio or for delivery pursuant to options
contracts it has entered into, a Fund may dispose of a commitment prior to
settlement if the Adviser deems it appropriate to do so. A Fund may realize
short-term profits or losses upon the sale of forward commitments.
Securities Loans. The Fund may make secured loans of securities amounting
to not more than 33 1/3% of the Fund's total assets thereby realizing
additional income. The risks in lending portfolio securities, as with other
extensions of credit, consist of possible delay in recovery of the securities or
possible loss of rights in the collateral should the borrower fail financially.
As a matter of the Funds' policy, securities loans are made to broker-dealers
pursuant to an agreement requiring that loans be continuously secured by
collateral in cash or short-term debt obligations at least equal at all times to
the value of the securities on loan. The borrower pays to the Fund an amount
equal to any dividends or interest received on securities lent. The Fund retains
all or a portion of the interest received on investment of the cash collateral
or receives a fee from the borrower. Although voting rights, or rights to
consent, with respect to the loaned securities pass to the borrower, the Fund
retains the right to call the loans at any time on reasonable notice, and it
will do so in order that the securities may be voted by the Fund if the holders
of such securities are asked to vote upon or consent to matters materially
affecting the investment. A Fund may also call such loans in order to sell the
securities involved.
Borrowing. The Funds may borrow from banks and enter into reverse
repurchase agreements or dollar rolls up to 33 1/3% of the value of the Fund's
total assets (computed at the time the loan is made) to take advantage of
investment opportunities and for extraordinary or emergency purposes, or for
the clearance of transactions. The Funds may pledge up to 33 1/3% of its total
assets to secure these borrowings. If a Fund's asset coverage for borrowings
falls below 300%, the Fund will take prompt action to reduce its borrowings
even though it may be disadvantageous at that time from an investment point of
view. A Fund will incur borrowing costs when it leverages, including payment
of interest and any fee necessary to maintain a line of credit, and may be
required to maintain a minimum average balance. If the income and
appreciation on assets acquired with borrowed funds exceed their borrowing
cost, the Fund's investment performance will increase, whereas if the income
and appreciation on assets acquired with borrowed funds are less than their
borrowing costs, investment performance will decrease. In addition, if a Fund
borrows to invest in securities, any investment gains made on the securities in
excess of the costs of the borrowing, and any gain or loss on hedging, will
cause the net asset value of the shares to rise faster than would otherwise be
the case.
6<PAGE>
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 a Fund, the net asset value of the Fund's shares will decrease
faster than would otherwise be the case. This speculative characteristic is
known as "leverage."
Reverse Repurchase Agreements and Dollar Roll Agreements. The Funds
may enter into reverse repurchase agreements and dollar roll agreements with
commercial banks and registered broker-dealers to seek to enhance returns.
Reverse repurchase agreements involve sales by the Fund of portfolio assets
concurrently with an agreement by the Fund to repurchase the same assets at a
later date at a fixed price. During the reverse repurchase agreement period,
the Fund continues to receive principal and interest payments on these
securities and also has the opportunity to earn a return on the collateral
furnished by the counterparty to secure its obligation to redeliver the
securities.
Dollar rolls are transactions in which the Fund sells securities for delivery in
the current month and simultaneously contracts to repurchase substantially
similar (same type and coupon) securities on a specified future date. During the
roll period, the Fund forgoes principal and interest paid on the securities. The
Fund is compensated by the difference between the current sales price and the
forward price for the future purchase (often referred to as the "drop") as well
as by the interest earned on the cash proceeds of the initial sale.
The 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 a Fund may decline below the price of the securities the Fund
has sold but is obligated to repurchase under the agreement. In the event
the buyer of securities under a reverse repurchase agreement or dollar roll
files for bankruptcy or becomes insolvent, the Fund's use of the proceeds of
the agreement may be restricted pending a determination by the other party
or its trustee or receiver, whether to enforce the Fund's obligation to
repurchase the securities. Reverse repurchase agreements and dollar rolls
are considered borrowings by the Fund and result in leverage.
Foreign Securities. All of the Funds, with the exception of the U.S. Equity
Market Plus Fund, may hold securities of foreign issuers that are not
registered with the SEC, and foreign issuers may not be subject to SEC
reporting requirements. Accordingly, there may be less publicly available
information concerning foreign issuers of securities held by these Funds
than is available concerning U.S. companies. Foreign companies are not
generally subject to uniform accounting, auditing and financial reporting
standards or to other regulatory requirements comparable to those applicable
to U.S. companies. The securities of some foreign companies are less liquid
and at times more volatile than securities of comparable U.S. companies.
7<PAGE>
A fund may invest in foreign securities by purchasing American Depository
Receipts ("ADRs"), European Depository Receipts ("EDRs"), Global
Depository Receipts ("GDRs") or other securities convertible into securities of
issuers based in foreign countries or a fund may also purchase the securities
directly in the foreign markets. ADRs are generally in registered form and are
denominated in U.S. dollars and are designed for use in U.S. securities markets.
EDRs are similar to ADRs but generally are in bearer form, may be
denominated in other currencies, and are designed for use in European
securities markets. GDRs are similar to EDRs and are designed for use in
several international markets. ADRs are typically receipts issued by a U.S.
bank or trust company evidencing ownership of the underlying securities.
For purposes of the Fund's investment policies, ADRs, EDRs and GDRs are
deemed to have the same classification as the underlying securities they
represent. Thus, an ADR, EDR, or GDR representing ownership of common stock
will be treated as common stock. The Europe, Asia/Pacific and High Yield
Bond Funds may also invest in fixed income securities of foreign issuers.
The Funds investing in foreign securities anticipate that brokerage
transactions involving foreign securities of companies headquartered outside of
the United States will be conducted primarily on the principal exchanges of such
countries. Transactions on foreign exchanges are subject to fixed commissions
that are generally higher than negotiated commissions on U.S. transactions,
although the Fund will endeavor to achieve the best net results in effecting
its portfolio transactions. There is generally less government supervision and
regulation of exchanges and brokers in foreign countries than in the United
States and as a result trade and settlement procedures in foreign securities
may involve certain risks or expenses not present in the settlement of domestic
transactions (such as delay in payment or delivery of securities or in the
recovery of the Fund's assets held abroad).
Investment income on certain foreign securities may be subject to foreign
withholding or other taxes that could reduce the return on these securities.
In addition, with respect to certain foreign countries, there is a
possibility of nationalization or expropriation of assets, imposition of
currency exchange controls, confiscatory taxation, political or financial
instability, and domestic developments which could affect the value of
investments in those countries. In certain countries, legal remedies
available to investors may bemore limited than those available with respect
to investments in the United States or other countries. The laws of some
foreign countries may limit a Fund's ability to invest in securities of
certain issuers located in those countries.
Foreign Currency Transactions. All of the Funds, with the exception of
the U.S. Equity Market Plus Fund, may conduct foreign currency transactions
on a spot (i.e. cash) or forward basis (i.e. by entering into forward contracts
to purchase or sell foreign currencies). Although foreign exchange dealers
generally do not charge a fee for such conversions, they do realize a profit
based on the difference between the prices at which they are buying and selling
various currencies. Thus a dealer may offer to sell a foreign currency at one
rate, while offering a lesser rate of exchange should the counterparty desire
to resell that currency to the dealer. Forward contracts are customized
transactions that require a specified amount of a currency to be delivered at a
specific exchange rate on a specific date or range of dates in the future.
Forward contracts are generally traded in an interbank market directly between
currency traders (usually large commercial banks) and their customers. The
parties to a forward contract may agree to offset or terminate the contract
before its maturity, or may hold the contract to maturity and complete the
contemplated currency exchange.
8<PAGE>
A Fund may use currency forward contracts to hedge against a decline in
the value of its investments denominated in foreign currency. For example,
if a Fund owned securities, or a futures contract, denominated in British
pound sterling, it could enter into a forward contract to sell pound
sterling inreturn for U.S. dollars to hedge against possible declines in the
pound's value.Such a hedge, called a "position hedge" would tend to offset
both positive and negative currency fluctuations, but would not offset
changes in the value of its investment caused by other factors.
Under certain conditions, SEC guidelines require mutual funds to set aside
liquid assets in a segregated custodial account to cover currency forward
contracts, if done for speculative purposes. Currently, the Funds do not
expect to use currency forward contracts for speculative purposes. A Fund
will not segregate assets to cover its forward contracts entered into for
hedging, such as the position hedge described above.
Convertible Securities. Convertible securities may be converted at either a
stated price or stated rate into underlying shares of common stock of the same
issuer. Convertible securities have general characteristics similar to both
fixed income and equity securities. The market value of convertible securities
declines as interest rates increase, and increases as interest rates decline.
In addition, because of the conversion feature, the market value of convertible
securities tends to vary with fluctuations in the market value of the
underlying common stocks and therefore will also react to variations in the
general market for equity securities. A unique feature of convertible
securities is that as the market price of the underlying common stock
declines, convertible securities tend to trade increasingly on a yield basis,
and consequently may not experience market value declines to the same extent
as the underlying common stock.
When the market price of the underlying common stock increases, the prices of
convertible securities tend to rise as a reflection of the value of the
underlying common stock. Issuers of convertible securities may default on
their obligations.
Collateralized Mortgage Obligations ("CMOs"). Each of the Funds may
invest in CMOs. A CMO is a security backed by a portfolio of mortgages or
mortgage-backed securities held under an indenture. The issuer's obligation to
make interest and principal payments is secured by the underlying portfolio of
mortgages or mortgage-backed securities. CMOs are issued with a number of
classes or series, which have different maturities representing interests in
some or all of the interest or principal on the underlying collateral or a
combination thereof. Payments of interest or principal on some classes or
series of CMOs may be subject to contingencies, or some classes or series may
bear some or all of the risk of default on the underlying mortgages. CMOs of
different classes are generally retired in sequence as the underlying mortgage
loans in the mortgage pools are repaid. In the event of sufficient early
prepayments on such mortgages, the class or series of CMO first to mature
generally will be retired prior to its stated maturity. Thus, the early
retirement of a particular class or series of a CMO held by a Fund would have
the same effect as the prepayment of mortgages underlying a mortgage-backed
pass-through security. Another type of CMO is a real estate mortgage
investment conduit ("REMIC") which qualifies for special tax treatment under
the Internal Revenue Code and invests in certain mortgages principally
secured by interests in real property and other permitted investments.
9<PAGE>
CMOs also include securities representing the interest in any excess cash flow
and/or the value of any collateral remaining after the issuer has applied cash
flow from the underlying mortgages or mortgage-backed securities to the
payment of principal of and interest on all other CMOs and the administrative
expenses of the issuer ("Residuals"). Residuals have value only to the extent
that income from such underlying mortgages or mortgage-backed securities
exceeds the amounts necessary to satisfy the issuer's debt obligations
represented by all other outstanding classes or series of the CMOs.
In addition, if a CMO bears interest at an adjustable-rate, the cash flows on
the related Residual will also be extremely sensitive to the level of the
index upon which the rate adjustments are based.
In reliance on an interpretation by the SEC, the Funds' investments in certain
qualifying CMOs and REMICs are not subject to the Investment Company Act's
limitations on acquiring interests in other investment companies. CMOs and
REMICs issued by an agency or instrumentality of the U.S. Government are
considered U.S. Government securities for the purposes of this Prospectus.
Stripped Securities ("STRIPS"). Each of the Funds may invest in
STRIPS. STRIPS are usually structured with two classes that receive different
proportions of the interest and principal distributions from a pool of
underlying assets. A common type of STRIP will have one class receiving all of
the interest from the underlying assets ("interest-only" or "IO" class), while
the other class will receive all of the principal ("principal-only" or "PO"
class). However, in some instances, one class will receive some of the interest
and most of the principal while the other class will receive most of the
interest and the remainder of the principal. STRIPS are unusually volatile in
response to changes in interest rates. The yield to maturity on an IO class of
STRIPS is extremely sensitive not only to changes in prevailing interest rates
but also to the rate of principal payments (including prepayments) on the
underlying assets. A rapid rate of principal prepayments may have a measurably
adverse effect on the Fund's yield to maturity to the extent it invests in IOs.
Conversely, POs tend to increase in value if prepayments are greater than
anticipated and decline if prepayments are slower than anticipated. Thus, if
the underlying assets experience greater than anticipated prepayments of
principal, the Fund may fail to fully recover its initial investment in these
securities, even if the STRIPS were rated of the highest credit quality by S&P
or Moody's, respectively. The Adviser will seek to manage these risks (and
potential benefits) by investing in a variety of such securities and by using
certain hedging techniques, as described in "Other Investment Practices and
Risk Considerations" in the Prospectus. In addition, the secondary market
for STRIPS may be less liquid than that for other mortgage-backed or
asset-backed securities, potentially limiting the Fund's ability to buy or
sell those securities at any particular time.
The Adviser expects that interest-only STRIPS will be purchased for their
hedging characteristics. Because of their structure, interest-only STRIPS will
most likely move differently than typical fixed income securities in relation
to changes in interest rates. For example, with increases in interest rates,
these securities will typically increase rather than decrease in value. As a
result, since they move differently to changes in interest rates than the
typical investments held by a Fund, interest-only STRIPS can be used as
hedging instruments to reduce the variance of a Fund's net asset value from
its targeted option-adjusted duration. There can be no assurance that the use
of interest-only STRIPS will be effective as a hedging technique, in which
event, a Fund's overall performance may be less than if the Fund had not
purchased the STRIPS. It is not anticipated that STRIPS will constitute more
than 5% of a Fund's net assets.
10<PAGE>
The determination of whether certain IO and PO STRIPS issued by the U.S.
Government and backed by fixed-rate mortgages are liquid shall be made by the
Trustees in accordance with applicable pronouncements of the SEC. At present
all other IO and PO STRIPS are treated as illiquid securities for the purposes
of the 15% limitation on illiquid securities as a percentage of a Fund's net
assets.
Pay-in-kind, Delayed and Zero Coupon Securities. Each of the Funds
may invest in pay-in-kind, delayed and zero coupon bonds. These are securities
issued at a discount from their face value because interest payments are
typically postponed until maturity. The amount of the discount varies
depending on factors including the time remaining until maturity, prevailing
interest rates, the security's liquidity and the issuer's credit quality.
These securities also may take the form of debt securities that have been
stripped of their interest payments. The market prices of pay-in-kind,
delayed and zero coupon bonds generally are more volatile than the market
prices of interest-bearing securities and are likely to respond to a greater
degree to changes in interest rates than interest bearing securities having
similar maturities and credit quality. A Fund's investment in pay-in-kind,
delayed and zero coupon bonds may require the Fund to sell certain of its
portfolio securities to generate sufficient cash to satisfy certain income
distribution requirements, which may reduce the Fund's assets and may thereby
decrease its rate of return.
Indexed Securities. Each of the Funds, with the exception of the Short and
Intermediate, may invest in "index-linked" notes, which are debt securities of
companies that call for interest payments and/or payment at maturity in
different terms than they typical note where the borrower agrees to make fixed
interest payments and to pay a fixed sum at maturity. Principal and/or
interest payments on an index-linked note depend on the performance of one or
more market indices, such as the S&P 500 Index. A Fund may also invest in
"equity-linked" and "currency-linked" debt securities. At maturity, the
principal amount of an equity-linked debt security is exchanged for common
stock of the issuer or is payable in an amount based on the issuer's common
stock price at the time of maturity. Currency-linked debt securities are
short-term or intermediate-term instruments having a value at maturity,
and/or an interest rate, determined by reference to one or more foreign
currencies. Payment of principal or periodic interest may be calculated as
a multiple of the movement of one currency against another currency, or
against an index. The U.S. Equity Market Plus Fund will not invest in
currency-linked debt securities.
Index and currency-linked securities are derivative instruments which may
entail substantial risks. The company may fail to pay the amount due on
maturity. The underlying investment or security may not perform as expected.
Indexed securities are also subject to the credit risk of the issuer.
Variable and Floating Rate Obligations. These obligations bear variable
or floating interest rates and carry rights that permit holders to demand
payment of the unpaid principal balance plus accrued interest from the issuers
or certain financial intermediaries. Floating rate instruments have interest
rates that change whenever there is a change in a designated base rate while
variable rate instruments provide for a specified periodic adjustment in the
interest rate. These formulas are designed to result in a market value for the
instrument that approximates its par value.
An active secondary market may not exist with respect to a particular
variable or floating rate instrument purchased by the Fund. The absence of
such an active secondary market could make it difficult for a Fund to sell
a variable or floating rate instrument when desired.
11<PAGE>
HEDGING AND OTHER STRATEGIES USING DERIVATIVE
CONTRACTS
Futures Contracts. When a Fund purchases a futures contract it agrees to
purchase a specified underlying instrument at a specified future date. When a
Fund sells a futures contract, it agrees to sell the underlying instrument at a
specified future date. The price at which the purchase and sale take place is
fixed when the fund enters the contract. Some currently available futures
contracts are based on specific securities, such as U.S. Treasury bonds or
notes, and some are based on indices of securities prices, such as the Standard
and Poor's 500 Composite Stock Index (S&P 500). Futures can be held until
their delivery dates, or can be closed out before then if a liquid secondary
market is available.
The value of a futures contract tends to increase and decrease in tandem
with the value of its underlying instrument. Therefore, purchasing futures
contracts will tend to increase a Fund's exposure to positive and negative
price fluctuations in the underlying instrument, much as if it had purchased
the underlying instrument directly. When a fund sells a futures contract, by
contrast, the value of its futures position will tend to move in a direction
contrary to the market. Selling futures contracts, therefore, will tend to
offset both positive and negative market price changes, much as if the
underlying instrument had been sold.
The Funds will not use futures contracts for leverage.
Futures Margin Payments. The purchaser or seller of a futures contract is not
required to deliver or pay for the underlying instrument unless the contract is
held until delivery date, and it is not cash settled. However, when the
contract is entered into, a purchaser or seller is required to deposit
"initial margin" with a futures broker, known as a futures commission merchant
("FCM"). Initial margin deposits are typically a percentage of the contract's
value. If the value of either party's position declines, that party will be
required to make additional "variation margin" payments to settle the change
in value on a daily basis. The party that has a gain may be entitled to
receive all or a portion of this amount. Initial and variation margin
payments do not constitute purchasing securities on margin for purposes of a
Fund's investment limitations. In the event of the bankruptcy of an FCM that
holds margin on behalf of a Fund,the Fund may be entitled to return of the
margin owed to it only in proportion to the amount received by the FCM's
other customers, potentially resulting in losses to a Fund.
Asset Coverage and Limitations on Futures and Options Transactions. The
Funds will comply with guidelines established by the SEC with respect to
coverage of options and futures strategies by mutual funds, and if the
guidelines so require, will set aside liquid assets in a segregated custodial
account in the amount prescribed. Securities held in a segregated account
cannot be sold while the futures and options strategy is outstanding,
unless they are replaced with other suitable assets. As a result there is
a possibility that segregation of a large percentage of a Fund's assets
could impede portfolio management or a Fund's ability to meet redemption
requests.
In accordance with regulations established by the Commodity Futures Trading
Commission, each Fund's aggregate initial margin and premiums on all futures
and options contract positions not held for bona fide hedging purposes, will
not exceed 5% of a Fund's net assets, after taking into account unrealized
profits and losses on such contracts.
12<PAGE>
Risks Associated with Correlation of Price Changes. Because there are a
limited number of types of exchange-traded option and future contracts, it is
likely that the standardized contracts available will not match a Fund's
current or anticipated market exposure directly. The Funds may invest in
options and futures contracts based on securities with different maturities
or other characteristics from the securities or market in which they
typically invest, which involves a risk that the options or futures position
will not track the performance of the Funds' targeted market, index or
investments.
Options and futures prices can also diverge from the prices of their underlying
instruments, even if the underlying instruments match a Fund's investments
well. Options and futures prices are affected by such factors as current and
anticipated short-term interest rates, changes in volatility of the underlying
instrument, and the time remaining until expiration of the contract, which may
not affect security prices the same way. Imperfect correlation may also result
from differing levels of demand in the options and futures markets versus the
securities markets, from structural differences in how options and futures and
securities are traded, or from the imposition of daily price fluctuation limits
or trading halts. A fund may purchase or sell options or futures contracts
with a greater or lesser value than the securities it wishes to hedge or
intends to purchase in order to attempt to compensate for differences in
volatility between the contract and the securities, although this may not be
successful in all cases. If price changes in a Fund's options or futures
positions are poorly correlated with its other investments, the positions
may fail to produce anticipated gains or result in losses that are not offset
by gains in other investments.
Liquidity of Options and Futures Contracts. There is no assurance a liquid
secondary market will exist for any particular options or futures contract at
any particular time. Options may have relatively low trading volume and
liquidity if their strike prices are not close to the underlying instrument's
current price. In addition, exchanges may establish daily price fluctuation
limits for options and futures contracts, and may halt trading if a contract's
price moves upward or downward more than the limit in a given day. On volatile
trading days when the price fluctuation limit is reached or a trading halt is
imposed, it may be impossible for a Fund to enter into new positions or close
out existing positions. If the secondary market for a contract is not liquid
because of price fluctuation limits or otherwise, it could prevent prompt
liquidation of unfavorable positions, and potentially could require a Fund to
continue to hold a position until delivery or expiration regardless of changes
in its value. As a result, a Fund's access to other assets held to cover its
option or futures positions could also be impaired.
OTC Options. Unlike exchange traded options, which are standardized with
respect to the underlying instrument, expiration date, contract size and strike
price, the terms of over-the-counter (OTC) options (options not traded on
exchanges) generally are established through negotiation with the other party
to the option contract. While this type of arrangement allows the Funds
greater flexibility to tailor an option to its needs, OTC options generally
involve greater credit risk than exchange traded options, which are guaranteed
by the clearing organization of the exchanges where they are traded.
The staff of the SEC currently considers OTC options to be illiquid for
purposes of the 15% limitation on illiquid securities as a percentage of a
Fund's net assets unless certain arrangements have been made with the other
party to the option contract that permit the prompt liquidation of the option
position.
13<PAGE>
Purchasing Put and Call Options. By purchasing a put option, a Fund obtains
the right (but not the obligation) to sell the option's underlying instrument
at a fixed strike price. In return for this right, a Fund pays the current
market price for the option (known as the option premium). Options have
various types of underlying instruments, including specified securities,
indices of securities prices, and futures contracts. A Fund may terminate its
position in a put option it has purchased by allowing it to expire or by
exercising the option. If the option is allowed to expire, a Fund will lose
the entire premium it paid. If a Fund exercises the option, it completes the
sale of the underlying instrument at the strike price. A Fund may also
terminate a put option position by closing it out in the secondary market at
its current price, if a liquid secondary market exists.
The buyer of a typical put option can expect to realize a gain if security
prices fall substantially. However, if the underlying instrument's price does
not fall enough to offset the cost of purchasing the option, a put buyer can
expect to suffer a loss (limited to the amount of the premium paid, plus
related transaction costs).
The features of call options are essentially the same as those of put options,
except that the purchaser of a call option obtains the right to purchase,rather
than sell, the underlying instrument at the option's strike price. A call
buyer typically attempts to participate in potential price increases of the
underlying instrument with risk limited to the cost of the option if security
prices fall. At the same time, the buyer can expect to suffer a loss if
security prices do not rise sufficiently to offset the cost of the option.
Writing Put and Call Options. When a Fund writes a put option, it takes the
opposite side of the transaction from the option's purchaser. In return for
receipt of the premium, the Fund assumes the obligation to pay the strike
price for the option's underlying instrument if the other party to the option
chooses to exercise it. When writing an option on a futures contract, a Fund
will be required to make margin payments to an FCM as described above for
futures contracts. A Fund may seek to terminate its position in a put option
it writes before exercise by closing out the option in the secondary market at
its current price. If the secondary market is not liquid for a put option the
Fund has written, however, the Fund must continue to be prepared to pay the
strike price while the option is outstanding, regardless of price changes,
and must continue to set aside assets to cover its position.
If security prices rise, a put writer would generally expect to profit although
its gain would be limited to the amount of the premium it received. If
security prices remain the same over time, it is likely that the writer
will also profit, because it should be able to close out the option at a
lower price. If security prices fall, the put writer would expect to suffer
a loss. This loss should be less than the loss from purchasing the underlying
instrument directly, however, because of the premium received for writing the
option.
Writing a call option obligates a Fund to sell or deliver the option's
underlying instrument, in return for the strike price, upon exercise of the
option. The characteristics of writing call options are similar to those of
writing put options, except that writing calls generally is a profitable
strategy if prices remain the same or fall. Through receipt of the option
premium, a call writer mitigates the effects of a price decline. At the same
time, because a call writer must be prepared to deliver the underlying
instrument in return for the strike price, even if its current value is
greater, a call writer gives up its ability to participate in security
price increases and will suffer a loss in the event of an increase.
14<PAGE>
Combined Positions. A Fund may purchase and write options in combination
with each other, or in combination with futures or forward contracts, to adjust
the risk and return characteristics of the overall position. For example, a
Fund may purchase a put option and write a call option on the same underlying
instrument, in order to construct a combined position whose risk and return
characteristics are similar to selling a futures contract. Another possible
combined position would involve writing a call option at one strike price and
buying a call option at a lower price, in order to reduce the risk of the
written call option in the event of a substantial price increase. Because
combined positions involve multiple trades, they result in higher transaction
costs and may be more difficult to open and close out.
Options and Futures Relating to Foreign Currencies. All of the Funds,
with the exception of the U.S. Equity Market Plus Fund, may utilize currency
futures contracts. Currency futures contracts are similar to forward currency
exchange contracts, except that they are traded on exchanges (and have margin
requirements) and are standardized as to contract size and delivery date. Most
currency futures contracts call for payment or delivery in U.S. dollars. The
underlying instrument of a currency option may be a foreign currency, which
generally is purchased or delivered in exchange for U.S. dollars, or may be a
futures contract. The purchaser of a currency call obtains the right to
purchase the underlying currency, and the purchaser of a currency put obtains
the right to sell they underlying currency.
A Fund may purchase and sell currency futures and purchase and write
currency options to increase or decrease its exposure to different foreign
currencies in order to hedge against the currency risk implicit in the
investments which it owns that are denominated in other than U.S. dollars.
Currency futures and options values can be expected to correlate with exchange
rates, but may not reflect other factors that affect the Fund's investments,
such as a decline in an issuer's creditworthiness. Because the value of a
Fund's foreign denominated investments changes in response to many factors
other than exchange rates, it may not be possible to march the amount of
currency options and futures to the value of the Fund's investments exactly
over time.
Swaps, Caps, Floors and Collars. Swap agreements can be individually
negotiated and structured to include exposure to a variety of different types
of investments or market factors. Depending on their nature, swap agreements
may increase or decrease exposure to interest rates (in the United States or
abroad), foreign currency values, mortgage securities, or other factors such
as stock or bond indices.
In a typical cap or floor agreement, one party agrees to make payments only
under specified circumstances, usually in return for payment of a fee by the
other party. For example, 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.
15<PAGE>
There can be no assurance that the Funds will be able to enter into swaps,
caps, floors or collars on favorable terms. Furthermore, there can be no
assurance that any of the Funds will be able to terminate a swap or sell or
offset caps, floors or collars notwithstanding any terms in the agreements
providing for such termination. The Funds will enter into 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 a swap contract may be made at the conclusion of the
contract or periodically during its term.
Inasmuch as these transactions are entered into for hedging purposes, the
Adviser and the Funds believe swaps, caps, floors and collars do not constitute
senior securities and, accordingly, will not treat them as being subject to its
borrowing restrictions. The net amount of the excess, if any, of a Fund's
obligations over its entitlement with respect to each swap will be accrued on a
daily basis, and an amount of cash or liquid securities having an aggregate net
asset value at least equal to the accrued excess will be maintained in a
segregated account by a custodian that satisfies the requirements of the
Investment Company Act.
The Funds will not enter into any swap, cap, collar or floor 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").
If there is default by the other party to such a transaction, the Funds will
have contractual remedies pursuant to the agreements related to the
transaction. There is no assurance that 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. Each Fund thus assumes the risk that it
may be delayed in or prevented from obtaining payments owed to it pursuant
to swaps, caps, floors or collars.
The swap, cap, floor and collar market has grown substantially in recent years
with a large number of banks and investment banking firms acting both as
principals and as agents utilizing standardized documentation. As a result,
this market has become relatively liquid, although the Funds will still treat
these instruments as illiquid investments subject to the limitation on such
investments described under "Illiquid Securities" in the Prospectus.
TAXES
Taxation of the Funds. Each Fund intends to qualify each year as a regulated
investment company under Subchapter M of the Internal Revenue Code of
1986, as amended (the "Code"). In order so to qualify and to qualify for the
special tax treatment accorded regulated investment companies and their
shareholders, the Fund must, among other things:
(a) derive at least 90% of its gross income from dividends,
interest, payments with respect to certain securities loans, and
gains from the sale of stock, securities and foreign currencies,
or other income (including but not limited to gains from
options, futures, or forward contracts) derived with respect to
its business of investing in such stock, securities, or
currencies;
16<PAGE>
(b)distribute with respect to each taxable year at least 90% of
the of its taxable net investment income, its net tax-exempt
income, and the excess, if any, of net short-term capital gains
over net long-term capital losses for such year; and
(c) diversify its holdings so that, at the end of each fiscal quarter
(i) at least 50% of the market value of the Fund's assets is
represented by cash and cash items, U.S. Government
securities, securities of other regulated investment companies,
and other securities limited in respect of any one issuer to a
value not greater than 5% of the value of the Fund's total
assets and 10% of the outstanding voting securities of such
issuer, and (ii) not more than 25% of the value of its assets is
invested in the securities (other than those of the U.S.
Government or other regulated investment companies) of any
one issuer or of two or more issuers which the Fund controls
and which are engaged in the same, similar, or related trades
or businesses.
Qualification as a regulated investment company exempts a Fund from federal
income tax on income paid to its shareholders in the form of dividends
(including capital gain dividends). A dividend paid to shareholders by the
Fund in January of a year generally is deemed to have been paid by the Fund on
December 31 of the preceding year, if the dividend was declared and payable to
shareholders of record on a date in October, November or December of that
preceding year.
If a Fund failed to qualify as a regulated investment company accorded special
tax treatment in any taxable year, the Fund would be subject to tax on its
taxable income at corporate rates, and could be required to recognize
unrealized gains, pay substantial taxes and interest and make substantial
distributions before requalifying as a regulated investment company that is
accorded special tax treatment.
If a Fund fails to distribute in a calendar year substantially all of its
ordinary income for such year and substantially all of its net capital gain for
the year ending October 31, plus any retained amount from the prior year, the
Fund will be subject to a 4% excise tax on the undistributed amounts. Each
Fundintends generally to make distributions sufficient to avoid imposition of
the 4% excise tax. In calculating its income, each Fund must include dividends
in income not when received but on the date when the stock in question is
acquired or becomes ex-dividend, whichever is later. Also, a portion of the
yield on certain high yield securities (including certain payment-in-kind
bonds) issued after July 10, 1989 may be treated as dividends.
17<PAGE>
Sale or redemption of shares. The sale, exchange, or redemption of Fund
Shares may give rise to a gain or loss. In general, any gain realized upon a
taxable disposition of shares will be treated as mid-term capital gain if the
shares have been held for 12 months, but not more than 18 months, and as
adjusted net long-term capital gains if the shares have been held for more than
18 months. Otherwise the gain on the sale, exchange, or redemption of Fund
shares will be treated as short-term capital gain or loss. In addition, any
loss (not already disallowed as provided in the next sentence) realized upon a
taxable disposition of shares held for six months or less will be treated as
long-term, rather than short-term, to the extent of any long-term capital gain
distributions received by the shareholder with respect to the shares. All or a
portion of any loss realized upon a taxable disposition of Fund shares will be
disallowed if other Fund shares are purchased within 30 days before or after
the disposition. In such a case, the basis of the newly purchased shares will
be adjusted to reflect the disallowed loss.
Return of capital distributions. If a Fund makes a distribution to you in
excess of its current and accumulated "earnings and profits" in any taxable
year,the excess distribution will be treated as a return of capital to the
extent of your tax basis in your shares, and thereafter as capital gain.
A return of capital is not taxable, but it reduces your tax basis in your
shares.
Hedging Transactions. If a Fund engages in hedging transactions, including
hedging transactions in option, futures contracts, and straddles, or similar
transactions, it will be subject to special tax rules (including constructive
sale, market-to-market, straddle, wash sales, and short sale rules), the effect
of which may be to accelerate income to the Fund, defer losses to the Fund,
cause adjustments in the holding periods of the Fund's securities, or convert
short-term capital losses into long-term capital losses. These rules could
therefore affect the amount, timing and character of distributions to
shareholders.
Tax Implications of Certain Investments. Certain of a Fund's investments,
including investments in stripped securities, will create taxable income in
excess of the cash they generate. In such cases, a Fund may be required to
sell assets (including when it is not advantageous to do so) to generate the
cash necessary to distribute as dividends to its shareholders all of its
income and gains and therefore to eliminate any tax liability at the Fund
level.
FUND CHARGES AND EXPENSES
Management Fees. Each 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. The fee is computed at an annual rate of 0.70% for each
of the High Yield Bond, U.S. Equity Market Plus, Asia/Pacific, and Europe
Funds, and 1.50% for the Financial Services Fund. Advisory fees paid by the
Funds for the past three fiscal years are as follows. The Financial Services
Fund commenced operations December 22, 1997 and the advisory fees paid as shown
below for the Financial Services Fund are for the period beginning with this
date and ending March 31, 1998.:
18<PAGE>
Advisory Fees Paid by Funds
Asia/Pacific,
U.S. Equity Financial Europe, and
Fiscal Year Market Plus Services High Yield
Ended Fund Fund Bond Funds
March 31, 1998 $423,706 $23,152* N/A*
March 31, 1997 $ 53,341 N/A* N/A*
March 31, 1996 $ 21,727 N/A* N/A*
The following chart details the reimbursements the Adviser made to the
Funds for each of the last three fiscal years, under voluntary expense
limitation provisions :
Amounts Reimbursed by Adviser to the Funds
Asia/Pacific,
U.S. Equity Financial Europe, and
Fiscal Year Market Plus Services High Yield
Ended Fund Fund Bond Funds
March 31, 1998 $215,049 $26,865* N/A*
March 31, 1997 $131,965 N/A* N/A*
March 31, 1996 $114,100 N/A* N/A*
*The Financial Services Fund commenced operations December 22, 1997. The
High Yield Bond, Asia/Pacific, and Europe Funds each commenced operations
October 15, 1998 and, as such, have not yet paid any advisory fees or
had amounts reimbursed.
Other Expenses. Subject to any voluntary expense limitation provisions,
each Fund pays its own expenses, including, but not limited to auditing, legal,
tax preparation and consulting, insurance, custodial, accounting, shareholder
servicing and shareholder report expenses. Fees paid to FPS Services which
serves as the Funds' shareholder servicing and accounting agent are determined
by contract as approved by the Board of Trustees.
MANAGEMENT OF THE FUNDS
The Board of Trustees has the responsibility for the overall management of the
Funds, including general supervision and review of its investment activities.
The Trustees, in turn, elect the officers of the Funds who are responsible for
administering the day-to-day operations of the Funds. Trustees and officers of
the Funds are identified in the Prospectus.
All of the Trustees are Trustees of all the other funds managed by the
Adviser and each independent Trustee receives fees for his or her services.The
Trustees do not receive pension or retirement benefits from the Funds. The
table below shows the fees paid by the each of the Funds separately to each
independent Trustee for the fiscal year ended March 31, 1998 and total fees
paid by the entire Fund complex for the fiscal year ended March 31, 1998.
There are two other funds in the complex besides the Funds of the Smith
Breeden Trust.
19<PAGE>
Total Compensation Paid to Independent Trustees by the Funds
Asia/Pacific,
U.S. Equity Financial Europe, and Entire
Market Plus Services High Yield Smith Breeden
Trustee Fund Fund Bond Funds Complex
Stephen M. Schaefer $ 7,083 $0.00* $0.00* $ 40,833
Myron S. Scholes $ 7,083 $0.00* $0.00* $ 40,833
William F. Sharpe $22,858 $0.00* $0.00* $ 40,833
*The High Yield Bond, Asia/Pacific, and Europe Funds each commenced
operations October 15, 1998 and, as such, have not yet made any compensation
to the Independent Trustees. Each of these Funds expects to pay approximately
$300 to each Trustee listed above prior to March 31, 1999. The Financial
Services Fund commenced operations December 22, 1997 and did not pay any
fees to the Trustees for its fiscal year ended March 31, 1998 , but expects to
pay approximately $2,500 to each Trustee for the fiscal year ended March 31,
1999.
The Agreement and Declaration of Trust provides that the Funds will
indemnify the Trustees and officers against liabilities and expenses incurred
in connection with litigation in which they may be involved because of their
offices with the Trust, except if it is determined in the manner specified in
the Agreement and Declaration of Trust that such indemnification would relieve
any officer or Trustee of any liability to the Funds or its shareholders by
reason of willful misfeasance, bad faith, gross negligence or reckless
disregard of his or her duties.
Trustees and officers of the Funds who are also officers or shareholders of the
Adviser will benefit from the advisory fees paid by the Fund.
Potential Conflicts of Interest. Principals of the Adviser as individuals own
approximately 70% of the common stock of Harrington Financial Group
("HFGI"), the holding company for Harrington Bank, FSB of Richmond,
Indiana (the "Bank"). HFGI and the Bank may invest in assets of the same
types as those to be held by the Funds.
Douglas T. Breeden, in combination with immediate family members, controls
over 75% of the common stock of Community First Financial Group, Inc.
("CFFG"), the holding company for certain banks and thrifts, to which the
Adviser renders Investment Advisory services. CFFG and its subsidiaries invest
in assets of the same types as those to be held by the Funds.
The Adviser may also manage advisory accounts with investment objectives
similar to or the same as those of the Funds, or different from the Funds but
trading in the same type of securities and instruments as the Funds. Portfolio
decisions and results of the Funds' investments may differ from those of such
accounts managed by the Adviser. When two or more accounts managed by the
Adviser seek to purchase or sell the same assets, the assets actually purchased
or sold may be allocated among the accounts on a basis determined by the
Adviser in its good faith discretion to be equitable. In some cases, this
system may adversely affect the size or the price of the position obtainable
for the Funds.
20<PAGE>
THE INVESTMENT ADVISORY AGREEMENT AND OTHER
SERVICES
The investment manager of the Funds is Smith Breeden Associates, Inc. (the
"Adviser"). The table in the Prospectus indicates which officers and trustees
are affiliated persons of the Adviser.
Under the Investment Advisory Agreements between the Funds and the Adviser,
subject to such policies as the Trustees may determine, the Adviser, at its
expense, furnishes continuously an investment program for the Funds and
makes investment decisions on behalf of the Funds. Subject to the control of
the Trustees, the Adviser also manages, supervises and conducts the other
affairs and business of the Funds, furnishes office space and equipment,
provides bookkeeping and clerical services and places all orders for the
purchase and sale of the Funds' portfolio securities.
For details of the Adviser's compensation under the Investment Advisory
Agreements, see "Fund Charges and Expenses" in this Statement. Under the
Investment Advisory Agreements, the Adviser may reduce its compensation to
the extent that the Funds' expenses exceed such lower expense limitation as the
Adviser may, by notice to the Funds, voluntarily declare to be effective. The
expenses subject to this limitation are exclusive of brokerage commissions,
other investment related expenses such as securities lending fees, interest,
taxes, and extraordinary expenses. The terms of the expense limitations
currently in effect are described in the Prospectus and on the following page.
The Funds pay all expenses not assumed by the Adviser including, without
limitation, auditing, legal, tax preparation and consulting, custodial,
investor servicing and shareholder reporting expenses.
The Investment Advisory Agreements provide that the Adviser shall not be
subject to any liability to the Funds or to any shareholder of the Funds for
any act or omission in the course of or connected with rendering services to
the Funds in the absence of willful misfeasance, bad faith, gross negligence
or reckless disregard of its duties on the part of the Adviser.
The Investment Advisory Agreements may be terminated without penalty
by vote of the Trustees or the shareholders of the relevant Fund, or by the
Adviser, on 60 days written notice. They may be amended only by a vote of
the shareholders of the relevant Fund. The Investment Advisory Agreements
also terminate without payment of any penalty in the event of its assignment
as defined in the Investment Company Act. The Investment Advisory Agreements
provide that they will continue in effect after their initial term of two
years only so long as such continuance is approved at least annually by vote
of either the Trustees or the shareholders, and, in either case, by a
majority of the Trustees who are not "interested persons" of the Adviser or
the Funds. In each of the foregoing cases, the vote of the shareholders is
the affirmative vote of a "majority of the outstanding voting securities".
21<PAGE>
Under the terms of the Investment Advisory Agreements, the Adviser performs
certain administrative services as follows: (1) coordinates with the Funds'
custodian and transfer agent and monitors the services they provide to the
Funds; (2) coordinates with and monitors other third parties furnishing
services to the Funds; (3) provides the Funds with necessary office space,
telephones and other communications facilities and personnel competent to
perform administrative and clerical functions for the Funds; (4) supervises
the preparation by third parties of all Federal, state and local tax returns
and reports of the Funds required by applicable law; (5) prepares and, after
approval by the Funds, files and arranges for the distribution of proxy
materials and periodic reports to shareholders of the Funds as required by
applicable law; (6) prepares and, after approval by the Funds, arranges for
the filing of such registration statements and other documents with the
Securities and Exchange Commission and other Federal and state regulatory
authorities as may be required by applicable law; (7) reviews and submits
to the officers of the Funds for their approval invoices or other requests
for payment of Fund expenses; and (8) takes such other actions with respect
to the Funds as may be necessary in the opinion of the Adviser to perform its
duties under the agreements.
The Adviser has voluntarily undertaken to bear normal operating expenses
(excluding litigation, indemnification and other extraordinary expenses) of
the Funds, and, if necessary, to waive its advisory fee, for the period ending
August 1, 1999 such that total operating expenses would not exceed 0.88% of the
average net assets of the U.S. Equity Market Plus Fund, 0.98% of the average
net assets of each of the High Yield Bond, Asia/Pacific and Europe Funds, and
1.48% of the average net assets of the Financial Services Fund. Such expense
limitations, if any, are calculated daily based on average net assets and may
be continued or modified by the Adviser at any time in its sole discretion.
Portfolio Transactions
Investment decisions. Investment decisions for the Funds and for the other
investment advisory clients of the Adviser are made with a view to achieving
their respective investment objectives. Investment decisions are the product of
many factors in addition to basic suitability for the particular client
involved. Thus, a particular security may be bought or sold for certain
clients even though it could have been bought or sold for other clients at
the same time. Likewise, a particular security may be bought for one or more
clients when one or more other clients are selling the security. In some
instances, one client may sell a particular security to another client.
It also sometimes happens that two or more clients simultaneously purchase
or sell the same security, in which event each day's transactions in such
security are, insofar as possible, averaged as to price and allocated between
such clients in a manner which in the Adviser's opinion is equitable to each
and in accordance with the amount being purchased or sold by each. There
may be circumstances when purchases or sales of portfolio securities for one
or more clients will have an adverse effect on other clients.
22<PAGE>
Brokerage and research services. Transactions on U.S. stock exchanges,
commodities markets and futures markets and other agency transactions involve
the payment by the Funds of negotiated brokerage commissions. Such
commissions vary among different brokers. In addition, a particular broker
may charge different commissions according to such factors as the difficulty
and size of the transaction. There is generally no stated commission in the
case of securities traded in the over-the-counter markets, but the price paid
by the Funds usually includes an undisclosed dealer commission or mark-up. In
underwritten offerings, the price paid by the Funds includes a disclosed, fixed
commission or discount retained by the underwriter or dealer. The following
table details the approximate brokerage commissions paid by the Funds for the
last three fiscal years:
Brokerage Commissions Paid by the Funds
Asia/Pacific,
U.S. Equity Financial Europe, and
Fiscal Year Market Plus Services High Yield
Ended Fund Fund Bond Funds
March 31, 1998 $ 26,251 $25,946* N/A*
March 31, 1997 $ 3,000 N/A* N/A*
March 31, 1996 $ 1,000 N/A* N/A*
*The Financial Services Fund commenced operations December 22, 1997. The
High Yield Bond, Asia/Pacific and Europe Funds each commenced operations
October 15, 1998, and, as such, have not yet paid any brokerage
commissions.
For a discussion of brokerage issues relating to investments in foreign
securities, see "Miscellaneous Investment Practices and Risk Considerations-
Foreign Securities".
The Adviser places all orders for the purchase and sale of portfolio
investments for the Funds and may buy and sell investments for the Funds
through a substantial number of brokers and dealers. In so doing, the
Adviser uses its best efforts to obtain for the Funds the most favorable
price and execution available. In seeking the most favorable price and
execution, the Adviser, having in mind the Funds' best interests, considers
all factors it deems relevant, including, by way of illustration, price, the
size of the transaction, the nature of the market for the security or other
investment, the amount of the commission, the timing of the transaction
taking into account market prices and trends, the reputation, experience
and financial stability of the broker-dealer involved and the quality of
service rendered by the broker-dealer in other transactions.
When it is determined that several brokers or dealers are equally able to
provide the best net price and execution, the Adviser may execute
transactions through brokers or dealers who provide quotations and other
services to its advisory clients, including the quotations necessary to
determine these clients' net assets, in such amount of total brokerage as
may reasonably be required in light of such services, and through brokers
and dealers who supply statistical and other data to the Adviser and its
clients in such amount of total brokerage as may reasonably be required.
23<PAGE>
Consistent with the Rules of Fair Practice of the National Association of
Securities Dealers, Inc. and subject to seeking the most favorable price and
execution available and such other policies as the Trustees may determine, the
Adviser may consider sales of shares of the Funds (and, if permitted by law, of
the other funds managed by the Adviser) as a factor in the selection of broker-
dealers to execute portfolio transactions for the Funds.
The Adviser conducts extensive proprietary research. The Adviser is not
dependent on any broker for such research and analysis and, thus is able to
transact business with brokers regardless of the brokers' research capabilities
or provision of such research to brokerage customers. The Adviser uses
multiple electronic quotation services for trading and pricing purposes.
The Adviser pays for these services directly out of its advisory fees.
The Adviser is not involved in any soft dollar arrangements. The Adviser
does utilize broker pricing guidance for certain assets not consistently
available through electronic quotation services.
Investor Servicing Agent
First Data Investor Services is each Fund's investor servicing agent
(transfer, plan and dividend disbursing agent), for which it receives fees
which are paid monthly by each Fund as an expense of all its shareholders.
See "Fund Charges and Expenses" in this Statement for information on fees and
reimbursements received by First Data Investor Services. First Data Investor
Services is also investor-servicing agent for the other funds managed by the
Adviser and receives fees from each of those funds for its services.
Custodian
The Bank of New York ("Custodian") acts as custodian of each of the Fund's
assets. In carrying out its duties under its custodian contract, the Custodian
may employ one or more subcustodians whose responsibilities will include
safeguarding and controlling each Fund's cash and securities, handling the
receipt and delivery of securities and collecting interest and dividends on
each Fund's investments. Each Fund pays the Custodian an annual fee based on
the assets of the Fund and the Fund's securities transactions. Each Fund also
pays the Custodian an annual fee based on the Fund's securities holdings for
the year and reimburses the Custodian for certain out-of-pocket expenses
incurred by it or any subcustodian employed by it in performing custodial
services. The Custodian pays the fees and other charges of any subcustodian
employed by it.
PRINCIPAL HOLDERS OF SECURITIES AND CONTROLLING
PERSONS
Listed below are the names and addresses of those shareholders who, to the
U.S. Equity Market Plus Fund's best knowledge, as of July15, 1998, owned 5%
or more of the shares of the Fund.
Charles Schwab & Co.
For the Beneficial Ownership of Its Accountholders
101 Montgomery Street
San Francisco, CA 94104 56.02%
Each Fund Trustee owns less than 1% of the shares of the U.S. Equity Market
Plus Fund as of July 15, 1998.
24<PAGE>
Listed below are the names and addresses of those shareholders who, to the
Financial Services Fund's best knowledge, as of July 15, 1998, owned 5% or
more of the shares of the Fund.
Smith Breeden Associates, Inc.
100 Europa Drive
Chapel Hill, NC 27514 70.89%
Charles Schwab & Co.
For the Beneficial Ownership of Its Accountholders
101 Montgomery Street
San Francisco, CA 94104 5.15%
Each Fund Trustee owns less than 1% of the shares of the Financial Services
Fund as of July 15, 1998.
Each of the High Yield Bond, Asia/Pacific and Europe Funds commenced
operations October 15, 1998, and, as such, do not currently have any
shareholders.
DETERMINATION OF NET ASSET VALUE
Each Fund determines net asset value as of the close of regular trading on the
New York Stock Exchange usually at 4 p.m. If any securities held by a Fund are
restricted as to resale, the Adviser determines their fair value following
procedures approved by the Trustees. The Trustees periodically review such
valuation procedures. The fair value of such securities is generally determined
as the amount which the Fund could reasonably expect to realize from an
orderly disposition of such securities over a reasonable period of time. The
valuation procedures applied in any specific instance are likely to vary from
case to case. However, consideration is generally given to the financial
position of the issuer and other fundamental analytical data relating to the
investment and to the nature of the restrictions on disposition of the
securities (including any registration expenses that might be borne by the Fund
in connection with such disposition). In addition, specific factors are also
generally considered, such as the cost of the investment, the market value of
any unrestricted securities of the same class (both at the time of purchase and
at the time of valuation), the size of the holding, the prices of any recent
transactions or offers with respect to such securities and any available
analysts' reports regarding the issuer.
Trading in certain securities is substantially completed each day at various
times prior to the close of regular trading on the Exchange. The values of
these securities used in determining the net asset value of the Fund's shares
are computed as of such times. Because regular trading in most foreign
securities markets is completed simultaneously with, or prior to, the close of
regular trading on the New York Stock Exchange, closing prices for foreign
securities usually are available for purposes of computing the net asset value
of those Funds which may invest in such securities. However, in the event that
the closing price of a foreign security is not available in time to calculate a
Fund's net asset value on a particular day, the Funds' Board of Trustees has
authorized the use of the market price for the security obtained from an
approved pricing service at an established time during the day which may be
prior to the close of regular trading in the security. The value of all of the
Fund's assets and liabilities expressed in foreign currencies will be converted
into U.S. dollars at the spot rate of such currencies against U.S. dollars
provided by an approved pricing service. Because of the amount of time required
to collect and process trading information of large numbers of securities
25<PAGE>
issues, the values of certain securities (such as convertible bonds and U.S.
Government securities) are determined based on market quotations collected
earlier in the day at the latest practicable time prior to the close of the
Exchange. Occasionally, events affecting the value of such securities may occur
between such times and the close of the Exchange that will not be reflected in
the computation of a Fund's net asset value. If events materially affecting
the value of such securities occur during such period, then these securities
may be valued at their fair market value following procedures approved by the
Trustees.
ADDITIONAL INFORMATION REGARDING PURCHASES
AND REDEMPTIONS OF FUND SHARES
All checks, drafts, wires and other payment mediums used for purchasing or
redeeming shares of a Fund must be denominated in U.S. Dollars. A Fund
reserves the right, in its sole discretion, to either (a) reject any order for
the purchase or sale of shares denominated in any other currency, or (b) to
honor the transaction or make adjustments to shareholder's account for the
transaction as of a date and with a foreign currency exchange factor
determined by the drawee bank.
Dividend checks which are returned to a Fund marked "unable to forward" by
the postal service will be deemed to be a request to change the dividend option
and the proceeds will be reinvested in additional shares at the current net
asset value until new instructions are received.
Redemptions in Kind. The Funds are committed to pay in cash all requests for
redemption by any shareholder of record, limited in amount, however, during
any 90-day period to the lesser of $250,000 or 1% of the value of a Fund's net
assets at the beginning of such period. Such commitment is irrevocable without
the prior approval of the Securities and Exchange Commission. In the case of
requests for redemption in excess of such amounts, the Trustees reserve the
right to make payments in whole or in part in securities or other assets of a
Fund in case of any emergency, or if the payment of such redemption in cash
would be detrimental to the existing shareholders of a Fund. In such
circumstances, the securities distributed would be valued at the price used to
compute the Fund's net assets. Should a Fund do so, a shareholder may incur
brokerage fees or other transaction costs in converting the securities to cash.
Principal Underwriter. FPS Broker Services, Inc. (the "Principal
Underwriter"), 3200 Horizon Drive, P.O. Box 61503, King of Prussia, PA
194060903, is the principal underwriter for the Funds and is acting on a best
efforts basis. Effective on or about January 1, 1999, pursuant to an asset
purchase plan entered into by the parent companies of FPS Broker Services, Inc.
and First Data Broker Services, Inc., First Data Broker Services, Inc. (also,
the "Principal Underwriter"), 3200 Horizon Drive, P.O. Box 61503, King of
Prussia, PA 19406-0903, is expected to become the principal underwriter for the
Funds and will act on a best efforts basis. Both FPS Broker Services, Inc. and
First Data Broker Services, Inc. are registered as broker-dealers under the
Securities Exchange Act of 1934 and are members of the National Association
of Securities Dealers, Inc. The offering of the Funds' shares is continuous.
26<PAGE>
The Funds' underwriting agreement with the Principal Underwriter
provides that the Funds will pay all fees and expenses in connection with:
registering and qualifying their shares under the various state "blue sky"
laws; preparing, setting in type, printing, and mailing its prospectuses
and reports to shareholders; and issuing their shares, including expenses
of confirming purchase orders. The Principal Underwriter acts as the agent
of the Funds in connection with the sale of their shares in all states in
which the shares are qualified and in which the Principal Underwriter is
qualified as a broker-dealer. Under the underwriting agreement, the
Principal Underwriter may accept orders for Funds' shares at their offering
prices. For these services for the Funds, the Adviser pays the Principal
Underwriter approximately $15,000. The Principal Underwriter may enter into
agreements with other broker-dealers for the sale ofthe Funds' shares by them.
Reinvestment Date. The dividend reinvestment date is the date on which the
additional shares are purchased for the investor who has its dividends
reinvested. This date will vary and is not necessarily the same date as the
record date or the payable date for cash dividends.
Special Services. The Funds may pay certain financial institutions that
maintain accounts with the Funds on behalf of numerous beneficial owners for
record keeping operations performed with respect to such beneficial owners.
Such financial institutions may also charge a fee for their services directly
to their clients.
SHAREHOLDER INFORMATION
Each time shareholders buy, redeem or exchange shares or receive a
distribution, they will receive a statement confirming the transaction and
listing their current share balance. The Funds also send annual and semiannual
reports that keep shareholders informed about each Fund's portfolio and
performance, and year-end tax information to simplify their recordkeeping.
Shareholders may call First Data Investor Services toll-free at 1-800 221-3137
for more information, including account balances.
SUSPENSION OF REDEMPTIONS
The Funds may not suspend shareholders' right of redemption, or postpone
payment for more than seven days, unless the New York Stock Exchange (the
"Exchange") is closed for other than customary weekends or holidays, or if
permitted by the rules of the Securities and Exchange Commission during
periods when trading on the Exchange is restricted or during any emergency
which makes it impracticable for the Funds to dispose of their securities or to
determine fairly the value of their net assets, or during any other period
permitted by order of the Commission for protection of investors.
27<PAGE>
SHAREHOLDER LIABILITY
Under Massachusetts law, shareholders could, under certain circumstances, be
held personally liable for the obligations of the Funds. However, the
Agreement and Declaration of Trust disclaims shareholder liability for acts
or obligations of the Funds and requires that notice of such disclaimer be
given in each agreement, obligation, or instrument entered into or executed
by the Funds or the Trustees. The Agreement and Declaration of Trust
provides for indemnification out of Fund property for all loss and expense
of any shareholder held personally liable for the obligations of a Fund.
Thus, the risk of a shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which a Fund would
be unable to meet its obligations. The likelihood of such circumstances is
remote.
STANDARD PERFORMANCE MEASURES
Total return data for the Funds may from time to time be presented in this
Statement and in advertisements. Total return for the one-year period and for
the life of a Fund is determined by calculating the actual dollar amount of
investment return on a $1,000 investment in a Fund made at the net asset value
at the beginning of the period, and then calculating the annual compounded rate
of return which would produce that amount. Total return for a period of one
year is equal to the actual return of the Fund during that period. Total return
calculations assume reinvestment of all Fund distributions at net asset value
on their respective reinvestment dates. The following table shows the average
annual total return for the periods stated, as of the fiscal year end of March
31, 1998.
Average Annual Total Return
One Year Five Years Inception
U.S. Equity Market Plus Fund 45.7% 22.9% 22.8%
Financial Services Fund N/A* N/A* 11.7%
*The Financial Services Fund commenced operations December 22, 1997.
The U.S. Equity Market Plus Fund commenced operations June 30, 1992.
The High Yield Bond, Asia/Pacific and Europe Funds commenced
operations October 15, 1998, and, as such, do not yet have total return data
available.
At times, the Adviser may reduce its compensation or assume expenses of a
Fund in order to reduce a Fund's expenses. The per share amount of any such
fee reduction or assumption of expenses for the life of a Fund, will be
reflected in the Prospectus as updated. Any such fee reduction or assumption of
expenses would increase a Fund's total return during the period of the fee
reduction or assumption of expenses.
Independent statistical agencies measure a Fund's investment performance and
publish comparative information showing how the Fund, and similar investment
companies, performed in specified time periods. The agencies whose reports
are commonly used are Morningstar, Inc, Lipper Analytical Services and
Wiesenberger Investment Companies Service. From time to time, a Fund may
distribute these comparisons to its shareholders or to potential investors.
28<PAGE>
The Funds' performance may also from time to time be compared to
Standard & Poor's 500 Composite Stock Price Index (the "S&P 500 Index").
Standard & Poor's performance figures reflect changes of market prices and
reinvestment of all regular cash dividends and are not adjusted for commissions
or other costs. Because each Fund is a managed portfolio investing in a
variety of securities and derivative instruments, the securities it owns will
not match those in the Index. Other publications, indices, and averages that
may be used are as follows:
a) CDA Mutual Fund Report, published by CDA Investment
Technologies, Inc. - analyzes price, current yield, risk, total return and
average rate of return (average annual compounded growth rate) over
specified time periods for the mutual fund industry.
b) Mutual Fund Source book, published by Morningstar, Inc.--analyzes
price, yield, risk and total return for equity and fixed income funds.
c) Financial publications: Barron's, Business Week, Changing Times,
Financial World, Forbes, Fortune, and Money magazines - rate fund
performance over specified time periods.
d) Consumer Price Index (or Cost of Living Index) published by the U.S.
Bureau of Labor Statistics a statistical measure of change, over time, in
the price of goods and services in major expenditure groups.
e) Stocks, Bonds, Bills, and Inflation, published by Ibbotson Associates -
historical measure of yield, price and total return for common and
small company stock, long-term government bonds, treasury bills, and
inflation.
f) Savings and Loan Historical Interest Rates - as published in the U.S.
Savings & Loan League Fact Book.
g) Salomon Brothers Broad Bond Index or its component indices - The
Broad Index measures yield, price and total return for Treasury,
Agency, Corporate, and Mortgage bonds.
h) Salomon Brothers Composite High Yield Index or its component
indices - The High Yield Index measures yield, price and total return
for Long-Term High-Yield Index, Intermediate-Term High-Yield
Index and Long-Term Utility High-Yield Index.
i) Lehman Brothers Aggregate Bond Index or its component indices -
The Aggregate Bond Index measures yield, price and total return for
Treasury, Agency, Corporate, Mortgage, and Yankee bonds.
j) Lehman Brothers Government/Corporate Bond Index.
k) Other taxable investments including certificates of deposit (CD's),
money market deposit accounts (MMDA's), checking accounts, savings
accounts, money market mutual funds, repurchase agreements, and
government securities.
l) Historical data supplied by the research departments of Lehman
Brothers, First Boston Corporation, Morgan Stanley, Salomon
Brothers, Merrill Lynch, Goldman Sachs, Prudential Securities and
Donaldson Lufkin and Jenrette.
29<PAGE>
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.
o) Merrill Lynch High Yield Master Index or other high yield bond
indices as published by a brokerage firm or others.
p) Average of competitive funds as published by Lipper Analytical
Services, Inc.
q) Morgan Stanley Capital International (MSCI) - Pacific (Free) Index,
which consists of common stocks of companies located in Australia,
Hong Kong, Japan, Malaysia, New Zealand, and Singapore.
r) Morgan Stanley Capital International (MSCI) - Europe Index, which is
comprised of common stocks of companies located in 15 European
countries (Austria, Belgium, Denmark, Finland,, France, Germany,
Ireland, Italy, the Netherlands, Norway, Portugal, Spain, Sweden,
Switzerland, and the United Kingdom).
s) Standard & Poor's Financial Composite.
t) An investment of 80% in the S&P Financial Composite Index and 20%
in Money Market funds.
u) The Keefe Bruyette & Woods Index.
v) The average of the mutual funds in Morningstar's Specialty Financial
category.
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.
30<PAGE>
EXPERTS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540, are
the Funds' independent auditors, providing audit services, tax return review
andpreparation services and assistance and consultation in connection with the
review of various Securities and Exchange Commission filings. The annual
financial statements of both the U.S. Equity Market Plus and Financial Services
Funds and related notes thereto attached to this Statement of Additional
Information have been so attached in reliance upon the report of Deloitte &
Touche LLP, given on the authority of said firm as experts in auditing and
accounting.
FINANCIAL STATEMENTS
Attached are the audited financial statements for the fiscal year ended March
31, 1998.
SMITH BREEDEN TRUST
Smith Breeden U.S. Equity Market Plus Fund
Smith Breeden Financial Services Fund
31<PAGE>
ANNUAL REPORTS
Smith Breeden Short Duration
U.S. Government Fund
Smith Breeden Intermediate Duration
U.S. Government Fund
Smith Breeden Equity Market Plus Fund
Smith Breeden Financial Services Fund
March 31, 1998
<PAGE>
TABLE OF CONTENTS
<TABLE>
<S> <C>
Letter to Our Shareholders 1
Smith Breeden Short Duration U.S. Government Fund
Performance Review 2
Schedule of Investments 4
Statement of Assets and Liabilities 6
Statement of Operations 7
Statements of Changes in Net Assets 8
Financial Highlights 9
Notes to Financial Statements 10
Report of Independent Auditors 13
Smith Breeden Intermediate Duration U.S. Government Fund
Performance Review 14
Schedule of Investments 16
Statement of Assets and Liabilities 17
Statement of Operations 18
Statements of Changes in Net Assets 19
Financial Highlights 20
Notes to Financial Statements 21
Report of Independent Auditors 24
Smith Breeden Equity Market Plus Fund
Performance Review 25
Schedule of Investments 27
Statement of Assets and Liabilities 29
Statement of Operations 30
Statements of Changes in Net Assets 31
Financial Highlights 32
Notes to Financial Statements 33
Report of Independent Auditors 36
Smith Breeden Financial Services Fund
Performance Review 37
Schedule of Investments 39
Statement of Assets and Liabilities 40
Statement of Operations 41
Statement of Changes in Net Assets 42
Financial Highlights 43
Notes to Financial Statements 44
Report of Independent Auditors 47
</TABLE>
<PAGE>
LETTER TO OUR SHAREHOLDERS
Dear Fellow Shareholder:
For many of you, this will be the first annual report you will have received as
a shareholder in the Smith Breeden Mutual Funds. Our growth has been both
exciting and gratifying, as we have welcomed over 6,000 new shareholders to
Smith Breeden since March of 1997. We wish to give each of you a warm welcome
to the family.
Although this is the first annual report for many shareholders, it is the sixth
report that we have issued for our funds, which commenced operations in 1992.
It has only been in the last year that we have become widely known, as
evidenced by our growth. We attribute this growth to a combination of factors.
Many national publications have recognized our funds' fine performance. In
addition, indexing is now receiving increased attention as an attractive
investment strategy. Many shareholders have also recommended our funds to
friends and relatives. The Smith Breeden Funds offer disciplined and successful
investment alternatives within the basic domestic asset classes: stocks, bonds
and cash. We invite you to continue to spread the word about us to your friends
and family. Our representatives are available to answer any questions at (800)
221-3138. Information is also available at Smith Breeden's web site at
www.smithbreeden.com.
1997 was an important year for us not only because of the recognition we
received, but also because we launched a new fund, the Smith Breeden Financial
Services Fund. Smith Breeden has been a successful investor in, and consultant
to, financial institutions for many years. In fact, Smith Breeden started in
business in 1982 as a consultant to banks and thrifts. We are proud to be able
to offer you this expertise through our new fund. The Financial Services Fund
commenced its operations on December 22, 1997 and its financial statements are
included in this report. Please take a moment to review its performance and
operations.
We continue to explore new ways to deliver our investment expertise to you. We
are considering additions to our fund family within additional asset classes to
allow our investors to diversify their portfolios further, and thereby to seek
the combination of risk and return best suited to each person's own goals and
constraints. We will keep you informed as our plans progress.
Thank you for your continued trust in the Smith Breeden Mutual Funds.
Sincerely,
[GRAPHIC OMITTED]
[GRAPHIC OMITTED]
Douglas T. Breeden Michael J. Giarla
Chairman President
1
<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
PERFORMANCE REVIEW
The Smith Breeden Short Duration U.S. Government Fund provided a total
return of 6.24% in the year ended March 31, 1998. The Fund's return exceeded
its benchmark, the six-month U.S. Treasury Bill, by 0.57% for the year. The
Fund's return versus money-market funds was even more compelling, with the
average money-market fund yielding 5.03%1 in the year. This was accomplished
steadily over the year, with the Fund's return exceeding the benchmark return
in each calendar quarter. Since the Fund's inception in June 1992, it has
provided an annualized return 0.71% in excess of the six-month U.S. Treasury
Bill. The graph below plots the Fund's return versus both its benchmark and the
average return of Morningstar's Ultra-Short Bond Fund category.
[GRAPHIC OMITTED]
Interest rates declined in the year, with the five-year U.S. Treasury Note
yield dropping 1.12%, from 6.74% at March 31, 1997 to 5.62% at March 31, 1998.
At the short end of the yield curve, the yield on the six-month U.S. T-Bill
fell from 5.54% to 5.26%, or just 0.28%. This overall flattening in the yield
curve resulted from a combination of economic events. The Federal Government
budget deficit declined, which reduced the U.S. Treasury's need to issue new
debt. The resultant reduction in supply of U.S. Treasury securities helped
drive yields down. Financial turmoil in Asia made U.S. Treasury securities even
more popular as a financial safe-harbor, increasing demand for U.S. Treasury
debt while supply was falling. Meanwhile, the Federal Reserve continued to be
watchful for signs of inflation amid strong economic growth and unemployment at
thirty-year lows, and they maintained their short-term rate at 5.50%. This
placed a floor under short-term rates, preventing a significant decline in
yields on Treasury Bills, and the result was a flatter yield curve.
- ---------
1. Average money-market fund yield from The Wall Street Journal.
2
<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
Part of the Fund's return over the return on the six-month U.S. Treasury
Bill was due to the favorable performance of mortgage-backed securities when
compared with U.S. Treasury securities. Expectations of future interest rate
volatility declined in tandem with the fall in interest rates. Mortgage-backed
securities perform best in steady interest rate environments, and so investors
are willing to pay comparatively more for mortgages when they expect stable
interest rates. The decline in expected interest rate volatility occurred
despite some unsettled periods during the year, especially at the height of the
recent Asian crisis. As long-term interest rates fell below 6.0% at the end of
the third quarter of 1997, many mortgage investors braced for an expected surge
in prepayments, and longer-duration mortgages underperformed comparable U.S.
Treasury securities. The benign effect of declining volatility was enough,
however, to outweigh the effect of faster prepayments for the mortgage sector
as a whole.
The Fund aims to add value by investing selectively in favorably valued
sectors of the mortgage market. During the year, the Fund reduced its overall
level of investment in mortgages and increased its cash holdings as interest
rates declined and the likelihood of a prepayment surge increased. The Fund
also reduced holdings in longer-term and higher-coupon fixed-rate mortgages in
the latter part of 1997, to reduce prepayment risk in the fund. The first
quarter of 1998 saw the expected surge in prepayments, and the Fund was
successful in outperforming the six-month U.S. Treasury Bill even in this
difficult period.
3
<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS MARCH 31, 1998
<TABLE>
<CAPTION>
Market
Face Amount Security Value
- --------------- ------------------------------------------------------------------------------ ---------------
<S> <C> <C>
U.S. GOVERNMENT & AGENCY OBLIGATIONS -- 132.69%
Freddie Mac -- 32.91% (1)
FH Gold
$ 7,900,000 6.00%, due 4/1/13 ............................................................ $ 7,785,511
10,000,000 6.50%, due 4/1/13 ............................................................ 10,036,719
7,650,530 8.50%, due 5/1/25 to 12/1/25 ................................................. 7,984,036
------------
25,806,266
------------
Fannie Mae -- 32.82% (1)
FN Interest only (2)
1,324,877 9.00%, due 7/25/21 ........................................................... 351,642
FN
20,199,991 6.50%, due 1/1/28 to 2/1/28 .................................................. 19,978,824
4,000,000 6.50%, due date to be announced .............................................. 3,955,406
1,395,490 7.04%, due 12/1/06 ........................................................... 1,457,381
------------
25,743,253
------------
Government National Mortgage Association -- 66.45% (1)
GNMA ARM
26,245,770 5.00%, due 7/20/27 to 3/20/28 ................................................ 26,221,553
19,633,725 5.50%, due 8/20/27 to 11/20/27 (5) ........................................... 19,804,312
3,591,256 7.00%, due 7/20/17 to 9/20/22 ................................................ 3,691,293
1,268,641 7.375%, due 5/20/22 to 4/20/24 ............................................... 1,301,807
GNMA
1,017,522 9.50%, due 7/15/09 to 9/15/21 ................................................ 1,098,553
------------
52,117,518
------------
U.S. Treasury Bills -- 0.51%
400,000 5.51% due 5/28/98 (3) ........................................................ 396,802
------------
396,802
------------
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(Cost $103,210,947) .......................................................... 104,063,839
------------
Notional
Amount Three-Month LIBOR Interest Rate Swap Contracts -- (0.97)%
- ------------
$ 20,000,000 Contract dated 6/22/93 with Prudential Global Funding, Expires 6/22/98,
pay rate 5.458% .............................................................. 17,095
20,000,000 Contract dated 8/31/93 with Salomon Swapco, Expires 8/30/00,
pay rate 5.34% ............................................................... 259,820
20,000,000 Contract dated 5/15/95 with Salomon Swapco, Expires 5/15/05,
pay rate 6.951% .............................................................. (1,038,677)
------------
Total Three-Month LIBOR Interest Rate Swap Contracts ......................... (761,762)
------------
Three-Month LIBOR Interest Rate Cap Contracts -- 0.34%
50,000,000 Contract with Salomon Swapco, expires 4/23/03, Strike rate 7.50% ............. 269,500
------------
Total Three-Month LIBOR Interest Rate Cap Contracts (Cost $1,509,907)......... 269,500
------------
Contracts Option Contracts -- 0.07%
- ------------
80 Call on 5 Year US Treasury Note Futures, expires 5/98, strike price $111...... $ 2,500
40 Call on 30 Year US Treasury Bond Futures, expires 5/98, strike price $126..... 5,000
80 Put on 5 Year US Treasury Note Futures, expires 5/98, strike price $108 ...... 18,750
40 Put on 30 Year US Treasury Bond Futures, expires 5/98, strike price $118 ..... 25,000
------------
Total Option Contracts (Cost $78,112) ........................................ 51,250
------------
TOTAL INVESTMENTS -- 132.13% (Cost $104,798,966) ............................. 103,622,827
------------
</TABLE>
4
<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS (continued) MARCH 31, 1998
<TABLE>
<CAPTION>
Market
Face Amount Security Value
- ---------------- --------------------------------------------------------- ---------------
<S> <C> <C>
Reverse Repurchase Agreements -- (5.10%)
$ (4,000,000) Morgan Stanley 5.74% due 4/7/98 dated 3/31/98 (4) ....... (4,000,000)
----------
(4,000,000)
----------
Short Sales -- (25.22%)
(20,000,000) FN 6.50% due date to be announced (5) ................... (19,777,031)
-----------
(19,777,031)
-----------
Other Liabilities, Less Cash and Other Assets -- (1.81%) (1,417,941)
-----------
NET ASSETS -- 100.00% ................................... $ 78,427,855
=============
</TABLE>
- ---------
(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) Represents an interest only stripped mortgage-backed security.
(3) Security is held as collateral by Carr Futures, Inc. The interest rate
shown is the discount rate paid at time of purchase.
(4) Reverse repurchase agreement is collateralized by $4,166,424 face of GNMA
ARM 5.50% due 8/20/27.
(5) Short sale represents the sale "against the box" of $20,000,000 FN 6.50%
securities owned by the Fund.
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.
5
<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 1998
<TABLE>
<S> <C>
Assets
Investments at market value (identified cost $104,798,966) (Note 1)...................... $ 103,622,827
Cash .................................................................................... 7,459
Restricted cash held to cover checkwriting privileges ................................... 28,000
Receivables:
Variation margin on futures contracts (Note 2) ........................................ 43,765
Subscriptions ......................................................................... 155,740
Interest .............................................................................. 487,618
Securities sold ....................................................................... 40,676,438
Other assets ............................................................................ 11,649
-------------
Total Assets .......................................................................... 145,033,496
-------------
Liabilities
Reverse repurchase agreement (proceeds $4,000,000) (Note 1).............................. 4,000,000
Short sales at market value (proceeds $19,806,250)....................................... 19,777,031
Payables:
Redemptions ........................................................................... 25,915
Securities purchased .................................................................. 42,629,141
Swap Interest (Note 2) ................................................................ 33,441
Due to Advisor (Note 3) ............................................................... 48,169
Accrued expenses ........................................................................ 91,944
-------------
Total Liabilities ..................................................................... 66,605,641
-------------
Net Assets
(Applicable to outstanding shares of 7,904,459 unlimited number of shares of beneficial
interest authorized; no stated par) ................................................... $ 78,427,855
=============
Net asset value, offering price and redemption price per share ($78,427,855 / 7,904,459). $ 9.92
=============
Source of Net Assets
Paid in capital ......................................................................... $ 82,964,182
Overdistributed net investment income ................................................... (631,273)
Accumulated net realized loss on investments ............................................ (2,702,907)
Net unrealized depreciation of investments, interest rate swaps, interest rate caps,
short
sales and futures contracts ........................................................... (1,202,147)
-------------
Net Assets ............................................................................ $ 78,427,855
=============
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
6
<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1998
<TABLE>
<S> <C>
Investment Income
Interest and discount earned, net of premium amortization and interest expense (Note 1) . $ 6,296,431
Expenses
Advisory fees (Note 3) .................................................................. 727,735
Accounting and pricing services fees .................................................... 59,134
Custodian fees........................................................................... 37,145
Audit and tax preparation fees .......................................................... 33,860
Legal fees .............................................................................. 27,305
Transfer agent fees ..................................................................... 33,609
Registration fees ....................................................................... 24,489
Trustees fees and expenses .............................................................. 66,931
Insurance ............................................................................... 21,599
Other ................................................................................... 10,482
------------
Total Expenses Before Reimbursement ................................................... 1,042,289
Expenses reimbursed by Advisor (Note 3) ............................................... (231,365)
------------
Net Expenses .......................................................................... 810,924
------------
Net Investment Income ................................................................. 5,485,507
------------
Realized and Unrealized Gain (Loss) on Investments
Net realized gain on investments ........................................................ 2,886,352
Change in unrealized appreciation (depreciation) of investments, interest rate swaps,
interest
rate caps, and futures contracts ...................................................... (2,022,049)
------------
Net realized and unrealized gain on investments ......................................... 864,303
------------
Net increase in net assets resulting from operations .................................... $ 6,349,810
============
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
7
<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Ended Year Ended
March 31, 1998 March 31, 1997
---------------- -----------------
<S> <C> <C>
Operations
Net investment income .................................................... $ 5,485,507 $ 10,225,930
Net realized gain on investments ......................................... 2,886,352 846,686
Change in unrealized appreciation (depreciation) of investments,
interest rate swaps, interest rate caps and futures contracts .......... (2,022,049) 1,887,652
------------- --------------
Net increase in net assets resulting from operations ..................... 6,349,810 12,960,268
------------- --------------
Distributions to Shareholders
Dividends from net investment income ..................................... (5,439,867) (10,225,930)
Dividends in excess of net investment income ............................. -- (929,596)
------------- --------------
Total distributions ...................................................... (5,439,867) (11,155,526)
------------- --------------
Capital Share Transactions
Shares sold .............................................................. 46,118,603 59,328,830
Shares issued on reinvestment of distributions ........................... 2,600,980 2,816,807
Shares redeemed .......................................................... (90,190,280) (166,786,906)
------------- --------------
Decrease in net assets resulting from capital share transactions (a) ..... (41,470,697) (104,641,269)
------------- --------------
Total Decrease in Net Assets ........................................... (40,560,754) (102,836,527)
Net Assets
Beginning of period ...................................................... 118,988,609 221,825,136
------------- --------------
End of period ............................................................ $ 78,427,855 $ 118,988,609
============= ==============
(a) Transactions in capital shares were as follows:
Shares sold ............................................................ 4,669,660 6,065,723
Shares issued on reinvestment of distributions ......................... 264,390 289,222
Shares redeemed ........................................................ (9,136,010) (17,017,982)
------------- --------------
Net decrease ........................................................... (4,201,960) (10,663,037)
Beginning balance ...................................................... 12,106,419 22,769,456
------------- --------------
Ending balance ......................................................... 7,904,459 12,106,419
============= ==============
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
8
<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
The following average per share data, ratios and supplemental information
have been derived from information provided in the financial statements.
<TABLE>
<CAPTION>
Year Year
Ended Ended
March 31, March 31,
1998 1997
--------------- ----------------
<S> <C> <C>
Net Asset Value,
Beginning of Period .......... $ 9.83 $ 9.74
----------- ------------
INCOME FROM INVESTMENT
OPERATIONS
Net investment income ........ 0.484 0.476
Net realized and
unrealized gain (loss)
on investments ............. 0.114 0.146
----------- ------------
Total from investment
operations ................ 0.598 0.622
----------- ------------
Less Distributions
Dividends from net
investment income .......... (0.508) (0.476)
Dividends in excess of
investment income .......... -- (0.056)
----------- ------------
Total distributions ........ (0.508) (0.532)
----------- ------------
Net Asset Value, End of
Period ....................... $ 9.92 $ 9.83
----------- ------------
Total Return .................. 6.24% 6.57%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period..... $78,427,855 $118,988,609
Ratio of expenses to
average net assets (2) ..... 0.78% 0.78%
Ratio of net investment
income to average net
assets ..................... 5.28% 5.04%
Portfolio turnover rate ...... 626% 556%
Ratio of expenses to
average net assets
before reimbursement
of expenses by the
Advisor (2) 1.00% 0.93%
Ratio of net investment
income to average net
assets before
reimbursement of
expenses by the
Advisor 5.06% 4.90%
<CAPTION>
For the Period
Year Year Year March 31,
Ended Ended Ended 1992 (1)
March 31, March 31, March 31, to March 31,
1996 1995 1994 1993
---------------- ---------------- ---------------- ---------------
<S> <C> <C> <C> <C>
Net Asset Value,
Beginning of Period .......... $ 9.90 $ 9.90 $ 10.00 $ 10.00
------------ ------------ ------------ -----------
INCOME FROM INVESTMENT
OPERATIONS
Net investment income ........ 0.621 0.628 0.432 0.552
Net realized and
unrealized gain (loss)
on investments ............. (0.148) -- ( 0.070) 0.002
------------ ------------ ------------ -----------
Total from investment
operations ................ 0.473 0.628 0.362 0.554
------------ ------------ ------------ -----------
Less Distributions
Dividends from net
investment income .......... (0.621) (0.628) ( 0.462) ( 0.554)
Dividends in excess of
investment income .......... (0.012) -- -- --
------------ ------------ ------------ -----------
Total distributions ........ (0.633) (0.628) ( 0.462) ( 0.554)
------------ ------------ ------------ -----------
Net Asset Value, End of
Period ....................... $ 9.74 $ 9.90 $ 9.90 $ 10.00
------------ ------------ ------------ -----------
Total Return .................. 4.95% 6.58% 3.67% 5.67%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period..... $221,825,136 $218,431,665 $218,167,491 $48,531,206
Ratio of expenses to
average net assets (2) ..... 0.78% 0.78% 0.78% 0.78%
Ratio of net investment
income to average net
assets ..................... 6.29% 6.33% 4.17% 4.53%
Portfolio turnover rate ...... 225% 47% 112% 3%
Ratio of expenses to
average net assets
before reimbursement
of expenses by the
Advisor (2) 0.93% 0.92% 1.00% 2.58%
Ratio of net investment
income to average net
assets before
reimbursement of
expenses by the
Advisor 6.13% 6.18% 3.95% 2.73%
</TABLE>
- ---------
(1) Commencement of operations.
(2) Through March 31, 1995, expense ratios include both the direct expenses of
the Smith Breeden Short Duration U.S. Government Fund, and the indirect
expenses incurred through the Fund's investment in the Smith Breeden
Institutional Short Duration U.S. Government Fund.
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
9
<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Breeden Series Fund (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 Short
Duration U.S. Government Fund (the "Short Fund" or "Fund", formerly the Smith
Breeden Short Duration U.S. Government Series) and the Smith Breeden
Intermediate Duration U.S. Government Fund (formerly, the Smith Breeden
Intermediate Duration U.S. Government Series). 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 a net
capital loss carryforward of $1,792,811, with $963,255 expiring on March 31,
2004, and $829,556 expiring on March 31, 2005.
F. 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.
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.
10
<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (continued)
1. SIGNIFICANT ACCOUNTING POLICIES -- Continued
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.
2. FINANCIAL INSTRUMENTS
Derivative Financial Instruments Held or Issued for Purposes other than
Trading: Interest rate futures, swap, cap and option contracts are used for
risk management purposes in order to reduce fluctuations in the Fund's net
asset value relative to its targeted option-adjusted duration.
A. Futures Contracts: 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 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.
The Fund had the following open futures contracts as of March 31, 1998:
<TABLE>
<CAPTION>
Number of Expiration Unrealized
Type Contracts Position Month Gain/(Loss)
- ---------------------------- ----------- ---------- ----------------- --------------
<S> <C> <C> <C> <C>
5 Year Treasury ............ 39 Long June, 1998 $ (5,355)
10 Year Treasury ........... 86 Long June, 1998 (59,512)
3 Month Eurodollar ......... 95 Long June, 1998 (6,365)
3 Month Eurodollar ......... (60) Short March, 1999 (143,770)
3 Month Eurodollar ......... 50 Long September, 2001 159,775
----------
Total $ (55,227)
==========
</TABLE>
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.
The aggregate market value of investments pledged to cover margin requirements
for the open positions at March 31, 1998 was $396,802.
B. Interest Rate Swap Contracts: The Fund may enter into over-the-counter
transactions swapping interest rates. Interest rate swaps represent an
agreement between counterparties to exchange cash flows based on the difference
between two interest rates, applied to a notional principal amount for a
specified period. The most common type of interest rate swap involves the
exchange of fixed-rate cash flows for variable-rate cash flows. Interest rate
swaps do not involve the exchange of principal between the parties. The Fund's
interest rate swap contracts have been entered into on a net basis, i.e., the
two payment streams are netted out, with the Fund receiving or paying, as the
case may be, only the net amount of the two payments. As of March 31, 1998, the
Fund had three open interest rate swap contracts. In each of the contracts, the
Fund has agreed to pay a fixed rate and receive a floating rate. The floating
rate on the contracts resets quarterly and is the three month London Inter-Bank
Offered Rate ("LIBOR"). The Fund will not enter into interest rate swap
contracts unless the unsecured commercial paper, unsecured senior debt or the
claims-paying ability of the counterparty is rated either AA or A-1 or better
by Standard & Poor's Corporation, or Aa or P-1 or better by Moody's Investors
Service, Inc. (or is otherwise
11
<PAGE>
SMITH BREEDEN SHORT DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (continued)
2. FINANCIAL INSTRUMENTS -- Continued
acceptable to either agency) at the time of entering into such a transaction.
If the counterparty to the swap transaction defaults, the Fund will be limited
to contractual remedies pursuant to the agreements governing the transaction.
There is no assurance that interest rate swap contract counterparties will be
able to meet their obligations under the swap contracts or that, in the event
of default, the Fund will succeed in pursuing contractual remedies. The Fund
thus assumes the risk that it may be delayed in, or prevented from, receiving
payments owed to it under the swap contracts. Should interest rates move
unexpectedly, the Fund may not achieve the anticipated benefits of the interest
rate swaps, and may realize a loss. The Fund records gains and losses under
interest rate swap contracts as realized gains or losses on investments.
The Fund's interest payable on the interest rate swap contracts as of March 31,
1998 was $33,441, and swap contract interest receivable was $6,410. No
collateral is required under these contracts.
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 caps. The Fund had one interest rate cap contract open at March 31, 1998.
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 reimburse normal business expenses of the
Fund through August 1, 1998 so that total direct and indirect operating
expenses do not exceed 0.78% of its average 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
0.78% through August 1, 1998. For the year ended March 31, 1998, the Advisor
received $727,735 in fees and reimbursed the Fund $231,365.
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 $653,578,765 and
$688,170,564 respectively for the Fund. The cost of the Fund's securities for
federal income tax purposes at March 31, 1998, is $104,798,966. Net unrealized
depreciation of investments, short sales and futures contracts consists of:
<TABLE>
<S> <C>
Gross unrealized appreciation $ 1,838,234
Gross unrealized depreciation (3,040,381)
-------------
Net unrealized depreciation $ (1,202,147)
=============
</TABLE>
12
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders,
Smith Breeden Short Duration U.S. Government Fund of the Smith Breeden Series
Fund:
We have audited the accompanying statements of assets and liabilities,
including the schedule of investments, of the Smith Breeden Short Duration U.S.
Government Fund (formerly "Smith Breeden Short Duration U.S. Government
Series") of the Smith Breeden Series Fund (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 Short Duration U.S. Government Fund of the Smith Breeden Series
Fund 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
13
<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
PERFORMANCE REVIEW
The Smith Breeden Intermediate Duration U.S. Government Fund provided a
total return of 10.65% in the year ending March 31, 1998. By comparison, the
return on the Fund's benchmark, the Salomon Smith Barney Mortgage Index, was
10.92%. The one-year return for the five-year U.S. Treasury Note, which is
comparable in interest rate risk to the Fund, was 10.52%. The return on the
average Government Mortgage mutual fund for the year was 10.15%, as measured by
Morningstar. Over five years, the Fund has returned 7.27%, versus the 5.80%
return on the average Government Mortgage Fund, and the 7.05% return on the
Salomon Smith Barney Mortgage Index. Since the Fund's inception, its return of
8.51% has exceeded that of its benchmark by 0.29% on an annualized basis. The
graph below plots the Fund's return versus its benchmark, which as noted in the
graph, changed effective January 1, 1994. The graph also shows the Fund's
return versus the average return of the Morningstar's Government Mortgage Fund
category.
[GRAPHIC OMITTED]
Interest rates declined in the year, with the five-year U.S. Treasury Note
yield dropping 1.12%, from 6.74% at March 31, 1997 to 5.62% at March 31, 1998.
At the short end of the yield curve, the yield on the six-month U.S. T-Bill
fell from 5.54% to 5.26%, or just 0.28%. This overall flattening in the yield
curve resulted from a combination of economic events. The Federal Government
budget deficit declined, which reduced the U.S. Treasury's need to issue new
debt. The resultant reduction in supply of U.S. Treasury securities helped
drive yields down. Financial turmoil in Asia made U.S. Treasury securities even
more popular as a financial safe-harbor, increasing demand for U.S. Treasury
debt while supply was falling. Meanwhile, the Federal Reserve continued to be
watchful for signs of inflation amid strong economic growth and unemployment at
thirty-year lows, and they maintained their short-term rate at 5.50%. This
placed a floor under short-term rates, preventing a significant decline in
yields on Treasury Bills, and the result was a flatter yield curve.
The Fund's return over the return on comparable-duration U.S. Treasury
Notes was due to three factors:
1) The higher yield offered by mortgage-backed securities as compared to
U.S. Treasury securities,
2) The decline in expectations of future interest rate volatility, and
3) How the fund was positioned within the mortgage sector.
14
<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
Expectations of future interest rate volatility declined in tandem with
the fall in interest rates. Mortgage-backed securities perform best in steady
interest rate environments, and so investors are willing to pay comparatively
more for mortgages when they expect stable interest rates. The decline in
expected interest rate volatility occurred despite some unsettled periods
during the year, especially at the height of the recent Asian crisis. As
long-term interest rates fell below 6.0% at the end of the third quarter of
1997, many mortgage investors braced for an expected surge in prepayments, and
longer-duration mortgages underperformed comparable U.S. Treasury securities.
The benign effect of declining volatility was enough, however, to outweigh the
effect of faster prepayments for the mortgage sector as a whole.
Given the decline in interest rates in the year, we adjusted the level of
prepayment risk to which the Fund was exposed. The weighting of fixed-rate
mortgages, which are more susceptible than adjustable-rate mortgages to poor
performance when prepayments are high, was reduced from 73% of net assets in
March 1997, to 57% of net assets in March 1998. We raised the level of
short-term cash investments in the fund by a comparable amount. The fund's
investment in adjustable-rate mortgages remained steady at about 30% of net
assets. Within the fixed-rate segment of the portfolio, we reduced the range of
coupons from 7.0%-9.5% to 6.0%-7.5%. Higher coupon fixed-rate mortgages see
faster prepayments when interest rates fall significantly as homeowners have
the opportunity to refinance their mortgages at lower rates.
15
<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS MARCH 31, 1998
<TABLE>
<CAPTION>
Market
Face Amount Security Value
- ---------------- ----------------------------------------------------------------------- ----------------
<S> <C> <C>
U.S. GOVERNMENT & AGENCY OBLIGATIONS -- 119.62%
Freddie Mac -- 30.61% (1)
FH Gold
$ 2,000,000 6.00%, due date to be announced ....................................... $ 1,971,017
9,950,001 6.50%, due 2/1/28 to 3/1/28 ........................................... 9,852,906
-------------
11,823,923
-------------
Fannie Mae -- 51.25% (1)
FN
13,129,998 6.50%, due 1/1/28 to 3/1/28 ........................................... 12,986,239
739,097 6.98%, due 6/1/07 ..................................................... 769,228
2,540,268 7.00%, due 1/1/28 to 2/1/28 ........................................... 2,566,380
3,400,000 7.50%, due date to be announced ....................................... 3,486,195
-------------
19,808,042
-------------
Government National Mortgage Association -- 37.55% (1)
GNMA
3,035,275 7.00%, due 3/15/26 to 1/15/28 ......................................... 3,067,892
GNMA ARM
3,029,997 5.00%, due 2/20/28 .................................................... 3,015,425
2,000,000 5.00%, due date to be announced ....................................... 1,989,688
2,986,617 5.50%, due 11/20/27 ................................................... 3,010,007
1,854,871 7.00%, due 3/20/16 to 8/20/18 ......................................... 1,906,272
1,479,719 7.375%, due 6/20/16 to 4/20/22 ........................................ 1,520,438
-------------
14,509,722
-------------
U.S. Treasury Bills -- 0.21%
10,000 5.11%, due 8/20/98 (2) ................................................ 9,801
70,000 5.51%, due 5/28/98 (2) ................................................ 69,440
-------------
79,241
-------------
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS (Cost $46,188,181).......... 46,220,928
-------------
TOTAL INVESTMENTS (Cost $46,188,181)--119.62%.......................... 46,220,928
-------------
Short Sales -- (33.27%)
(13,000,000) FN 6.50%, due date to be announced (3) ................................ (12,855,070)
-------------
(12,855,070)
-------------
Cash and Other Assets Less Liabilities -- 13.65% ...................... 5,276,021
-------------
NET ASSETS -- 100.00% ................................................. $ 38,641,879
=============
</TABLE>
- ---------
(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) Security is held as collateral by Carr Futures, Inc. The interest rate
shown is the discount rate paid at time of purchase.
(3) Short sale represents the sale "against the box" of $13,000,000 FN 6.50%
securities owned by the fund.
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.
16
<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 1998
<TABLE>
<S> <C>
Assets
Investments at market value (identified cost $46,188,181)(Note 1)........................ $ 46,220,928
Receivables: ............................................................................
Subscriptions ......................................................................... 157,910
Interest .............................................................................. 228,512
Securities sold ....................................................................... 20,849,757
Due from Advisor (Note 3) ............................................................. 1,021
Other assets ............................................................................ 5,479
------------
Total Assets .......................................................................... 67,463,607
------------
Liabilities
Bank overdraft .......................................................................... 458,254
Short sales at market value (proceeds $12,874,063)....................................... 12,855,070
Payables:
Variation margin on futures contracts (Note 2) ........................................ 5,623
Securities purchased .................................................................. 15,429,655
Redemptions ........................................................................... 32,575
Distributions ......................................................................... 4,236
Accrued expenses ........................................................................ 36,315
------------
Total Liabilities ..................................................................... 28,821,728
------------
Net Assets
(Applicable to outstanding shares of 3,865,492; unlimited number of shares of beneficial
interest authorized; no stated par) ................................................... $ 38,641,879
============
Net asset value, offering price and redemption price per share ($38,641,879 / 3,865,492) $ 10.00
============
Source of Net Assets
Paid in capital ......................................................................... $ 38,590,422
Overdistributed net investment income ................................................... (134,448)
Accumulated net realized gains on investments ........................................... 123,366
Net unrealized appreciation of investments .............................................. 62,539
------------
Net Assets ........................................................................... $ 38,641,879
============
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
17
<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1998
<TABLE>
<S> <C>
Investment Income
Interest and discount earned, net of premium amortization (Note 1) ...... $2,516,399
Expenses
Advisory fees (Note 3) .................................................. 271,230
Accounting and pricing services fees .................................... 39,913
Custodian fees .......................................................... 15,432
Audit & tax preparation fees ............................................ 19,794
Legal fees .............................................................. 18,482
Transfer agent fees ..................................................... 30,564
Registration fees ....................................................... 12,333
Trustees fees and expenses .............................................. 18,125
Insurance ............................................................... 10,881
Other ................................................................... 2,056
----------
Total Expenses Before Reimbursement ................................... 438,810
Expenses reimbursed by Advisor (Note 3) ............................... (97,835)
----------
Net Expenses .......................................................... 340,975
----------
Net Investment Income ................................................. 2,175,424
----------
Realized and Unrealized Gain (Loss) on Investments
Net realized gain on investments ........................................ 1,835,038
Change in unrealized appreciation (depreciation) of investments ......... (73,907)
----------
Net realized and unrealized gain on investments ......................... 1,761,131
----------
Net increase in net assets resulting from operations .................... $3,936,555
==========
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
18
<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Ended Year Ended
March 31, 1998 March 31, 1997
---------------- ---------------
<S> <C> <C>
Operations
Net investment income .................................................... $ 2,175,424 $ 2,303,301
Net realized (loss) gain on investments .................................. 1,835,038 (82,705)
Change in unrealized appreciation (depreciation) of investments .......... (73,907) (93,993)
------------- ------------
Net increase in net assets resulting from operations ..................... 3,936,555 2,126,603
------------- ------------
Distributions to Shareholders
Dividends from net investment income ..................................... (2,175,424) (2,260,030)
Dividends in excess of net investment income ............................. (10,140) --
Distributions from net realized gains on investments ..................... (880,968) (943,662)
------------- ------------
Total distributions ...................................................... (3,066,532) (3,203,692)
------------- ------------
Capital Share Transactions
Shares sold .............................................................. 34,884,833 1,730,791
Shares issued on reinvestment of distributions ........................... 1,570,705 935,335
Shares redeemed .......................................................... (36,419,207) (300,452)
------------- ------------
Increase in net assets resulting from capital share transactions (a) ..... 36,331 2,365,674
------------- ------------
Total Increase in Net Assets ........................................... 906,354 1,288,585
Net Assets
Beginning of period ...................................................... 37,735,525 36,446,940
------------- ------------
End of period ............................................................ $ 38,641,879 $ 37,735,525
============= ============
(a) Transactions in capital shares were as follows:
Shares sold ............................................................. 3,494,156 174,344
Shares issued on reinvestment of distributions .......................... 157,456 94,439
Shares redeemed ......................................................... (3,664,130) (30,101)
------------- ------------
Net increase (decrease) ................................................. (12,518) 238,682
Beginning balance ....................................................... 3,878,010 3,639,328
------------- ------------
Ending balance .......................................................... 3,865,492 3,878,010
============= ============
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
19
<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
The following average per share data, ratios and supplemental information
have been derived from information provided in the financial statements.
<TABLE>
<CAPTION>
Year Year
Ended Ended
March 31, March 31,
1998 1997
--------------- ---------------
<S> <C> <C>
Net Asset Value, Beginning
of Period ......................... $ 9.73 $ 10.01
---------- ----------
INCOME FROM INVESTMENT
OPERATIONS
Net investment income ............. 0.590 0.599
Net realized and unrealized
(loss) gain on
investments ..................... 0.419 ( 0.024)
----------- -----------
Total from investment
operations ..................... 1.009 0.575
----------- -----------
LESS DISTRIBUTIONS
Dividends from net
investment income ............... ( 0.561) ( 0.604)
Dividends in excess of net
investment income ............... -- --
Distributions from net
realized gains on
investments ..................... ( 0.178) ( 0.251)
Distributions in excess of
net realized gains on
investments ..................... -- --
----------- -----------
Total distributions ............. ( 0.739) ( 0.855)
Net Asset Value, End of
Period ............................ $ 10.00 $ 9.73
----------- -----------
Total Return ....................... 10.65% 5.92%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period ......... $38,641,879 $37,735,525
Ratio of expenses to
average net assets (2) .......... 0.88% 0.88%
Ratio of net investment
income to average net
assets .......................... 5.61% 6.19%
Portfolio turnover rate ........... 583% 409%
Ratio of expenses to
average net assets
before reimbursement of
expenses by the Advisor 1.13% 1.16%
Ratio of net investment
income to average net
assets before
reimbursement of
expenses by the Advisor 5.36% 5.92%
<CAPTION>
For the period
Year Year Year March 31,
Ended Ended Ended 1992 (1)
March 31, March 31, March 31, to March 31,
1996 1995 1994 1993
---------------- ---------------- --------------- ---------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning
of Period ......................... $ 9.83 $ 10.01 $ 10.62 $ 10.00
----------- ----------- ---------- ----------
INCOME FROM INVESTMENT
OPERATIONS
Net investment income ............. 0.660 0.664 1.050 0.826
Net realized and unrealized
(loss) gain on
investments ..................... 0.277 ( 0.049) ( 0.601) 0.621
------------ ------------ ----------- -----------
Total from investment
operations ..................... 0.937 0.615 0.449 1.447
------------ ------------ ----------- -----------
LESS DISTRIBUTIONS
Dividends from net
investment income ............... ( 0.656) ( 0.664) ( 1.044) ( 0.826)
Dividends in excess of net
investment income ............... -- ( 0.108) -- --
Distributions from net
realized gains on
investments ..................... ( 0.101) -- ( 0.015) --
Distributions in excess of
net realized gains on
investments ..................... -- ( 0.022) -- --
------------ ------------ ----------- -----------
Total distributions ............. ( 0.757) ( 0.794) ( 1.059) ( 0.826)
Net Asset Value, End of
Period ............................ $ 10.01 $ 9.83 $ 10.01 $ 10.62
------------ ------------ ----------- -----------
Total Return ....................... 9.69% 6.10% 4.11% 14.93%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period ......... $ 36,446,940 $ 34,797,496 $ 6,779,666 $ 2,923,913
Ratio of expenses to
average net assets (2) .......... 0.90% 0.90% 0.90% 0.82%
Ratio of net investment
income to average net
assets .......................... 6.49% 6.20% 7.74% 8.18%
Portfolio turnover rate ........... 193% 557% 84% 42%
Ratio of expenses to
average net assets
before reimbursement of
expenses by the Advisor 1.14% 2.33% 2.34% 17.52%
Ratio of net investment
income to average net
assets before
reimbursement of
expenses by the Advisor 6.26% 4.77% 6.30% -8.52%
</TABLE>
- ---------
(1) Commencement of operations.
(2) Through August 1, 1994, expense ratios include both the direct expenses of
the Intermediate Duration U.S. Government Fund, and the indirect expenses
incurred through the Fund's investment in the Smith Breeden Institutional
Intermediate Duration U.S. Government Fund.
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
20
<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Breeden Series Fund (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 Short
Duration U.S. Government Fund (formerly the Smith Breeden Short Duration U.S.
Government Series) and the Smith Breeden Intermediate Duration U.S. Government
Fund (the "Fund", formerly, the Smith Breeden Intermediate Duration U.S.
Government Series). 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
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.
21
<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (continued)
1. SIGNIFICANT ACCOUNTING POLICIES -- Continued
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.
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.
The Fund had the following open futures contracts as of March 31, 1998:
<TABLE>
<CAPTION>
Number of Expiration Unrealized
Type Contracts Position Month Gain/(Loss)
- -------------------------- ----------- ---------- ------------ ------------
<S> <C> <C> <C> <C>
5 Year Treasury .......... 190 Long June, 1998 $ (4,960)
10 Year Treasury ......... (240) Short June, 1998 15,759
---------
Total $ 10,799
=========
</TABLE>
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.
The aggregate market value of investments pledged to cover margin requirements
for the open positions at March 31, 1998 was $79,241.
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 other expenses
of the Fund (excluding advisory fees and litigation, indemnification and other
extraordinary expenses) 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 $271,230 and reimbursed the Fund $97,835.
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
22
<PAGE>
SMITH BREEDEN INTERMEDIATE DURATION U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (continued)
3. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES -- Continued
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 $211,174,973 and
$216,659,693, respectively. The purchases and proceeds shown above do not
include dollar roll agreements which are considered borrowings by the Fund. The
cost of securities for federal income tax purposes is $46,188,181. Net
unrealized appreciation of investments, short sales and futures contracts
consist of:
<TABLE>
<S> <C>
Gross unrealized appreciation ........ $ 151,962
Gross unrealized depreciation ........ (89,423)
---------
Net unrealized appreciation .......... $ 62,539
=========
</TABLE>
23
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders,
Smith Breeden Intermediate Duration U.S. Government Fund of the Smith Breeden
Series Fund:
We have audited the accompanying statements of assets and liabilities,
including the schedule of investments, of the Smith Breeden Intermediate
Duration U.S. Government Fund (formerly "Smith Breeden Intermediate Duration
U.S. Government Series") of the Smith Breeden Series Fund (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 Intermediate Duration U.S. Government Fund of the Smith Breeden
Series Fund 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
24
<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.
[GRAPHIC OMITTED]
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>
SMITH BREEDEN EQUITY MARKET PLUS FUND
- --------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS MARCH 31, 1998
<TABLE>
<CAPTION>
Market
Face Amount Security Value
- -------------- ------------------------------------------------------ --------------
<S> <C> <C>
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>
SMITH BREEDEN EQUITY MARKET PLUS FUND
- --------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS (continued) MARCH 31, 1998
<TABLE>
<CAPTION>
Market
Contracts Security Value
- -------------- ----------------------------------------------------------------------- ----------------
<S> <C> <C>
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
=============
</TABLE>
- ---------
(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.
28
<PAGE>
SMITH BREEDEN EQUITY MARKET PLUS FUND
- --------------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 1998
<TABLE>
<S> <C>
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
==============
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
29
<PAGE>
SMITH BREEDEN EQUITY MARKET PLUS FUND
- --------------------------------------------------------------------------------
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1998
<TABLE>
<S> <C>
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
===========
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
30
<PAGE>
SMITH BREEDEN EQUITY MARKET PLUS FUND
- --------------------------------------------------------------------------------
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Ended Year Ended
March 31, 1998 March 31, 1997
---------------- ---------------
<S> <C> <C>
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
============= ============
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
31
<PAGE>
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.
<TABLE>
<CAPTION>
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)
---------------- --------------- -------------- -------------- -------------- ------------
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning
of Period ..................... $ 12.56 $ 12.27 $ 10.84 $ 9.88 $ 10.85 $ 10.00
----------- ---------- --------- --------- --------- -------
INCOME FROM INVESTMENT
OPERATIONS
Net investment income ......... 0.591 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%*
</TABLE>
- ---------
(1) Commenced operations June 30, 1992.
* Annualized
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
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.
The Fund had the following open futures contracts as of March 31, 1998:
<TABLE>
<CAPTION>
Number of Expiration Unrealized
Type Contracts Position Month Gain/(Loss)
- ---------------------------- ----------- ---------- ----------------- --------------
<S> <C> <C> <C> <C>
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>
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:
<TABLE>
<CAPTION>
Number of Expiration Unrealized
Type Contracts Position Month Gain
- ----------------- ----------- ---------- ----------------- --------------
<S> <C> <C> <C> <C>
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:
<TABLE>
<S> <C>
Gross unrealized appreciation $ 10,045,826
Gross unrealized depreciation (960,545)
------------
Net unrealized depreciation $ 9,085,281
============
</TABLE>
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.
[GRAPHIC OMITTED]
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>
SMITH BREEDEN FINANCIAL SERVICES FUND
- --------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS MARCH 31, 1998
<TABLE>
<CAPTION>
Market
Shares Security Value
- ------------- --------------------------------------------------------- ------------
<S> <C> <C>
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
==========
</TABLE>
- ---------
(1) Non-income producing security
(2) Limited partnership units
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
39
<PAGE>
SMITH BREEDEN FINANCIAL SERVICES FUND
- --------------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 1998
<TABLE>
<S> <C>
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
===========
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
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)
<TABLE>
<S> <C>
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
=========
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
41
<PAGE>
SMITH BREEDEN FINANCIAL SERVICES FUND
- --------------------------------------------------------------------------------
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Period Ended
March 31, 1998(1)
Operations ------------------
<S> <C>
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
===========
</TABLE>
- ---------
(1) Commenced operations on December 22, 1997.
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
42
<PAGE>
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.
<TABLE>
<CAPTION>
Period Ended
March 31, 1998 (1)
-------------------
<S> <C>
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
</TABLE>
- ---------
(1) Commenced operations on December 22, 1997.
* Annualized
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
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.
The Fund had the following open futures contracts as of March 31, 1998:
<TABLE>
<CAPTION>
Number of Expiration Unrealized
Type Contracts Position Month Gain/(Loss)
- ----------------- ----------- ---------- ------------ ------------
<S> <C> <C> <C> <C>
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:
<TABLE>
<S> <C>
Gross unrealized appreciation ........ $ 693,282
Gross unrealized depreciation ........ (14,488)
---------
Net unrealized appreciation .......... $ 678,794
=========
</TABLE>
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
<PAGE>
<PAGE>
BOARD OF TRUSTEES
Douglas T. Breeden
Michael J. Giarla
Stephen M. Schaefer
Myron S. Scholes
William F. Sharpe
OFFICERS
Chairman
Douglas T. Breeden
President
Michael J. Giarla
Vice Presidents
Daniel C. Dektar (Smith Breeden Series Fund)
Timothy D. Rowe (Smith Breeden Series Fund)
John B. Sprow (Smith Breeden Trust)
Robert B. Perry (Smith Breeden Trust)
Treasurer and Secretary
Marianthe S. Mewkill
INVESTMENT ADVISOR
Smith Breeden Associates, Inc.
100 Europa Drive, Suite 200
Chapel Hill, NC 27514
TRANSFER AND DIVIDEND PAYING AGENT
First Data Investor Services Group, Inc.
3200 Horizon Drive
PO Box 61503
King of Prussia, PA 19406-0903
DISTRIBUTOR
FPS Broker Services, Inc.
3200 Horizon Drive
PO Box 61503
King of Prussia, PA 19406-0903
CUSTODIAN
Bank of New York
48 Wall Street
New York, NY 10286
INDEPENDENT AUDITORS
Deloitte & Touche LLP
117 Campus Drive
Princeton, NJ 08540
For information about:
o Establishing an account
o Account procedures and status
o Exchanges
Call 1-800-221-3137
For all other information about the Funds:
Call 1-800-221-3138
<PAGE>
<TABLE>
[GRAPHIC OMITTED]
<S> <C>
U.S. POSTAGE
PAID
CHARLOTTE, NC
BULK RATE
PERMIT NO. 136
100 EUROPA DRIVE
SUITE 200
CHAPEL HILL, N.C. 27514
</TABLE>
SMITH BREEDEN TRUST
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 for the Smith Breeden U.S.
Equity Market Plus Fund and the
Smith Breeden Financial Services
Fund; amendment thereto filed herein
to establish the Smith Breeden High
Yield Bond Fund, the Smith Breeden
Asia/Pacific Fund, and the Smith
Breeden Europe Fund
(2) By-Laws: Incorporated by Reference
(3) Voting Trust Agreement: Not Applicable
(4) Specimen Share Certificate: Not
Applicable
(5) Form of Investment Advisory Agreement for Smith
Breeden Trust: Incorporated by
Reference for the Smith Breeden U.S.
Equity Market Plus Fund and the
Smith Breeden Financial Services
Fund; filed herein for each of the
Smith Breeden High Yield Bond Fund,
the Smith Breeden Asia/Pacific Fund,
and the Smith Breeden Europe Fund
(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)(b)Accounting and Shareholder Services Agreement:
Incorporated by Reference for the
Smith Breeden U.S. Equity Market Plus
Fund and the Smith Breeden Financial
Services Fund; to be filed by amendment
hereto for each of the Smith Breeden
High Yield Bond Fund, the Smith Breeden
Asia/Pacific Fund, and the Smith
Breeden Europe Fund
(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
for the Smith Breeden U.S. Equity
Market Plus Fund and the Smith Breeden
Financial Services Fund; filed herein
for each of the Smith Breeden High
Yield Bond Fund, the Smith Breeden
Asia/Pacific Fund, and the Smith
Breeden Europe Fund
(16) Performance Calculation: Not Applicable
(17) Financial Data Schedule
(18) 18f-3 Multiclass Plan: Not Applicable
Item 25. Persons Controlled by or under Common
Control with Registrant.
As of 7/15/98, there were no persons controlled by
or under common control with any of the Smith Breeden
U.S. Equity Market Plus Fund, the Smith Breeden High
Yield Bond Fund, the Smith Breeden Asia/Pacific Fund,
or the Smith Europe Fund. Smith Breeden Associates,
Inc. of Chapel Hill, North Carolina may be deemed to
control the Smith Breeden Financial Services Fund by
virtue of owning 70.89% of the outstanding shares of the
Fund as of 7/15/98.
Item 26. Number of Holders of Securities.
NUMBER OF RECORD HOLDERS
TITLE OF CLASS AS OF JULY 15, 1998
Smith Breeden U.S.
Equity Market Plus Fund 6,365
Smith Breeden Financial
Services Fund 235
As of July 15, 1998, there were no holders of
securities in any of the Smith Breeden High Yield
Bond Fund, the Smith Breeden Asia/Pacific Fund, or
the Smith Breeden Europe Fund.
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 Funds"
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:
Bjurman Funds
Focus Trust, Inc.
The Govett Funds, 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
Smith Breeden Series Fund
Smith Breeden Trust
The Sports Funds 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 None
3200 Horizon Drive and President
P.O. Box 61503
King of Prussia, PA
19406-0903
Lynne M. Cannon Vice President None
3200 Horizon Drive and Principal
P.O. Box 61503
King of Prussia, PA
19406-0903
Rocco C. Cavalieri Director None
3200 Horizon Drive and Vice President
P.O Box 61503
King of Prussia, PA
19406-0903
Gerald J. Holland Director, Senior None
3200 Horizon Drive Vice President
P.O. Box 61503 and Principal
King of Prussia, PA
19406-0903
Sandra L. Adams Assistant None
3200 Horizon Drive Vice President
P.O. Box 61503 and Principal
King of Prussia, PA
19406-0903
John H. Leven Treasurer None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA
19406-0903
Carolyn F. Mead, Esq. 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 FinDaTex, 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) First Data Investor 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 31st
day of July, 1998.
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, Principal July 31, 1998
Executive Officer,
and Trustee
Douglas T. Breeden* Trustee July 31, 1998
Stephen M. Schaefer* Trustee July 31, 1998
Myron S. Scholes* Trustee July 31, 1998
William F. Sharpe* Trustee July 31, 1998
Marianthe S. Mewkill Principal Financial July 31, 1998
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. 15 to Registration
Statement No. 33-44909 of our reports dated May 15, 1998 relating to the
Smith Breeden U.S. Equity Market Plus Fund (formerly known as Smith Breeden
Equity Market Plus Fund) and Smith Breeden Financial Services Fund of Smith
Breeden Trust and Smith Breeden Short Duration U.S. Government Fund and
Smith Breeden Intermediate Duration U.S. Government Fund of Smith Breeden
Series Fund appearing in the Statement of Additional Information, which is
a part of such Registration Statement and to the references to us under the
captions "Experts" appearing in the Statement of Additional Information and
"Financial Highlights" appearing in the Prospectus, which also is a part of
such Registration Statement.
DELOITTE & TOUCHE LLP
Princeton, New Jersey
July 31, 1998
<TABLE> <S> <C>
<ARTICLE> 6
<SERIES>
<NUMBER> 1
<NAME> SMITH BREEDEN EQUITY MARKET PLUS FUND
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-END> MAR-31-1998
<INVESTMENTS-AT-COST> 108825137
<INVESTMENTS-AT-VALUE> 108648360
<RECEIVABLES> 13513115
<ASSETS-OTHER> 61130012
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 183291487
<PAYABLE-FOR-SECURITIES> 46395547
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 228501
<TOTAL-LIABILITIES> 46624078
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 119446947
<SHARES-COMMON-STOCK> 8107634
<SHARES-COMMON-PRIOR> 1075509
<ACCUMULATED-NII-CURRENT> 312398
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 7822813
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 9085281
<NET-ASSETS> 136667439
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 3442654
<OTHER-INCOME> 0
<EXPENSES-NET> 532659
<NET-INVESTMENT-INCOME> 2909995
<REALIZED-GAINS-CURRENT> 9514596
<APPREC-INCREASE-CURRENT> 9573592
<NET-CHANGE-FROM-OPS> 21998183
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 2632273
<DISTRIBUTIONS-OF-GAINS> 2556880
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 123373056
<NUMBER-OF-SHARES-REDEEMED> 21939416
<SHARES-REINVESTED> 4918950
<NET-CHANGE-IN-ASSETS> 123160062
<ACCUMULATED-NII-PRIOR> 36234
<ACCUMULATED-GAINS-PRIOR> 865097
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 423706
<INTEREST-EXPENSE> 1558
<GROSS-EXPENSE> 747708
<AVERAGE-NET-ASSETS> 31886289
<PER-SHARE-NAV-BEGIN> 12.560
<PER-SHARE-NII> 0.591
<PER-SHARE-GAIN-APPREC> 4.940
<PER-SHARE-DIVIDEND> 0.586
<PER-SHARE-DISTRIBUTIONS> 0.645
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 16.86
<EXPENSE-RATIO> 0.88
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
SMITH BREEDEN TRUST
(the "Trust")
Amendment No. 4
to
Agreement and Declaration of Trust
The undersigned, being at least a majority of the Trustees of the
Smith Breeden Trust, hereby amend the Agreement and Declaration
of Trust by deleting therefrom the entire sentence included in
(a) of Section 5.11, and substituting therefore the following:
"Without limiting the authority of the Trustees set
forth in Section 5.1, inter alia, to establish and
designate any further series or classes or to modify
the rights and preferences of any series, the "Smith
Breeden U.S. Equity Market Plus Fund", the "Smith
Breeden Financial Services Fund", the "Smith Breeden
High Yield Bond Fund", the "Smith Breeden Asia/Pacific
Fund", and the "Smith Breeden Europe Fund" shall be,
and are hereby, established and designated."
WITNESS our hands set hereto as of this twenty-ninth day of
June, 1998.
June 29, 1998
Douglas T. Breeden
June 29, 1998
Michael J. Giarla
June 29, 1998
Stephen M. Schaefer
June 29, 1998
Myron S. Scholes
June 29, 1998
William F. Sharpe
<TABLE> <S> <C>
<ARTICLE> 6
<SERIES>
<NUMBER> 2
<NAME> SMITH BREEDEN FINANCIAL SERVICES FUND
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-END> MAR-31-1998
<INVESTMENTS-AT-COST> 6518572
<INVESTMENTS-AT-VALUE> 7197881
<RECEIVABLES> 87081
<ASSETS-OTHER> 47796
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 7332758
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 16042
<TOTAL-LIABILITIES> 16042
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 6575099
<SHARES-COMMON-STOCK> 727608
<SHARES-COMMON-PRIOR> 0
<ACCUMULATED-NII-CURRENT> 12416
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 50407
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 678994
<NET-ASSETS> 7316716
<DIVIDEND-INCOME> 27982
<INTEREST-INCOME> 7585
<OTHER-INCOME> 35567
<EXPENSES-NET> 23152
<NET-INVESTMENT-INCOME> 47982
<REALIZED-GAINS-CURRENT> 50408
<APPREC-INCREASE-CURRENT> 678794
<NET-CHANGE-FROM-OPS> 777184
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 0
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 729112
<NUMBER-OF-SHARES-REDEEMED> 1504
<SHARES-REINVESTED> 0
<NET-CHANGE-IN-ASSETS> 7316716
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 23152
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 50017
<AVERAGE-NET-ASSETS> 5760913
<PER-SHARE-NAV-BEGIN> 9.000
<PER-SHARE-NII> 0.017
<PER-SHARE-GAIN-APPREC> 1.043
<PER-SHARE-DIVIDEND> 0
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 10.06
<EXPENSE-RATIO> 1.48
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
INVESTMENT ADVISORY AGREEMENT
Between
SMITH BREEDEN TRUST
on behalf of the Smith Breeden High Yield Bond Fund
and
SMITH BREEDEN ASSOCIATES, INC.
INVESTMENT ADVISORY AGREEMENT dated June 29, 1998
between SMITH BREEDEN TRUST, a Massachusetts trust ("the
Trust"), on behalf of its Smith Breeden High Yield Bond Fund
series (the "Portfolio"), and SMITH BREEDEN ASSOCIATES,
INC., a corporation organized and existing under the laws of
the State of Kansas (hereinafter called the "Manager").
W I T N E S S E T H:
Whereas, the Portfolio is engaged in business as an
open-end management investment company and has registered as
such under the federal Investment Company Act of 1940, as
amended (the "Act");
WHEREAS, the Manager is engaged principally in the
business of rendering investment management and
administrative services and is registered as an investment
adviser under the federal investment Advisers Act of 1940,
as amended; and
WHEREAS, the Portfolio wishes to engage the Manager to
provide certain investment management and administrative
services, and the Manager is willing to provide such
services, all on the terms and conditions hereinafter set
forth.
NOW, THEREFORE, in consideration of the premises and
the mutual promises hereinafter set forth, the parties
hereto agree as follows:
1. Duties and Responsibilities of Manager.
A. Investment Advisory Services. The Manager shall
act as investment adviser to and shall supervise
and direct the investments of the Portfolio in
accordance with the Portfolio's investment
objectives, program and restrictions as provided
in the Portfolio's then current Registration
Statement under the Act, and such other directions
or limitations as the Portfolio may impose by
notice in writing to the Manager. The Manager
shall obtain and evaluate such information
relating to the economy, industries, businesses,
securities markets and securities as it may deem
necessary or useful in the discharge of its
obligations hereunder and shall formulate and
implement a continuing program for the management
of the assets and resources of the Portfolio in a
manner consistent with its investment objective.
The Manager shall for all purposes be deemed to be
an independent contractor and shall, except as
expressly provided or authorized (whether herein
or otherwise), have no authority to act for or
represent the Portfolio in any way or otherwise be
deemed an agent of the Portfolio.
In furtherance of its duties hereunder, the
Manager is authorized, in its discretion and
without prior consultation with the Portfolio, to:
(i) buy, sell, exchange, convert, lend, and
otherwise trade in any stocks, bonds, and
other securities; financial, stock, and stock
index futures and options; swap contracts or
other assets; and
(ii) directly place orders and negotiate the
commissions (if any) for the execution of
transactions in securities, financial
futures, swap contracts or other assets with
or through such brokers, dealers,
underwriters or issuers as the Manager may
select.
B. Administrative Services. Subject to the overall
authority of the Board of Trustees of the
Portfolio, the Manager shall provide general
administrative services and oversee the operation
of the Portfolio ("Administrative Services").
Such Administrative Services shall not include
investment advisory, custodial, underwriting and
distribution, transfer agency, shareholder or
accounting services, or the preparation and filing
of the Portfolio's tax returns, but shall include,
without limitation:
(i) the provision of office space and equipment
necessary in connection with the maintenance
of the headquarters of the Portfolio;
(ii) the maintenance of the books and records of
the Portfolio, and making arrangements for
the meetings of the Trustees of the Portfolio
including the preparation of agendas and
supporting materials therefore;
(iii) the preparation of communications and
reports to investors in the Portfolio and
making arrangements for meetings of such
investors;
(iv) the preparation and filing of all required
reports and all updating and other amendments
to the Portfolio's registration statement
under the Act and the rules and regulations
thereunder;
(v) the periodic computation and, as necessary,
reporting to the Trustees of the Portfolio of
the Portfolio's compliance with its
investment objective and policies with the
Portfolio diversification and other Portfolio
requirements of the Act and, to the extent
required, the Internal Revenue Code; and
(vi) the negotiation of agreements or other
arrangements with, and general oversight and
coordination of the activities of, agents and
others retained by the Portfolio to provide
custodial, net asset value computation,
Portfolio accounting, legal, tax and
accounting services.
It is understood that the Manager may, in its
discretion and at its expense, delegate some or
all of its administrative duties and
responsibilities under this Paragraph 1.B. to any
person provided that the Manager gives prior
notice to the Portfolio.
C. Reports to Portfolio. The Manager shall furnish
to or place at the disposal of the Portfolio such
information, reports, evaluations, analyses and
opinions relating to the Manager and its
investment management of the Portfolio's portfolio
securities as the Portfolio may, at any time or
from time to time, reasonably request or as the
Manager may deem helpful.
D. Reports and Other Communications to Investors.
The Manager shall assist the Portfolio in
providing communications to investors as may
reasonably be necessary.
E. Portfolio Personnel. The Manager will permit
individuals who are officers or employees of the
Manager to serve (if duly elected or appointed) as
officers, trustees, members of any committee of
trustees, members of any advisory board, or
members of any other committee of the Portfolio,
without remuneration or other cost to the
Portfolio.
F. Personnel, Office Space, and Facilities of
Manager. The Manager at its own expense shall
furnish or provide and pay the cost of such office
space, office equipment, office personnel, and
office services as the Manager requires in the
performance of its investment advisory,
administrative and other obligations under this
Agreement.
2. Allocation of Expenses.
A. Expenses Paid by Manager.
(i) Expenses Paid by Manager. The Manager shall
pay all salaries, expenses, and fees of the
officers and trustees of the Portfolio who
are employees of the Manager. The Manager is
not obligated to bear any other expenses
incidental to the operations and business of
the Portfolio.
(ii) Assumption of Expenses by Manager. The
payment or assumption by the Manager of any
expense of the Portfolio that the Manager is
not required by this Agreement to pay or
assume shall not obligate the Manager to pay
or assume the same or any similar expense on
any subsequent occasion.
B. Expenses Paid by Portfolio. The Portfolio shall
bear all expenses of its organization, operations,
and business not specifically assumed or agreed to
be paid by the Manager as provided in this
Agreement. In particular, but without limiting
the generality of the foregoing, the Portfolio
shall pay:
(i) Management Fees. the fees of the Manager as
provided in paragraph 3 below;
(ii) Custody and Accounting Services. All
expenses of the transfer, receipt,
safekeeping, servicing and accounting for the
cash, securities, and other property of the
Portfolio, including all charges of
depositories, custodians, and other agents,
if any;
(iii) Investor Servicing. All expenses of
establishing, maintaining and servicing
investor accounts, including all charges of
agents for account transfers, account record
keeping, and account distribution or
disbursement;
(iv) Distribution and Service Fees. The fees, if
any, payable pursuant to any plan heretofore
or hereafter adopted by the Portfolio
pursuant to Rule 12b-1 under the Act;
(v) Investor Meetings. All expenses incidental
to holding meetings of the Portfolio's
investors;
(vi) Pricing. All expenses of computing the
Portfolio's net asset value, including the
cost of any equipment or services used for
obtaining price quotations and the fees of
any independent pricing service authorized by
the Trustees of the Portfolio;
(vii) Communication Equipment. All charges
for equipment or services used for
communication between the Manager or the
Portfolio and the custodian, transfer agent
or any other agent selected by the Portfolio;
(viii) Legal, Accounting, and Tax Preparation
Fees and Expenses. All charges for services
and expenses of the Portfolio's legal counsel
and independent auditors;
(ix) Trustees' Fees and Expenses. All
compensation of Trustees of the Portfolio,
other than those who are interested persons
of the Portfolio, and all expenses (including
fees and disbursements of their legal
counsel) incurred in connection with their
service;
(x) Federal Registration Fees. All fees and
expenses of registering and maintaining the
registration of the Portfolio under the Act,
including all fees and expenses incurred in
connection with the preparation and filing of
any registration statement under the Act, and
any amendments or supplements that may be
made from time to time;
(xi) Bonding and Insurance. All expenses of bond,
liability, and other insurance coverage
required by law or deemed advisable by the
Trustees of the Portfolio;
(xii) Brokerage Commissions. All brokers'
commissions and other charges incident to the
purchase, sale, or lending of the Portfolio's
portfolio securities;
(xiii) Interest and Taxes. Interest on
borrowed money and all taxes or governmental
fees payable by or with respect to the
Portfolio to federal, state, or other
governmental agencies, domestic or foreign,
including stamp or other transfer taxes;
(xiv) Trade Association Fees. All fees, dues,
and other expenses incurred in connection
with the membership of the Portfolio in the
Investment Company Institute or any other
trade association or other investment
organization; and
(xv) Nonrecurring and Extraordinary Expenses.
Such nonrecurring expenses as may arise,
including the costs of actions, suits, or
proceedings to which the Portfolio is a party
and the expenses that the Portfolio may incur
as a result of its legal obligation to
provide indemnification to its officers,
trustees, employees and agents.
3. Management Fees. The Portfolio shall pay the Manager a
fee at an annual rate computed as follows based on the
value of the net assets of the Portfolio.
A. Method of Computation. The fee shall be accrued
for each calendar day and the sum of the daily fee
accruals shall be paid monthly to the Manager on
the first business day of the next succeeding
calendar month. The daily fee accruals will be
computed by multiplying the fraction of one over
the number of calendar days in the year by 0.70%,
and multiplying the resulting product by the net
assets of the Portfolio as determined in
accordance with the Portfolio's Registration
Statement under the Act as of the close of
business on the previous business day on which the
Portfolio was open for business.
B. Proration of Fee. If this Agreement becomes
effective or terminates before the end of any
calendar month, the fee for the period from the
effective date to the end of such calendar month
or from the beginning of such calendar month to
the date of termination, as the case may be, shall
be prorated according to the proportion which such
period bears to the full month in which such
effectiveness or termination occurs.
4. Limitation of Portfolio's Normal Business Expenses. In
the event that expenses of the Portfolio for any fiscal year
(not including any distribution expenses paid by the
Portfolio pursuant to any distribution plan) should exceed
the expense limitation on investment company expenses
enforced by any statute or regulatory authority of any
jurisdiction in which shares of the Trust are qualified for
offer and sale, the compensation due the Manager for such
fiscal year shall be reduced by the amount of such excess by
a reduction or refund thereof. In the event that the
expenses of the Portfolio exceed any expense limitation
which the Manager may, by written notice to the Trust,
voluntarily declare to be effective with respect to the
Portfolio, subject to such terms and conditions as the
Manager may prescribe in such notice, the compensation due
the Manager shall be reduced, and, if necessary, the Manager
shall bear the Portfolio's expenses to the extent required
by such expense limitation.
5. Brokerage. In the selection of brokers or dealers and
the placing of orders for the purchase and sale of portfolio
investments for the Portfolio, the Manager shall seek to
obtain the most favorable price and execution available,
except to the extent it may be permitted to pay higher
brokerage commissions for brokerage and research services as
described below. In using its best efforts to obtain for
the Portfolio the most favorable price and execution
available, the Manager, bearing in mind the Portfolio 's
best interests at all times, shall consider all factors it
deems relevant, including, by way of illustration, price,
the size of the transaction, the nature of the market for
the security, 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 or dealer involved and the quality of service
rendered by the broker or dealer in other transactions.
Subject to such policies as the Trustees may determine, the
Manager shall not be deemed to have acted unlawfully or to
have breached any duty created by this Contract or otherwise
solely by reason of its having caused the Trust to pay, on
behalf of the Portfolio, a broker or dealer that provides
brokerage and research services to the Manager an amount of
commission for effecting a portfolio investment transaction
in excess of the amount of commission another broker or
dealer would have charged for effecting that transaction, if
the Manager determines in good faith that such amount of
commission was reasonable in relation to the value of the
brokerage and research services provided by such broker or
dealer, viewed in terms of either that particular
transaction or the Manager's overall responsibilities with
respect to the Portfolio and to other clients of the
Manager as to which the Manager exercises investment
discretion. The Trust hereby agrees with the Manager that
any entity or person associated with the Manager which is a
member of a national securities exchange is authorized to
effect any transaction on such exchange for the account of
the Portfolio which is permitted by Section 11(a) of the
Securities Exchange Act of 1934 and Rule 11a-2-2(T)
thereunder, and the Trust hereby consents to the retention
of compensation for such transactions in accordance with
Rule 11a2-2(T)(2)(iv).
6. Manager's Use of the Services of Others. The Manager
may (at its cost except as contemplated by Paragraph 5
of this Agreement) employ, retain or otherwise avail
itself of the services or facilities of other persons
or organizations for the purpose of providing the
Manager or the Portfolio with such statistical and
other factual information, such advice regarding
economic factors and trends, such advice as to
occasional transactions in specific securities or such
other information, advise or assistance as the Manager
may deem necessary, appropriate or convenient for the
discharge of its obligations hereunder or otherwise
helpful to the Portfolio or in the discharge of the
Manager's overall responsibility with respect to other
accounts which it serves as investment adviser or
manager.
7. Ownership of Records. All records required to be
maintained and preserved by the Portfolio pursuant to
the rules or regulations of the Securities and Exchange
Commission under Section 31(a) of the Act and
maintained and preserved by the manager on behalf of
the Portfolio are the property of the Portfolio and
will be surrendered by the Manager promptly on request
by the Portfolio. The Manager may retain, for itself,
copies of all such records.
8. Reports to Manager. The Portfolio shall furnish or
otherwise make available to the Manager such
prospectuses, financial statements, proxy statements,
reports, and other information relating to the business
and affairs of the Portfolio as the Manager may, at any
time or from time to time, reasonably require in order
to discharge its obligations under this Agreement.
9. Other Agreements, Etc. It is understood that any of
the shareholders, Trustees, officers and employees of
the Trust may be a shareholder, director, officer or
employee of, or be otherwise interested in, the
Manager, and in any person controlled by or under
common control with the Manager, and that the Manager
and any person controlled by or under common control
with the Manager may have an interest in the Trust. It
is also understood that the Manager and persons
controlled by or under common control with the Manager
have and may have advisory, management service,
distribution or other contracts with other
organizations and persons, and may have other interests
and businesses.
10. Limitation of Liability of Manager. Neither the
Manager nor any of its officers, directors,
stockholders (or partners of stockholders), agents or
employees, nor any person performing executive,
administrative, trading, or other functions for the
Portfolio (at the direction or request of the manager)
or the Manager in connection with the Manager's
discharge of its obligation undertaken or reasonably
assumed with respect to this Agreement, shall be liable
for any error of judgment or mistake of law or for any
loss suffered by the Portfolio in connection with the
matters to which this Agreement relates, except for
loss resulting from willful misfeasance, bad faith, or
gross negligence in the performance of its or his
duties on behalf of the Portfolio or from reckless
disregard by the Manager or any such person of the
duties of the Manager under this Agreement.
11. Limitation of Liability of Portfolio. The term "Smith
Breeden Trust" means and refers to the trustees from
time to time serving under the Declaration of Trust of
the Trust dated December 18, 1991, as the same may
subsequently thereto have been, or subsequently hereto
be, amended (the "Declaration of Trust"). It is
expressly agreed that the obligations of the Portfolio
hereunder shall not be binding upon any of the
trustees, shareholders, nominees, officers, agents or
employees of the Portfolio personally, but shall bind
only the trust property of the Portfolio, as provided
in the Declaration of Trust of the Portfolio. The
execution and delivery of this Agreement have been
authorized by the trustees and shareholders of the
Portfolio and this Agreement has been signed by an
authorized officer of the Portfolio, acting as such,
and neither such authorization by such trustees and
shareholders nor such execution and delivery by such
officer shall be deemed to have been made by any of
them but shall bind only the trust property of the
Portfolio as provided in its Declaration of Trust.
12. Use of Name. The Manager owns the name "Smith
Breeden," which may be used by the Trust only with the
consent of the Manager. The Manager consents to the
use by the Trust of the name "Smith Breeden Funds" or
any other name embodying the name "Smith Breeden," but
only on the condition and so long as (i) this Agreement
shall remain in full force, (ii) the Trust shall fully
perform, fulfill and comply with all provisions of this
Agreement expressed herein to be performed, fulfilled
or complied with by it, and (iii) Smith Breeden
Associates, Inc. is the Manager of the Trust. No such
name shall be used by the Trust at any time or in any
place or for any purposes or under any conditions
except as in this section provided. The foregoing
authorization by the Manager to the Trust to use the
name "Smith Breeden" as a part of a business or name is
not exclusive of the right of the Manager itself to
use, or to authorize others to use, the same; the Trust
acknowledges and agrees that as between the Manager and
the Trust, the Manager has the exclusive right so to
use, or authorize others to use, said name, and the
Trust agrees to take such action as may reasonably be
requested by the Manager to give full effect to the
provisions of this section (including, without
limitation, consenting to such use of said name).
Without limiting the generality of the foregoing, the
Trust agrees that, upon (i) any termination of this
Agreement by either party, (ii) the violation of any of
its provisions by the Trust or (iii) termination of
this Investment Advisory Agreement between Smith
Breeden Associates, Inc. and the Trust, the Trust will,
at the request of the Manager made within six months
after such termination or violation, use its best
efforts to change the name of the Trust so as to
eliminate all reference, if any, to the name "Smith
Breeden" and will not thereafter transact any business
in a name containing the name "Smith Breeden" in any
form or combination whatsoever, or designate itself as
the same entity as or successor to an entity of such
name, or otherwise use the name "Smith Breeden" or any
other reference to the Manager. Such covenants on the
part of the Trust shall be binding upon it, its
Trustees, officers, stockholders, creditors and all
other persons claiming under or through it.
13. Term of Agreement. The term of this Agreement shall
begin on the date first above written, and unless
sooner terminated as hereinafter provided, this
Agreement shall remain in effect until July 31, 2000.
Thereafter, this Agreement shall continue in effect
from year to year, subject to the termination
provisions and all other terms and conditions hereof,
so long as such continuation shall be specifically
approved at least annually (a) by either the Board of
Trustees of the Portfolio, or by vote of a majority of
the outstanding voting securities of the Portfolio, and
(b) in either event by the vote, cast in person at a
meeting called for the purpose of voting on such
approval, of a majority of the Trustees of the
Portfolio who are not interested persons of the Trust
or the Manager; provided, however, that if the
continuance of this Agreement is submitted to the
shareholders of the Portfolio for their approval and
such shareholders fail to approve such continuance of
this Contract as provided herein, the Manager may
continue to serve hereunder in a manner consistent with
the Investment Company Act of 1940 and the rules and
regulations thereunder. The Manager shall furnish to
the Portfolio, promptly upon its request, such
information as may reasonably be necessary to evaluate
the terms of this Agreement or any extension, renewal
or amendment hereof.
14. Amendment and Assignment of Agreement. This Agreement
may not be amended in any material respect or assigned
without the affirmative vote of a majority of the
outstanding voting securities of the Portfolio, and
this Agreement shall automatically and immediately
terminate in the event of its assignment.
15. Termination of Agreement. This Agreement may be
terminated by either party hereto, without the payment
of any penalty, upon 60 days' prior notice in writing
to the other party; provided, that in the case of
termination by the Portfolio, such action shall have
been authorized by resolution of a majority of the
Trustees of the Portfolio who are not parties to this
Agreement or interested persons of any such party, or
by vote of a majority of the outstanding voting
securities of the Portfolio.
16. Miscellaneous.
A. Captions. The captions in this Agreement are
included for convenience of reference only and in
no way define or delineate any of the provisions
hereof or otherwise affect their construction or
effect.
B. Interpretation. Nothing herein contained shall be
deemed to require the Portfolio to take any action
contrary to its Declaration of Trust or By-Laws,
or any applicable statutory or regulatory
requirement to which it is subject or by which it
is bound, or to relieve or deprive the Board of
Trustees of the Portfolio of its responsibility
for and control of the conduct of the affairs of
the Portfolio. This Agreement shall be construed
and enforced in accordance with and governed by
the laws of The Commonwealth of Massachusetts.
C. Definitions. For the purposes of this Agreement,
the "affirmative vote of a majority of the
outstanding shares" of the Portfolio means the
affirmative vote, at a duly called and held
meeting of shareholders, (a) of the holders of 67%
or more of the shares of the Portfolio present (in
person or by proxy) and entitled to vote as such
meeting, if the holders of more than 50% of the
outstanding shares of the Portfolio entitled to
vote at such meeting are present in person or by
proxy, or (b) of the holders of more than 50% of
the outstanding shares of the Portfolio entitled
to vote at such meeting, whichever is less.
For the purposes of this Agreement, the terms
"affiliated person," "interested person" and
"assignment" shall have their respective meanings
defined in the Investment Company Act of 1940 and
the rules and regulations thereunder, subject,
however, to such exemptions as may be granted by
the Securities and Exchange Commission under said
Act; the term "specifically approve at least
annually" shall be construed in a manner
consistent with the Investment Company Act of 1940
and the rules and regulations thereunder; and the
term "brokerage and research services" shall have
the meaning given in the Securities Exchange Act
of 1934 and the rules and regulations thereunder.
IN WITNESS WHEREOF, the parties hereto have caused this
Agreement to be signed by their respective officers
thereunto duly authorized and their respective corporate
seals to be hereunto affixed, as of the date and year first
above written.
SMITH BREEDEN TRUST
(on behalf Smith Breeden High
Yield Bond Fund)
Attest: By:
SMITH BREEDEN ASSOCIATES, INC.
Attest: By:
INVESTMENT ADVISORY AGREEMENT
Between
SMITH BREEDEN TRUST
on behalf of the Smith Breeden Europe Fund
and
SMITH BREEDEN ASSOCIATES, INC.
INVESTMENT ADVISORY AGREEMENT dated June 29, 1998
between SMITH BREEDEN TRUST, a Massachusetts trust ("the
Trust"), on behalf of its Smith Breeden Europe Fund series
(the "Portfolio"), and SMITH BREEDEN ASSOCIATES, INC., a
corporation organized and existing under the laws of the
State of Kansas (hereinafter called the "Manager").
W I T N E S S E T H:
Whereas, the Portfolio is engaged in business as an
open-end management investment company and has registered as
such under the federal Investment Company Act of 1940, as
amended (the "Act");
WHEREAS, the Manager is engaged principally in the
business of rendering investment management and
administrative services and is registered as an investment
adviser under the federal investment Advisers Act of 1940,
as amended; and
WHEREAS, the Portfolio wishes to engage the Manager to
provide certain investment management and administrative
services, and the Manager is willing to provide such
services, all on the terms and conditions hereinafter set
forth.
NOW, THEREFORE, in consideration of the premises and
the mutual promises hereinafter set forth, the parties
hereto agree as follows:
1. Duties and Responsibilities of Manager.
A. Investment Advisory Services. The Manager shall
act as investment adviser to and shall supervise
and direct the investments of the Portfolio in
accordance with the Portfolio's investment
objectives, program and restrictions as provided
in the Portfolio's then current Registration
Statement under the Act, and such other directions
or limitations as the Portfolio may impose by
notice in writing to the Manager. The Manager
shall obtain and evaluate such information
relating to the economy, industries, businesses,
securities markets and securities as it may deem
necessary or useful in the discharge of its
obligations hereunder and shall formulate and
implement a continuing program for the management
of the assets and resources of the Portfolio in a
manner consistent with its investment objective.
The Manager shall for all purposes be deemed to be
an independent contractor and shall, except as
expressly provided or authorized (whether herein
or otherwise), have no authority to act for or
represent the Portfolio in any way or otherwise be
deemed an agent of the Portfolio.
In furtherance of its duties hereunder, the
Manager is authorized, in its discretion and
without prior consultation with the Portfolio, to:
(i) buy, sell, exchange, convert, lend, and
otherwise trade in any stocks, bonds, and
other securities; financial, stock, and stock
index futures and options; swap contracts or
other assets; and
(ii) directly place orders and negotiate the
commissions (if any) for the execution of
transactions in securities, financial
futures, swap contracts or other assets with
or through such brokers, dealers,
underwriters or issuers as the Manager may
select.
B. Administrative Services. Subject to the overall
authority of the Board of Trustees of the
Portfolio, the Manager shall provide general
administrative services and oversee the operation
of the Portfolio ("Administrative Services").
Such Administrative Services shall not include
investment advisory, custodial, underwriting and
distribution, transfer agency, shareholder or
accounting services, or the preparation and filing
of the Portfolio's tax returns, but shall include,
without limitation:
(i) the provision of office space and equipment
necessary in connection with the maintenance
of the headquarters of the Portfolio;
(ii) the maintenance of the books and records of
the Portfolio, and making arrangements for
the meetings of the Trustees of the Portfolio
including the preparation of agendas and
supporting materials therefore;
(iii) the preparation of communications and
reports to investors in the Portfolio and
making arrangements for meetings of such
investors;
(iv) the preparation and filing of all required
reports and all updating and other amendments
to the Portfolio's registration statement
under the Act and the rules and regulations
thereunder;
(v) the periodic computation and, as necessary,
reporting to the Trustees of the Portfolio of
the Portfolio's compliance with its
investment objective and policies with the
Portfolio diversification and other Portfolio
requirements of the Act and, to the extent
required, the Internal Revenue Code; and
(vi) the negotiation of agreements or other
arrangements with, and general oversight and
coordination of the activities of, agents and
others retained by the Portfolio to provide
custodial, net asset value computation,
Portfolio accounting, legal, tax and
accounting services.
It is understood that the Manager may, in its
discretion and at its expense, delegate some or
all of its administrative duties and
responsibilities under this Paragraph 1.B. to any
person provided that the Manager gives prior
notice to the Portfolio.
C. Reports to Portfolio. The Manager shall furnish
to or place at the disposal of the Portfolio such
information, reports, evaluations, analyses and
opinions relating to the Manager and its
investment management of the Portfolio's portfolio
securities as the Portfolio may, at any time or
from time to time, reasonably request or as the
Manager may deem helpful.
D. Reports and Other Communications to Investors.
The Manager shall assist the Portfolio in
providing communications to investors as may
reasonably be necessary.
E. Portfolio Personnel. The Manager will permit
individuals who are officers or employees of the
Manager to serve (if duly elected or appointed) as
officers, trustees, members of any committee of
trustees, members of any advisory board, or
members of any other committee of the Portfolio,
without remuneration or other cost to the
Portfolio.
F. Personnel, Office Space, and Facilities of
Manager. The Manager at its own expense shall
furnish or provide and pay the cost of such office
space, office equipment, office personnel, and
office services as the Manager requires in the
performance of its investment advisory,
administrative and other obligations under this
Agreement.
2. Allocation of Expenses.
A. Expenses Paid by Manager.
(i) Expenses Paid by Manager. The Manager shall
pay all salaries, expenses, and fees of the
officers and trustees of the Portfolio who
are employees of the Manager. The Manager is
not obligated to bear any other expenses
incidental to the operations and business of
the Portfolio.
(ii) Assumption of Expenses by Manager. The
payment or assumption by the Manager of any
expense of the Portfolio that the Manager is
not required by this Agreement to pay or
assume shall not obligate the Manager to pay
or assume the same or any similar expense on
any subsequent occasion.
B. Expenses Paid by Portfolio. The Portfolio shall
bear all expenses of its organization, operations,
and business not specifically assumed or agreed to
be paid by the Manager as provided in this
Agreement. In particular, but without limiting
the generality of the foregoing, the Portfolio
shall pay:
(i) Management Fees. the fees of the Manager as
provided in paragraph 3 below;
(ii) Custody and Accounting Services. All
expenses of the transfer, receipt,
safekeeping, servicing and accounting for the
cash, securities, and other property of the
Portfolio, including all charges of
depositories, custodians, and other agents,
if any;
(iii) Investor Servicing. All expenses of
establishing, maintaining and servicing
investor accounts, including all charges of
agents for account transfers, account record
keeping, and account distribution or
disbursement;
(iv) Distribution and Service Fees. The fees, if
any, payable pursuant to any plan heretofore
or hereafter adopted by the Portfolio
pursuant to Rule 12b-1 under the Act;
(v) Investor Meetings. All expenses incidental
to holding meetings of the Portfolio's
investors;
(vi) Pricing. All expenses of computing the
Portfolio's net asset value, including the
cost of any equipment or services used for
obtaining price quotations and the fees of
any independent pricing service authorized by
the Trustees of the Portfolio;
(vii) Communication Equipment. All charges
for equipment or services used for
communication between the Manager or the
Portfolio and the custodian, transfer agent
or any other agent selected by the Portfolio;
(viii) Legal, Accounting, and Tax Preparation
Fees and Expenses. All charges for services
and expenses of the Portfolio's legal counsel
and independent auditors;
(ix) Trustees' Fees and Expenses. All
compensation of Trustees of the Portfolio,
other than those who are interested persons
of the Portfolio, and all expenses (including
fees and disbursements of their legal
counsel) incurred in connection with their
service;
(x) Federal Registration Fees. All fees and
expenses of registering and maintaining the
registration of the Portfolio under the Act,
including all fees and expenses incurred in
connection with the preparation and filing of
any registration statement under the Act, and
any amendments or supplements that may be
made from time to time;
(xi) Bonding and Insurance. All expenses of bond,
liability, and other insurance coverage
required by law or deemed advisable by the
Trustees of the Portfolio;
(xii) Brokerage Commissions. All brokers'
commissions and other charges incident to the
purchase, sale, or lending of the Portfolio's
portfolio securities;
(xiii) Interest and Taxes. Interest on
borrowed money and all taxes or governmental
fees payable by or with respect to the
Portfolio to federal, state, or other
governmental agencies, domestic or foreign,
including stamp or other transfer taxes;
(xiv) Trade Association Fees. All fees, dues,
and other expenses incurred in connection
with the membership of the Portfolio in the
Investment Company Institute or any other
trade association or other investment
organization; and
(xv) Nonrecurring and Extraordinary Expenses.
Such nonrecurring expenses as may arise,
including the costs of actions, suits, or
proceedings to which the Portfolio is a party
and the expenses that the Portfolio may incur
as a result of its legal obligation to
provide indemnification to its officers,
trustees, employees and agents.
3. Management Fees. The Portfolio shall pay the Manager a
fee at an annual rate computed as follows based on the
value of the net assets of the Portfolio.
A. Method of Computation. The fee shall be accrued
for each calendar day and the sum of the daily fee
accruals shall be paid monthly to the Manager on
the first business day of the next succeeding
calendar month. The daily fee accruals will be
computed by multiplying the fraction of one over
the number of calendar days in the year by 0.70%,
and multiplying the resulting product by the net
assets of the Portfolio as determined in
accordance with the Portfolio's Registration
Statement under the Act as of the close of
business on the previous business day on which the
Portfolio was open for business.
B. Proration of Fee. If this Agreement becomes
effective or terminates before the end of any
calendar month, the fee for the period from the
effective date to the end of such calendar month
or from the beginning of such calendar month to
the date of termination, as the case may be, shall
be prorated according to the proportion which such
period bears to the full month in which such
effectiveness or termination occurs.
8. Limitation of Portfolio's Normal Business Expenses. In
the event that expenses of the Portfolio for any fiscal year
(not including any distribution expenses paid by the
Portfolio pursuant to any distribution plan) should exceed
the expense limitation on investment company expenses
enforced by any statute or regulatory authority of any
jurisdiction in which shares of the Trust are qualified for
offer and sale, the compensation due the Manager for such
fiscal year shall be reduced by the amount of such excess by
a reduction or refund thereof. In the event that the
expenses of the Portfolio exceed any expense limitation
which the Manager may, by written notice to the Trust,
voluntarily declare to be effective with respect to the
Portfolio, subject to such terms and conditions as the
Manager may prescribe in such notice, the compensation due
the Manager shall be reduced, and, if necessary, the Manager
shall bear the Portfolio's expenses to the extent required
by such expense limitation.
9. Brokerage. In the selection of brokers or dealers and
the placing of orders for the purchase and sale of portfolio
investments for the Portfolio, the Manager shall seek to
obtain the most favorable price and execution available,
except to the extent it may be permitted to pay higher
brokerage commissions for brokerage and research services as
described below. In using its best efforts to obtain for
the Portfolio the most favorable price and execution
available, the Manager, bearing in mind the Portfolio 's
best interests at all times, shall consider all factors it
deems relevant, including, by way of illustration, price,
the size of the transaction, the nature of the market for
the security, 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 or dealer involved and the quality of service
rendered by the broker or dealer in other transactions.
Subject to such policies as the Trustees may determine, the
Manager shall not be deemed to have acted unlawfully or to
have breached any duty created by this Contract or otherwise
solely by reason of its having caused the Trust to pay, on
behalf of the Portfolio, a broker or dealer that provides
brokerage and research services to the Manager an amount of
commission for effecting a portfolio investment transaction
in excess of the amount of commission another broker or
dealer would have charged for effecting that transaction, if
the Manager determines in good faith that such amount of
commission was reasonable in relation to the value of the
brokerage and research services provided by such broker or
dealer, viewed in terms of either that particular
transaction or the Manager's overall responsibilities with
respect to the Portfolio and to other clients of the
Manager as to which the Manager exercises investment
discretion. The Trust hereby agrees with the Manager that
any entity or person associated with the Manager which is a
member of a national securities exchange is authorized to
effect any transaction on such exchange for the account of
the Portfolio which is permitted by Section 11(a) of the
Securities Exchange Act of 1934 and Rule 11a-2-2(T)
thereunder, and the Trust hereby consents to the retention
of compensation for such transactions in accordance with
Rule 11a2-2(T)(2)(iv).
6. Manager's Use of the Services of Others. The Manager
may (at its cost except as contemplated by Paragraph 5
of this Agreement) employ, retain or otherwise avail
itself of the services or facilities of other persons
or organizations for the purpose of providing the
Manager or the Portfolio with such statistical and
other factual information, such advice regarding
economic factors and trends, such advice as to
occasional transactions in specific securities or such
other information, advise or assistance as the Manager
may deem necessary, appropriate or convenient for the
discharge of its obligations hereunder or otherwise
helpful to the Portfolio or in the discharge of the
Manager's overall responsibility with respect to other
accounts which it serves as investment adviser or
manager.
7. Ownership of Records. All records required to be
maintained and preserved by the Portfolio pursuant to
the rules or regulations of the Securities and Exchange
Commission under Section 31(a) of the Act and
maintained and preserved by the manager on behalf of
the Portfolio are the property of the Portfolio and
will be surrendered by the Manager promptly on request
by the Portfolio. The Manager may retain, for itself,
copies of all such records.
8. Reports to Manager. The Portfolio shall furnish or
otherwise make available to the Manager such
prospectuses, financial statements, proxy statements,
reports, and other information relating to the business
and affairs of the Portfolio as the Manager may, at any
time or from time to time, reasonably require in order
to discharge its obligations under this Agreement.
9. Other Agreements, Etc. It is understood that any of
the shareholders, Trustees, officers and employees of
the Trust may be a shareholder, director, officer or
employee of, or be otherwise interested in, the
Manager, and in any person controlled by or under
common control with the Manager, and that the Manager
and any person controlled by or under common control
with the Manager may have an interest in the Trust. It
is also understood that the Manager and persons
controlled by or under common control with the Manager
have and may have advisory, management service,
distribution or other contracts with other
organizations and persons, and may have other interests
and businesses.
10. Limitation of Liability of Manager. Neither the
Manager nor any of its officers, directors,
stockholders (or partners of stockholders), agents or
employees, nor any person performing executive,
administrative, trading, or other functions for the
Portfolio (at the direction or request of the manager)
or the Manager in connection with the Manager's
discharge of its obligation undertaken or reasonably
assumed with respect to this Agreement, shall be liable
for any error of judgment or mistake of law or for any
loss suffered by the Portfolio in connection with the
matters to which this Agreement relates, except for
loss resulting from willful misfeasance, bad faith, or
gross negligence in the performance of its or his
duties on behalf of the Portfolio or from reckless
disregard by the Manager or any such person of the
duties of the Manager under this Agreement.
11. Limitation of Liability of Portfolio. The term "Smith
Breeden Trust" means and refers to the trustees from
time to time serving under the Declaration of Trust of
the Trust dated December 18, 1991, as the same may
subsequently thereto have been, or subsequently hereto
be, amended (the "Declaration of Trust"). It is
expressly agreed that the obligations of the Portfolio
hereunder shall not be binding upon any of the
trustees, shareholders, nominees, officers, agents or
employees of the Portfolio personally, but shall bind
only the trust property of the Portfolio, as provided
in the Declaration of Trust of the Portfolio. The
execution and delivery of this Agreement have been
authorized by the trustees and shareholders of the
Portfolio and this Agreement has been signed by an
authorized officer of the Portfolio, acting as such,
and neither such authorization by such trustees and
shareholders nor such execution and delivery by such
officer shall be deemed to have been made by any of
them but shall bind only the trust property of the
Portfolio as provided in its Declaration of Trust.
12. Use of Name. The Manager owns the name "Smith
Breeden," which may be used by the Trust only with the
consent of the Manager. The Manager consents to the
use by the Trust of the name "Smith Breeden Funds" or
any other name embodying the name "Smith Breeden," but
only on the condition and so long as (i) this Agreement
shall remain in full force, (ii) the Trust shall fully
perform, fulfill and comply with all provisions of this
Agreement expressed herein to be performed, fulfilled
or complied with by it, and (iii) Smith Breeden
Associates, Inc. is the Manager of the Trust. No such
name shall be used by the Trust at any time or in any
place or for any purposes or under any conditions
except as in this section provided. The foregoing
authorization by the Manager to the Trust to use the
name "Smith Breeden" as a part of a business or name is
not exclusive of the right of the Manager itself to
use, or to authorize others to use, the same; the Trust
acknowledges and agrees that as between the Manager and
the Trust, the Manager has the exclusive right so to
use, or authorize others to use, said name, and the
Trust agrees to take such action as may reasonably be
requested by the Manager to give full effect to the
provisions of this section (including, without
limitation, consenting to such use of said name).
Without limiting the generality of the foregoing, the
Trust agrees that, upon (i) any termination of this
Agreement by either party, (ii) the violation of any of
its provisions by the Trust or (iii) termination of
this Investment Advisory Agreement between Smith
Breeden Associates, Inc. and the Trust, the Trust will,
at the request of the Manager made within six months
after such termination or violation, use its best
efforts to change the name of the Trust so as to
eliminate all reference, if any, to the name "Smith
Breeden" and will not thereafter transact any business
in a name containing the name "Smith Breeden" in any
form or combination whatsoever, or designate itself as
the same entity as or successor to an entity of such
name, or otherwise use the name "Smith Breeden" or any
other reference to the Manager. Such covenants on the
part of the Trust shall be binding upon it, its
Trustees, officers, stockholders, creditors and all
other persons claiming under or through it.
13. Term of Agreement. The term of this Agreement shall
begin on the date first above written, and unless
sooner terminated as hereinafter provided, this
Agreement shall remain in effect until July 31, 2000.
Thereafter, this Agreement shall continue in effect
from year to year, subject to the termination
provisions and all other terms and conditions hereof,
so long as such continuation shall be specifically
approved at least annually (a) by either the Board of
Trustees of the Portfolio, or by vote of a majority of
the outstanding voting securities of the Portfolio, and
(b) in either event by the vote, cast in person at a
meeting called for the purpose of voting on such
approval, of a majority of the Trustees of the
Portfolio who are not interested persons of the Trust
or the Manager; provided, however, that if the
continuance of this Agreement is submitted to the
shareholders of the Portfolio for their approval and
such shareholders fail to approve such continuance of
this Contract as provided herein, the Manager may
continue to serve hereunder in a manner consistent with
the Investment Company Act of 1940 and the rules and
regulations thereunder. The Manager shall furnish to
the Portfolio, promptly upon its request, such
information as may reasonably be necessary to evaluate
the terms of this Agreement or any extension, renewal
or amendment hereof.
14. Amendment and Assignment of Agreement. This Agreement
may not be amended in any material respect or assigned
without the affirmative vote of a majority of the
outstanding voting securities of the Portfolio, and
this Agreement shall automatically and immediately
terminate in the event of its assignment.
15. Termination of Agreement. This Agreement may be
terminated by either party hereto, without the payment
of any penalty, upon 60 days' prior notice in writing
to the other party; provided, that in the case of
termination by the Portfolio, such action shall have
been authorized by resolution of a majority of the
Trustees of the Portfolio who are not parties to this
Agreement or interested persons of any such party, or
by vote of a majority of the outstanding voting
securities of the Portfolio.
16. Miscellaneous.
A. Captions. The captions in this Agreement are
included for convenience of reference only and in
no way define or delineate any of the provisions
hereof or otherwise affect their construction or
effect.
B. Interpretation. Nothing herein contained shall be
deemed to require the Portfolio to take any action
contrary to its Declaration of Trust or By-Laws,
or any applicable statutory or regulatory
requirement to which it is subject or by which it
is bound, or to relieve or deprive the Board of
Trustees of the Portfolio of its responsibility
for and control of the conduct of the affairs of
the Portfolio. This Agreement shall be construed
and enforced in accordance with and governed by
the laws of The Commonwealth of Massachusetts.
C. Definitions. For the purposes of this Agreement,
the "affirmative vote of a majority of the
outstanding shares" of the Portfolio means the
affirmative vote, at a duly called and held
meeting of shareholders, (a) of the holders of 67%
or more of the shares of the Portfolio present (in
person or by proxy) and entitled to vote as such
meeting, if the holders of more than 50% of the
outstanding shares of the Portfolio entitled to
vote at such meeting are present in person or by
proxy, or (b) of the holders of more than 50% of
the outstanding shares of the Portfolio entitled
to vote at such meeting, whichever is less.
For the purposes of this Agreement, the terms
"affiliated person," "interested person" and
"assignment" shall have their respective meanings
defined in the Investment Company Act of 1940 and
the rules and regulations thereunder, subject,
however, to such exemptions as may be granted by
the Securities and Exchange Commission under said
Act; the term "specifically approve at least
annually" shall be construed in a manner
consistent with the Investment Company Act of 1940
and the rules and regulations thereunder; and the
term "brokerage and research services" shall have
the meaning given in the Securities Exchange Act
of 1934 and the rules and regulations thereunder.
IN WITNESS WHEREOF, the parties hereto have caused this
Agreement to be signed by their respective officers
thereunto duly authorized and their respective corporate
seals to be hereunto affixed, as of the date and year first
above written.
SMITH BREEDEN TRUST
(on behalf Smith Breeden
Europe Fund)
Attest: By:
SMITH BREEDEN ASSOCIATES, INC.
Attest: By:
INVESTMENT ADVISORY AGREEMENT
Between
SMITH BREEDEN TRUST
on behalf of the Smith Breeden Asia/Pacific Fund
and
SMITH BREEDEN ASSOCIATES, INC.
INVESTMENT ADVISORY AGREEMENT dated June 29, 1998
between SMITH BREEDEN TRUST, a Massachusetts trust ("the
Trust"), on behalf of its Smith Breeden Asia/Pacific Fund
series (the "Portfolio"), and SMITH BREEDEN ASSOCIATES,
INC., a corporation organized and existing under the laws of
the State of Kansas (hereinafter called the "Manager").
W I T N E S S E T H:
Whereas, the Portfolio is engaged in business as an
open-end management investment company and has registered as
such under the federal Investment Company Act of 1940, as
amended (the "Act");
WHEREAS, the Manager is engaged principally in the
business of rendering investment management and
administrative services and is registered as an investment
adviser under the federal investment Advisers Act of 1940,
as amended; and
WHEREAS, the Portfolio wishes to engage the Manager to
provide certain investment management and administrative
services, and the Manager is willing to provide such
services, all on the terms and conditions hereinafter set
forth.
NOW, THEREFORE, in consideration of the premises and
the mutual promises hereinafter set forth, the parties
hereto agree as follows:
1. Duties and Responsibilities of Manager.
A. Investment Advisory Services. The Manager shall
act as investment adviser to and shall supervise
and direct the investments of the Portfolio in
accordance with the Portfolio's investment
objectives, program and restrictions as provided
in the Portfolio's then current Registration
Statement under the Act, and such other directions
or limitations as the Portfolio may impose by
notice in writing to the Manager. The Manager
shall obtain and evaluate such information
relating to the economy, industries, businesses,
securities markets and securities as it may deem
necessary or useful in the discharge of its
obligations hereunder and shall formulate and
implement a continuing program for the management
of the assets and resources of the Portfolio in a
manner consistent with its investment objective.
The Manager shall for all purposes be deemed to be
an independent contractor and shall, except as
expressly provided or authorized (whether herein
or otherwise), have no authority to act for or
represent the Portfolio in any way or otherwise be
deemed an agent of the Portfolio.
In furtherance of its duties hereunder, the
Manager is authorized, in its discretion and
without prior consultation with the Portfolio, to:
(i) buy, sell, exchange, convert, lend, and
otherwise trade in any stocks, bonds, and
other securities; financial, stock, and stock
index futures and options; swap contracts or
other assets; and
(ii) directly place orders and negotiate the
commissions (if any) for the execution of
transactions in securities, financial
futures, swap contracts or other assets with
or through such brokers, dealers,
underwriters or issuers as the Manager may
select.
B. Administrative Services. Subject to the overall
authority of the Board of Trustees of the
Portfolio, the Manager shall provide general
administrative services and oversee the operation
of the Portfolio ("Administrative Services").
Such Administrative Services shall not include
investment advisory, custodial, underwriting and
distribution, transfer agency, shareholder or
accounting services, or the preparation and filing
of the Portfolio's tax returns, but shall include,
without limitation:
(i) the provision of office space and equipment
necessary in connection with the maintenance
of the headquarters of the Portfolio;
(ii) the maintenance of the books and records of
the Portfolio, and making arrangements for
the meetings of the Trustees of the Portfolio
including the preparation of agendas and
supporting materials therefore;
(iii) the preparation of communications and
reports to investors in the Portfolio and
making arrangements for meetings of such
investors;
(iv) the preparation and filing of all required
reports and all updating and other amendments
to the Portfolio's registration statement
under the Act and the rules and regulations
thereunder;
(v) the periodic computation and, as necessary,
reporting to the Trustees of the Portfolio of
the Portfolio's compliance with its
investment objective and policies with the
Portfolio diversification and other Portfolio
requirements of the Act and, to the extent
required, the Internal Revenue Code; and
(vi) the negotiation of agreements or other
arrangements with, and general oversight and
coordination of the activities of, agents and
others retained by the Portfolio to provide
custodial, net asset value computation,
Portfolio accounting, legal, tax and
accounting services.
It is understood that the Manager may, in its
discretion and at its expense, delegate some or
all of its administrative duties and
responsibilities under this Paragraph 1.B. to any
person provided that the Manager gives prior
notice to the Portfolio.
C. Reports to Portfolio. The Manager shall furnish
to or place at the disposal of the Portfolio such
information, reports, evaluations, analyses and
opinions relating to the Manager and its
investment management of the Portfolio's portfolio
securities as the Portfolio may, at any time or
from time to time, reasonably request or as the
Manager may deem helpful.
D. Reports and Other Communications to Investors.
The Manager shall assist the Portfolio in
providing communications to investors as may
reasonably be necessary.
E. Portfolio Personnel. The Manager will permit
individuals who are officers or employees of the
Manager to serve (if duly elected or appointed) as
officers, trustees, members of any committee of
trustees, members of any advisory board, or
members of any other committee of the Portfolio,
without remuneration or other cost to the
Portfolio.
F. Personnel, Office Space, and Facilities of
Manager. The Manager at its own expense shall
furnish or provide and pay the cost of such office
space, office equipment, office personnel, and
office services as the Manager requires in the
performance of its investment advisory,
administrative and other obligations under this
Agreement.
2. Allocation of Expenses.
A. Expenses Paid by Manager.
(i) Expenses Paid by Manager. The Manager shall
pay all salaries, expenses, and fees of the
officers and trustees of the Portfolio who
are employees of the Manager. The Manager is
not obligated to bear any other expenses
incidental to the operations and business of
the Portfolio.
(ii) Assumption of Expenses by Manager. The
payment or assumption by the Manager of any
expense of the Portfolio that the Manager is
not required by this Agreement to pay or
assume shall not obligate the Manager to pay
or assume the same or any similar expense on
any subsequent occasion.
B. Expenses Paid by Portfolio. The Portfolio shall
bear all expenses of its organization, operations,
and business not specifically assumed or agreed to
be paid by the Manager as provided in this
Agreement. In particular, but without limiting
the generality of the foregoing, the Portfolio
shall pay:
(i) Management Fees. the fees of the Manager as
provided in paragraph 3 below;
(ii) Custody and Accounting Services. All
expenses of the transfer, receipt,
safekeeping, servicing and accounting for the
cash, securities, and other property of the
Portfolio, including all charges of
depositories, custodians, and other agents,
if any;
(iii) Investor Servicing. All expenses of
establishing, maintaining and servicing
investor accounts, including all charges of
agents for account transfers, account record
keeping, and account distribution or
disbursement;
(iv) Distribution and Service Fees. The fees, if
any, payable pursuant to any plan heretofore
or hereafter adopted by the Portfolio
pursuant to Rule 12b-1 under the Act;
(v) Investor Meetings. All expenses incidental
to holding meetings of the Portfolio's
investors;
(vi) Pricing. All expenses of computing the
Portfolio's net asset value, including the
cost of any equipment or services used for
obtaining price quotations and the fees of
any independent pricing service authorized by
the Trustees of the Portfolio;
(vii) Communication Equipment. All charges
for equipment or services used for
communication between the Manager or the
Portfolio and the custodian, transfer agent
or any other agent selected by the Portfolio;
(viii) Legal, Accounting, and Tax Preparation
Fees and Expenses. All charges for services
and expenses of the Portfolio's legal counsel
and independent auditors;
(ix) Trustees' Fees and Expenses. All
compensation of Trustees of the Portfolio,
other than those who are interested persons
of the Portfolio, and all expenses (including
fees and disbursements of their legal
counsel) incurred in connection with their
service;
(x) Federal Registration Fees. All fees and
expenses of registering and maintaining the
registration of the Portfolio under the Act,
including all fees and expenses incurred in
connection with the preparation and filing of
any registration statement under the Act, and
any amendments or supplements that may be
made from time to time;
(xi) Bonding and Insurance. All expenses of bond,
liability, and other insurance coverage
required by law or deemed advisable by the
Trustees of the Portfolio;
(xii) Brokerage Commissions. All brokers'
commissions and other charges incident to the
purchase, sale, or lending of the Portfolio's
portfolio securities;
(xiii) Interest and Taxes. Interest on
borrowed money and all taxes or governmental
fees payable by or with respect to the
Portfolio to federal, state, or other
governmental agencies, domestic or foreign,
including stamp or other transfer taxes;
(xiv) Trade Association Fees. All fees, dues,
and other expenses incurred in connection
with the membership of the Portfolio in the
Investment Company Institute or any other
trade association or other investment
organization; and
(xv) Nonrecurring and Extraordinary Expenses.
Such nonrecurring expenses as may arise,
including the costs of actions, suits, or
proceedings to which the Portfolio is a party
and the expenses that the Portfolio may incur
as a result of its legal obligation to
provide indemnification to its officers,
trustees, employees and agents.
3. Management Fees. The Portfolio shall pay the Manager a
fee at an annual rate computed as follows based on the
value of the net assets of the Portfolio.
A. Method of Computation. The fee shall be accrued
for each calendar day and the sum of the daily fee
accruals shall be paid monthly to the Manager on
the first business day of the next succeeding
calendar month. The daily fee accruals will be
computed by multiplying the fraction of one over
the number of calendar days in the year by 0.70%,
and multiplying the resulting product by the net
assets of the Portfolio as determined in
accordance with the Portfolio's Registration
Statement under the Act as of the close of
business on the previous business day on which the
Portfolio was open for business.
B. Proration of Fee. If this Agreement becomes
effective or terminates before the end of any
calendar month, the fee for the period from the
effective date to the end of such calendar month
or from the beginning of such calendar month to
the date of termination, as the case may be, shall
be prorated according to the proportion which such
period bears to the full month in which such
effectiveness or termination occurs.
6. Limitation of Portfolio's Normal Business Expenses. In
the event that expenses of the Portfolio for any fiscal year
(not including any distribution expenses paid by the
Portfolio pursuant to any distribution plan) should exceed
the expense limitation on investment company expenses
enforced by any statute or regulatory authority of any
jurisdiction in which shares of the Trust are qualified for
offer and sale, the compensation due the Manager for such
fiscal year shall be reduced by the amount of such excess by
a reduction or refund thereof. In the event that the
expenses of the Portfolio exceed any expense limitation
which the Manager may, by written notice to the Trust,
voluntarily declare to be effective with respect to the
Portfolio, subject to such terms and conditions as the
Manager may prescribe in such notice, the compensation due
the Manager shall be reduced, and, if necessary, the Manager
shall bear the Portfolio's expenses to the extent required
by such expense limitation.
7. Brokerage. In the selection of brokers or dealers and
the placing of orders for the purchase and sale of portfolio
investments for the Portfolio, the Manager shall seek to
obtain the most favorable price and execution available,
except to the extent it may be permitted to pay higher
brokerage commissions for brokerage and research services as
described below. In using its best efforts to obtain for
the Portfolio the most favorable price and execution
available, the Manager, bearing in mind the Portfolio 's
best interests at all times, shall consider all factors it
deems relevant, including, by way of illustration, price,
the size of the transaction, the nature of the market for
the security, 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 or dealer involved and the quality of service
rendered by the broker or dealer in other transactions.
Subject to such policies as the Trustees may determine, the
Manager shall not be deemed to have acted unlawfully or to
have breached any duty created by this Contract or otherwise
solely by reason of its having caused the Trust to pay, on
behalf of the Portfolio, a broker or dealer that provides
brokerage and research services to the Manager an amount of
commission for effecting a portfolio investment transaction
in excess of the amount of commission another broker or
dealer would have charged for effecting that transaction, if
the Manager determines in good faith that such amount of
commission was reasonable in relation to the value of the
brokerage and research services provided by such broker or
dealer, viewed in terms of either that particular
transaction or the Manager's overall responsibilities with
respect to the Portfolio and to other clients of the
Manager as to which the Manager exercises investment
discretion. The Trust hereby agrees with the Manager that
any entity or person associated with the Manager which is a
member of a national securities exchange is authorized to
effect any transaction on such exchange for the account of
the Portfolio which is permitted by Section 11(a) of the
Securities Exchange Act of 1934 and Rule 11a-2-2(T)
thereunder, and the Trust hereby consents to the retention
of compensation for such transactions in accordance with
Rule 11a2-2(T)(2)(iv).
6. Manager's Use of the Services of Others. The Manager
may (at its cost except as contemplated by Paragraph 5
of this Agreement) employ, retain or otherwise avail
itself of the services or facilities of other persons
or organizations for the purpose of providing the
Manager or the Portfolio with such statistical and
other factual information, such advice regarding
economic factors and trends, such advice as to
occasional transactions in specific securities or such
other information, advise or assistance as the Manager
may deem necessary, appropriate or convenient for the
discharge of its obligations hereunder or otherwise
helpful to the Portfolio or in the discharge of the
Manager's overall responsibility with respect to other
accounts which it serves as investment adviser or
manager.
7. Ownership of Records. All records required to be
maintained and preserved by the Portfolio pursuant to
the rules or regulations of the Securities and Exchange
Commission under Section 31(a) of the Act and
maintained and preserved by the manager on behalf of
the Portfolio are the property of the Portfolio and
will be surrendered by the Manager promptly on request
by the Portfolio. The Manager may retain, for itself,
copies of all such records.
8. Reports to Manager. The Portfolio shall furnish or
otherwise make available to the Manager such
prospectuses, financial statements, proxy statements,
reports, and other information relating to the business
and affairs of the Portfolio as the Manager may, at any
time or from time to time, reasonably require in order
to discharge its obligations under this Agreement.
9. Other Agreements, Etc. It is understood that any of
the shareholders, Trustees, officers and employees of
the Trust may be a shareholder, director, officer or
employee of, or be otherwise interested in, the
Manager, and in any person controlled by or under
common control with the Manager, and that the Manager
and any person controlled by or under common control
with the Manager may have an interest in the Trust. It
is also understood that the Manager and persons
controlled by or under common control with the Manager
have and may have advisory, management service,
distribution or other contracts with other
organizations and persons, and may have other interests
and businesses.
10. Limitation of Liability of Manager. Neither the
Manager nor any of its officers, directors,
stockholders (or partners of stockholders), agents or
employees, nor any person performing executive,
administrative, trading, or other functions for the
Portfolio (at the direction or request of the manager)
or the Manager in connection with the Manager's
discharge of its obligation undertaken or reasonably
assumed with respect to this Agreement, shall be liable
for any error of judgment or mistake of law or for any
loss suffered by the Portfolio in connection with the
matters to which this Agreement relates, except for
loss resulting from willful misfeasance, bad faith, or
gross negligence in the performance of its or his
duties on behalf of the Portfolio or from reckless
disregard by the Manager or any such person of the
duties of the Manager under this Agreement.
11. Limitation of Liability of Portfolio. The term "Smith
Breeden Trust" means and refers to the trustees from
time to time serving under the Declaration of Trust of
the Trust dated December 18, 1991, as the same may
subsequently thereto have been, or subsequently hereto
be, amended (the "Declaration of Trust"). It is
expressly agreed that the obligations of the Portfolio
hereunder shall not be binding upon any of the
trustees, shareholders, nominees, officers, agents or
employees of the Portfolio personally, but shall bind
only the trust property of the Portfolio, as provided
in the Declaration of Trust of the Portfolio. The
execution and delivery of this Agreement have been
authorized by the trustees and shareholders of the
Portfolio and this Agreement has been signed by an
authorized officer of the Portfolio, acting as such,
and neither such authorization by such trustees and
shareholders nor such execution and delivery by such
officer shall be deemed to have been made by any of
them but shall bind only the trust property of the
Portfolio as provided in its Declaration of Trust.
12. Use of Name. The Manager owns the name "Smith
Breeden," which may be used by the Trust only with the
consent of the Manager. The Manager consents to the
use by the Trust of the name "Smith Breeden Funds" or
any other name embodying the name "Smith Breeden," but
only on the condition and so long as (i) this Agreement
shall remain in full force, (ii) the Trust shall fully
perform, fulfill and comply with all provisions of this
Agreement expressed herein to be performed, fulfilled
or complied with by it, and (iii) Smith Breeden
Associates, Inc. is the Manager of the Trust. No such
name shall be used by the Trust at any time or in any
place or for any purposes or under any conditions
except as in this section provided. The foregoing
authorization by the Manager to the Trust to use the
name "Smith Breeden" as a part of a business or name is
not exclusive of the right of the Manager itself to
use, or to authorize others to use, the same; the Trust
acknowledges and agrees that as between the Manager and
the Trust, the Manager has the exclusive right so to
use, or authorize others to use, said name, and the
Trust agrees to take such action as may reasonably be
requested by the Manager to give full effect to the
provisions of this section (including, without
limitation, consenting to such use of said name).
Without limiting the generality of the foregoing, the
Trust agrees that, upon (i) any termination of this
Agreement by either party, (ii) the violation of any of
its provisions by the Trust or (iii) termination of
this Investment Advisory Agreement between Smith
Breeden Associates, Inc. and the Trust, the Trust will,
at the request of the Manager made within six months
after such termination or violation, use its best
efforts to change the name of the Trust so as to
eliminate all reference, if any, to the name "Smith
Breeden" and will not thereafter transact any business
in a name containing the name "Smith Breeden" in any
form or combination whatsoever, or designate itself as
the same entity as or successor to an entity of such
name, or otherwise use the name "Smith Breeden" or any
other reference to the Manager. Such covenants on the
part of the Trust shall be binding upon it, its
Trustees, officers, stockholders, creditors and all
other persons claiming under or through it.
13. Term of Agreement. The term of this Agreement shall
begin on the date first above written, and unless
sooner terminated as hereinafter provided, this
Agreement shall remain in effect until July 31, 2000.
Thereafter, this Agreement shall continue in effect
from year to year, subject to the termination
provisions and all other terms and conditions hereof,
so long as such continuation shall be specifically
approved at least annually (a) by either the Board of
Trustees of the Portfolio, or by vote of a majority of
the outstanding voting securities of the Portfolio, and
(b) in either event by the vote, cast in person at a
meeting called for the purpose of voting on such
approval, of a majority of the Trustees of the
Portfolio who are not interested persons of the Trust
or the Manager; provided, however, that if the
continuance of this Agreement is submitted to the
shareholders of the Portfolio for their approval and
such shareholders fail to approve such continuance of
this Contract as provided herein, the Manager may
continue to serve hereunder in a manner consistent with
the Investment Company Act of 1940 and the rules and
regulations thereunder. The Manager shall furnish to
the Portfolio, promptly upon its request, such
information as may reasonably be necessary to evaluate
the terms of this Agreement or any extension, renewal
or amendment hereof.
14. Amendment and Assignment of Agreement. This Agreement
may not be amended in any material respect or assigned
without the affirmative vote of a majority of the
outstanding voting securities of the Portfolio, and
this Agreement shall automatically and immediately
terminate in the event of its assignment.
15. Termination of Agreement. This Agreement may be
terminated by either party hereto, without the payment
of any penalty, upon 60 days' prior notice in writing
to the other party; provided, that in the case of
termination by the Portfolio, such action shall have
been authorized by resolution of a majority of the
Trustees of the Portfolio who are not parties to this
Agreement or interested persons of any such party, or
by vote of a majority of the outstanding voting
securities of the Portfolio.
16. Miscellaneous.
A. Captions. The captions in this Agreement are
included for convenience of reference only and in
no way define or delineate any of the provisions
hereof or otherwise affect their construction or
effect.
B. Interpretation. Nothing herein contained shall be
deemed to require the Portfolio to take any action
contrary to its Declaration of Trust or By-Laws,
or any applicable statutory or regulatory
requirement to which it is subject or by which it
is bound, or to relieve or deprive the Board of
Trustees of the Portfolio of its responsibility
for and control of the conduct of the affairs of
the Portfolio. This Agreement shall be construed
and enforced in accordance with and governed by
the laws of The Commonwealth of Massachusetts.
C. Definitions. For the purposes of this Agreement,
the "affirmative vote of a majority of the
outstanding shares" of the Portfolio means the
affirmative vote, at a duly called and held
meeting of shareholders, (a) of the holders of 67%
or more of the shares of the Portfolio present (in
person or by proxy) and entitled to vote as such
meeting, if the holders of more than 50% of the
outstanding shares of the Portfolio entitled to
vote at such meeting are present in person or by
proxy, or (b) of the holders of more than 50% of
the outstanding shares of the Portfolio entitled
to vote at such meeting, whichever is less.
For the purposes of this Agreement, the terms
"affiliated person," "interested person" and
"assignment" shall have their respective meanings
defined in the Investment Company Act of 1940 and
the rules and regulations thereunder, subject,
however, to such exemptions as may be granted by
the Securities and Exchange Commission under said
Act; the term "specifically approve at least
annually" shall be construed in a manner
consistent with the Investment Company Act of 1940
and the rules and regulations thereunder; and the
term "brokerage and research services" shall have
the meaning given in the Securities Exchange Act
of 1934 and the rules and regulations thereunder.
IN WITNESS WHEREOF, the parties hereto have caused this
Agreement to be signed by their respective officers
thereunto duly authorized and their respective corporate
seals to be hereunto affixed, as of the date and year first
above written.
SMITH BREEDEN TRUST
(on behalf Smith Breeden
Asia/Pacific Fund)
Attest: By:
SMITH BREEDEN ASSOCIATES, INC.
Attest: By:
SMITH BREEDEN HIGH
YIELD BOND FUND
DISTRIBUTION AND SERVICES PLAN
This Plan (the "Plan") constitutes the Distribution and
Services Plan of the Smith Breeden High Yield Bond Fund (the
"Fund"), a separate series of Smith Breeden Trust, a
Massachusetts business trust (the "Trust"), adopted pursuant
to the provisions of Rule 12b-1 under the Investment Company
Act of 1940 (the "Act"). During the effective term of this
Plan, Smith Breeden Associates, Inc., the Fund's investment
advisor ("Smith Breeden") may make payments out of the
investment advisory fee to be received by Smith Breeden from
the Fund to investment dealers and other persons providing
services to the Fund upon the terms and conditions
hereinafter set forth. No payments by the Fund shall be
made directly by the Fund under this plan for the purposes
set forth in Section 1.
Section 1. Smith Breeden may make payments to
investment dealers or the other persons providing
services to the Fund, in the form of fees or
reimbursements, as compensation for services provided
and expenses incurred for purposes of promoting the
sale of shares of the Fund, reducing redemptions of
shares, or maintaining or improving services provided
to shareholders by investment dealers and other
persons. The amount of such payments and the purposes
for which they are made shall be determined by Smith
Breeden. Smith Breeden's payments covered by this Plan
shall not exceed in any fiscal year the annual rate of
0.25% of the average net asset value of the Fund, as
determined at the close of each business day during the
year. A majority of the Qualified Trustees (as defined
below) may, at any time and from time to time, may
reduce the amount of such payments covered by this
Plan, or may suspend the operation of the Plan for such
period or periods of time as they may determine.
Section 2. This Plan shall not take effect until:
(a) it has been approved by a vote of a
majority of the outstanding voting
securities of the Fund; and
(b) it has been approved, together with any
related agreements, by votes, of the
majority (or whatever greater percentage
may, from time to time, be required by
Section 12(b) of the Act or the rules
and regulations thereunder) of both (i)
the Trustees of the Trust, and (ii) the
Qualified Trustee of the Trust, cast in
person at a meeting called for the
purpose of voting on this Plan or such
agreement.
Section 3. This Plan shall continue in effect for a
period of more than one year after it takes effect only
so long as such continuance is specifically approved at
least annually in the manner provided for approval of
this Plan in Section 2(b).
Section 4. Smith Breeden shall provide to the Trustees
of the Trust, and the Trustees shall review, at least
quarterly, a written report of the amounts covered by
this Plan and the purposes for which such expenditures
were made.
Section 5. This Plan may be terminated at any time by
vote of a majority of the Qualified Trustees, or by
vote of a majority of the Fund's outstanding voting
securities.
Section 6. All agreements with any person relating to
implementation of this Plan shall be in writing, and
any agreement related to this Plan shall provide:
(a) that such agreement may be terminated at
any time, without payment of any
penalty, by vote of a majority of the
Qualified Trustees or by vote of a
majority of the Fund's outstanding
voting securities, on not more than 60
days' written notice to any other party
to the agreement; and
(b) that such agreement shall terminate
automatically in the event of its
assignment.
Section 7. This Plan may not be amended to increase
materially the amount of distribution expenses
permitted pursuant to Section 1 hereof without the
approval of a majority of the outstanding voting
securities of the Fund, and all material amendments to
this Plan shall be approved in the manner provided for
approval of this Plan in Section 2(b).
Section 8. As used in this Plan, (a) the term
"Qualified Trustees" shall mean those Trustees of the
Trust who are not interested persons of the Trust, and
have no direct or indirect financial interest in the
operation of this Plan or any agreements related to it,
and (b) the terms "assignment", "interested person" and
"vote of a majority of the outstanding voting
securities" shall have the respective meaning specified
in the Act and the rules and regulations thereunder,
subject to such exemptions as may be granted by the
Securities and Exchange Commission.
Section 9. A copy of the Amended and Restated
Declaration of Trust of the Trust is on file with the
Secretary of The Commonwealth of Massachusetts and
notice is hereby given that this instrument is executed
on behalf of the Trustees of the Trust as Trustees and
not individually, and that the obligations of or
arising out of this instrument are not binding upon any
of the Trustees, officers or shareholders individually
but are binding only upon the assets and property of
the Trust.
Adopted as of June 26, 1998.
SMITH BREEDEN EUROPE FUND
DISTRIBUTION AND SERVICES PLAN
This Plan (the "Plan") constitutes the Distribution and
Services Plan of the Smith Breeden Europe Fund (the "Fund"),
a separate series of Smith Breeden Trust, a Massachusetts
business trust (the "Trust"), adopted pursuant to the
provisions of Rule 12b-1 under the Investment Company Act of
1940 (the "Act"). During the effective term of this Plan,
Smith Breeden Associates, Inc., the Fund's investment
advisor ("Smith Breeden") may make payments out of the
investment advisory fee to be received by Smith Breeden from
the Fund to investment dealers and other persons providing
services to the Fund upon the terms and conditions
hereinafter set forth. No payments by the Fund shall be
made directly by the Fund under this plan for the purposes
set forth in Section 1.
Section 1. Smith Breeden may make payments to
investment dealers or the other persons providing
services to the Fund, in the form of fees or
reimbursements, as compensation for services provided
and expenses incurred for purposes of promoting the
sale of shares of the Fund, reducing redemptions of
shares, or maintaining or improving services provided
to shareholders by investment dealers and other
persons. The amount of such payments and the purposes
for which they are made shall be determined by Smith
Breeden. Smith Breeden's payments covered by this Plan
shall not exceed in any fiscal year the annual rate of
0.25% of the average net asset value of the Fund, as
determined at the close of each business day during the
year. A majority of the Qualified Trustees (as defined
below) may, at any time and from time to time, may
reduce the amount of such payments covered by this
Plan, or may suspend the operation of the Plan for such
period or periods of time as they may determine.
Section 2. This Plan shall not take effect until:
(a) it has been approved by a vote of a
majority of the outstanding voting
securities of the Fund; and
(b) it has been approved, together with any
related agreements, by votes, of the
majority (or whatever greater percentage
may, from time to time, be required by
Section 12(b) of the Act or the rules
and regulations thereunder) of both (i)
the Trustees of the Trust, and (ii) the
Qualified Trustee of the Trust, cast in
person at a meeting called for the
purpose of voting on this Plan or such
agreement.
Section 3. This Plan shall continue in effect for a
period of more than one year after it takes effect only
so long as such continuance is specifically approved at
least annually in the manner provided for approval of
this Plan in Section 2(b).
Section 4. Smith Breeden shall provide to the Trustees
of the Trust, and the Trustees shall review, at least
quarterly, a written report of the amounts covered by
this Plan and the purposes for which such expenditures
were made.
Section 5. This Plan may be terminated at any time by
vote of a majority of the Qualified Trustees, or by
vote of a majority of the Fund's outstanding voting
securities.
Section 6. All agreements with any person relating to
implementation of this Plan shall be in writing, and
any agreement related to this Plan shall provide:
(a) that such agreement may be terminated at
any time, without payment of any
penalty, by vote of a majority of the
Qualified Trustees or by vote of a
majority of the Fund's outstanding
voting securities, on not more than 60
days' written notice to any other party
to the agreement; and
(b) that such agreement shall terminate
automatically in the event of its
assignment.
Section 7. This Plan may not be amended to increase
materially the amount of distribution expenses
permitted pursuant to Section 1 hereof without the
approval of a majority of the outstanding voting
securities of the Fund, and all material amendments to
this Plan shall be approved in the manner provided for
approval of this Plan in Section 2(b).
Section 8. As used in this Plan, (a) the term
"Qualified Trustees" shall mean those Trustees of the
Trust who are not interested persons of the Trust, and
have no direct or indirect financial interest in the
operation of this Plan or any agreements related to it,
and (b) the terms "assignment", "interested person" and
"vote of a majority of the outstanding voting
securities" shall have the respective meaning specified
in the Act and the rules and regulations thereunder,
subject to such exemptions as may be granted by the
Securities and Exchange Commission.
Section 9. A copy of the Amended and Restated
Declaration of Trust of the Trust is on file with the
Secretary of The Commonwealth of Massachusetts and
notice is hereby given that this instrument is executed
on behalf of the Trustees of the Trust as Trustees and
not individually, and that the obligations of or
arising out of this instrument are not binding upon any
of the Trustees, officers or shareholders individually
but are binding only upon the assets and property of
the Trust.
Adopted as of June 26, 1998.
SMITH BREEDEN ASIA/PACIFIC FUND
DISTRIBUTION AND SERVICES PLAN
This Plan (the "Plan") constitutes the Distribution and
Services Plan of the Smith Breeden Asia/Pacific Fund (the
"Fund"), a separate series of Smith Breeden Trust, a
Massachusetts business trust (the "Trust"), adopted pursuant
to the provisions of Rule 12b-1 under the Investment Company
Act of 1940 (the "Act"). During the effective term of this
Plan, Smith Breeden Associates, Inc., the Fund's investment
advisor ("Smith Breeden") may make payments out of the
investment advisory fee to be received by Smith Breeden from
the Fund to investment dealers and other persons providing
services to the Fund upon the terms and conditions
hereinafter set forth. No payments by the Fund shall be
made directly by the Fund under this plan for the purposes
set forth in Section 1.
Section 1. Smith Breeden may make payments to
investment dealers or the other persons providing
services to the Fund, in the form of fees or
reimbursements, as compensation for services provided
and expenses incurred for purposes of promoting the
sale of shares of the Fund, reducing redemptions of
shares, or maintaining or improving services provided
to shareholders by investment dealers and other
persons. The amount of such payments and the purposes
for which they are made shall be determined by Smith
Breeden. Smith Breeden's payments covered by this Plan
shall not exceed in any fiscal year the annual rate of
0.25% of the average net asset value of the Fund, as
determined at the close of each business day during the
year. A majority of the Qualified Trustees (as defined
below) may, at any time and from time to time, may
reduce the amount of such payments covered by this
Plan, or may suspend the operation of the Plan for such
period or periods of time as they may determine.
Section 2. This Plan shall not take effect until:
(a) it has been approved by a vote of a
majority of the outstanding voting
securities of the Fund; and
(b) it has been approved, together with any
related agreements, by votes, of the
majority (or whatever greater percentage
may, from time to time, be required by
Section 12(b) of the Act or the rules
and regulations thereunder) of both (i)
the Trustees of the Trust, and (ii) the
Qualified Trustee of the Trust, cast in
person at a meeting called for the
purpose of voting on this Plan or such
agreement.
Section 3. This Plan shall continue in effect for a
period of more than one year after it takes effect only
so long as such continuance is specifically approved at
least annually in the manner provided for approval of
this Plan in Section 2(b).
Section 4. Smith Breeden shall provide to the Trustees
of the Trust, and the Trustees shall review, at least
quarterly, a written report of the amounts covered by
this Plan and the purposes for which such expenditures
were made.
Section 5. This Plan may be terminated at any time by
vote of a majority of the Qualified Trustees, or by
vote of a majority of the Fund's outstanding voting
securities.
Section 6. All agreements with any person relating to
implementation of this Plan shall be in writing, and
any agreement related to this Plan shall provide:
(a) that such agreement may be terminated at
any time, without payment of any
penalty, by vote of a majority of the
Qualified Trustees or by vote of a
majority of the Fund's outstanding
voting securities, on not more than 60
days' written notice to any other party
to the agreement; and
(b) that such agreement shall terminate
automatically in the event of its
assignment.
Section 7. This Plan may not be amended to increase
materially the amount of distribution expenses
permitted pursuant to Section 1 hereof without the
approval of a majority of the outstanding voting
securities of the Fund, and all material amendments to
this Plan shall be approved in the manner provided for
approval of this Plan in Section 2(b).
Section 8. As used in this Plan, (a) the term
"Qualified Trustees" shall mean those Trustees of the
Trust who are not interested persons of the Trust, and
have no direct or indirect financial interest in the
operation of this Plan or any agreements related to it,
and (b) the terms "assignment", "interested person" and
"vote of a majority of the outstanding voting
securities" shall have the respective meaning specified
in the Act and the rules and regulations thereunder,
subject to such exemptions as may be granted by the
Securities and Exchange Commission.
Section 9. A copy of the Amended and Restated
Declaration of Trust of the Trust is on file with the
Secretary of The Commonwealth of Massachusetts and
notice is hereby given that this instrument is executed
on behalf of the Trustees of the Trust as Trustees and
not individually, and that the obligations of or
arising out of this instrument are not binding upon any
of the Trustees, officers or shareholders individually
but are binding only upon the assets and property of
the Trust.
Adopted as of June 26, 1998.
