As filed with the Securities and Exchange Commission
on July 30, 1999
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. 18
and
Registration Statement Under the Investment Company
Act of 1940
Amendment No. 20
_____________________
SMITH BREEDEN TRUST
(Exact Name of Registrant as Specified in Charter)
100 Europa Drive, Suite 200
Chapel Hill, North Carolina 27514
(Address of Principal Executive Office)
(919) 967-7221
(Registrant's Telephone Number, Including Area Code)
MICHAEL J. GIARLA
100 Europa Drive, Suite 200
Chapel Hill, North Carolina 27514
(Name and Address of Agent for Service)
_______________
Please Send Copy of Communications to:
MARIANTHE S. MEWKILL
Smith Breeden Associates, Inc.
100 Europa Drive, Suite 200
Chapel Hill, NC 27514
(919)-967-7221
This filing shall become effective on July 31, 1999
pursuant to paragraph (b) 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 22, 1999.
SMITH BREEDEN TRUST
SMITH BREEDEN U.S. EQUITY MARKET PLUS FUND
(THE "U.S. EQUITY MARKET PLUS FUND")
SMITH BREEDEN ASIAN/PACIFIC EQUITY MARKET FUND
(THE "ASIAN/PACIFIC EQUITY MARKET FUND")
SMITH BREEDEN EUROPEAN EQUITY MARKET FUND
(THE "EUROPEAN EQUITY MARKET 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. Front & Back Front & Back
Cover Pages Cover Pages
2. Risk/Return Summary: Smith Breeden Equity Funds:
Investments, Risk Investment Objectives,
and Performance Principal Investments
Strategies, Principal
Investment Risks, Annual
Performance
3. Risk/Return Summary: Smith Breeden Equity Funds:
Fee Table Your Expenses
4. Investment Objectives, Summary of Principal Risks
Principal Investment and Investment Strategies
Strategies, and
Related Risks
5. Management's Discussion Contained in the Funds'
of Fund's Performance Annual Report to
Shareholders
6. Management, Organization, Management of the Funds
and Capital Structure
7. Shareholder Information Pricing of Fund Shares,
How to Purchase Shares,
How to Exchange Shares,
How to Redeem Shares,
Dividends and
Distributions,
Shareholder Reports and
Information, Taxes
8. Distribution Arrangements How to Purchase Shares,
Service and Distribution
Plans
9. Financial Highlights Financial Highlights
Information
SMITH BREEDEN MUTUAL FUNDS
Smith Breeden Short Duration U.S. Government Fund
Smith Breeden Intermediate Duration U.S. Government Fund
Smith Breeden U.S. Equity Market Plus Fund
Smith Breeden Asian/Pacific Equity Market Fund
Smith Breeden European Equity Market Fund
PROSPECTUS
JULY 31, 1999
Advised by Smith Breeden Associates, Inc.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE 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
SUMMARY INFORMATION
This Prospectus describes five no load mutual funds offering you a choice
of investments to help
fulfill your asset allocation needs:
Smith Breeden Short Duration U.S. Government Fund
Smith Breeden Intermediate Duration U.S. Government Fund
Smith Breeden U.S. Equity Market Plus Fund
Smith Breeden Asian/Pacific Equity Market Fund
Smith Breeden European Equity Market Fund
Each Fund is a series of the Smith Breeden Series Fund or the Smith Breeden
Trust, each an open-end
management investment company. The investment adviser for the Funds is
Smith Breeden Associates,
Inc. (the "Adviser").
TABLE OF CONTENTS
SMITH BREEDEN BOND FUNDS
SMITH BREEDEN EQUITY FUNDS
SUMMARY OF PRINCIPAL RISKS AND INVESTMENT STRATEGIES
CHARACTERISTICS AND RISKS OF THE SECURITIES IN WHICH THE FUNDS MAY INVEST
MANAGEMENT OF FUNDS
PRICING OF FUND SHARES
HOW TO PURCHASE SHARES
HOW TO EXCHANGE SHARES
HOW TO REDEEM SHARES
DIVIDENDS AND DISTRIBUTIONS
SHAREHOLDER REPORTS AND INFORMATION
RETIREMENT PLANS
SERVICE AND DISTRIBUTION PLANS
TAXES
CAPITAL STRUCTURE
TRANSFER AND DIVIDEND DISBURSING AGENT, CUSTODIAN AND INDEPENDENT AUDITORS
FINANCIAL HIGHLIGHTS
SMITH BREEDEN BOND FUNDS
Smith Breeden Short Duration U.S. Government Fund
Smith Breeden Intermediate Duration U.S. Government Fund
Investment Objectives
The Short Duration U.S. Government Fund (the "Short Fund") seeks to provide
investors with a high
level of current income, consistent with a low volatility of net asset value.
The Intermediate Duration U.S. Government Fund (the "Intermediate Fund")
seeks to provide investors with a total return in excess of the total
return of the major market indices for mortgage-backed securities.
Principal Investment Strategies
2
The Short Fund seeks to achieve its objective by matching 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 Intermediate Fund seeks to achieve its objective by matching the
duration, or interest-rate
risk, of a portfolio that invests exclusively in mortgage-backed securities,
as weighted in the major
market indices for mortgage-backed securities. These indices currently
include the Salomon
Brothers Mortgage Index and the Lehman Brothers Mortgage Index, each of
which includes all
outstanding government sponsored fixed-rate mortgage-backed securities,
weighted in proportion to
their current market capitalization. The duration of these indices is
generally similar to that of
intermediate-term U.S. Treasury Notes, and typically will range between
three and five years.
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 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. Each year of duration represents an approximate 1% change in
price for a 1% change in interest
rates. For example, if a bond fund has an average duration of three
years, its price will fall
approximately 3% when interest rates rise by one percentage point.
Conversely, the bond fund's price
will rise approximately 3% when interest rates fall by one
percentage point.
Under normal circumstances, each Fund will invest at least 70% of
its total assets in U.S.
Government Securities, primarily in mortgage-backed securities issued
by the U.S. Government, its
agencies and instrumentalities.
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.
3
The investment objectives of the Short and Intermediate Funds are
fundamental, meaning they may not
be changed without a vote of the shareholders of the relevant Fund.
In addition, as a matter of
fundamental policy the Funds will limit purchases to securities from
the following classes of assets:
Securities issued directly or guaranteed by the U.S. Government or
its agencies or instrumentalities.
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.
Securities fully collateralized by assets in either of the above classes.
Assets which would qualify as liquidity items under federal regulations
(which may change from
time to time) if held by a commercial bank or savings institution.
Hedge instruments and stripped Mortgage-Backed Securities, which may
only be used for risk
management purposes.
Principal Investment Risks
An investor could lose money by investing in these Funds. Other primary
risks of investing in the
Funds are:
Basis Risk
Credit Risk
Derivatives Risk
Interest Rate and Maturity Risk
Leveraging Risk
Liquidity Risk
Management Risk
Market Risk
Prepayment Risk
Year 2000 Risk
Please see "Summary of Principal Risks and Investment Strategies" for a
discussion of these and other
risks of investing in the Funds.
Annual Performance
The bar charts below show how the Funds' performance has varied from
year to year by illustrating
the Fund's total calendar-year returns. The table following the bar
charts compares each Fund's average
annual returns for the periods indicated to those of a broad-based
securities market index. The charts and
table are intended to illustrate some of the risks of investing in
the Funds by showing how the Funds'
performance can vary from year to year. Past performance does not
guarantee future results.
4
CALENDAR-YEAR TOTAL RETURNS
SHORT FUND
Best quarter: First quarter 1995, + 2.40%
Worst quarter: First quarter 1994, + 0.06%
More recent information:
(January 1, 1999 - June 30, 1999) 1.68%
Short Fund
4.30% 4.14% 6.13% 6.28% 6.32% 4.77%
1993 1994 1995 1996 1997 1998
CALENDAR-YEAR TOTAL RETURNS
INTERMEDIATE FUND
Best quarter: First quarter 1995, + 5.45%
Worst quarter: First quarter 1994, - 2.25%
More recent return information:
(January 1, 1999 - June 30, 1999) .01%
Intermediate Fund
11.09% (1.67)% 16.40% 5.05% 9.00% 6.56%
1993 1994 1995 1996 1997 1998
AVERAGE ANNUAL TOTAL RETURNS
(for periods ended December 31, 1998)
Short Fund
1 Year 5 Years Fund Inception
(March 31, 1992)
Short Fund 4.77% 5.52% 5.46%
Merrill Lynch 6 Month US T-Bill 5.58% 5.37% 4.97%
<TABLE>
Intermediate Fund
<CAPTION>
1 Year 5 Years Fund Inception
(March 31, 1992)
<S> <C> <C> <C>
Intermediate Fund 6.56% 6.91% 8.26%
Salomon Smith Barney Mortgage Index ("SBMI") <F1> 6.99% 7.23% 7.58%
<FN>
<F1>
The fund changed its investment objective 1/1/94. Prior to 1/1/1994, the Fund's objective was to provide a return
in excess of the five year U.S. Treasury Note.
</FN>
</TABLE>
Your Expenses
The information below describes the fees and expenses you may pay if you
buy and hold shares of the Funds and
do not reflect any expense reimbursements by the Adviser.
5
<TABLE>
Short Fund Intermediate Fund
<S> <C> <C>
Shareholder Fees <F1> (fees paid directly from your investment)
Annual Maintenance Fee for accounts less than $2,000 $16 $16
Account Closing Fee $ 8 $ 8
<S>
Annual Fund Operating Expenses
(expenses that are deducted from Fund assets) <C> <C>
Management Fees <F2> <F3> 0.70% 0.70%
Other Expenses <F3> 0.30% 0.36%
12b-1 Fee <F2> None None
Total Fund Operating Expenses <F3> 1.00% 1.06%
<FN>
<F1>
For accounts of less than $2,000, each Fund assesses an annual account maintenance fee of $16. In addition,
a transaction charge of $9 may be imposed on redemptions by wire transfer and an account closing fee of $8 may be imposed.
<F2>
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 Fund's net assets out of its management fee.
<F3>
Expenses shown are before giving effect to expense limitations. The Adviser voluntarily reimburses the Funds' expenses
so that during the fiscal year ended March 31, 1999 total fund operating expenses were 0.78% for the Short Fund and 0.88%
for the Intermediate Fund.
</FN>
</TABLE>
Examples
The examples below are intended to help you compare the cost
of investing in the Funds with the cost of investing in
other mutual funds. The examples assume that you invest $10,000 in
each Fund for the time periods indicated, that your
investment earns a 5% return each year and that the Fund's
operating expenses remain the same and that the Adviser does
not reimburse the Fund any expenses. Although your actual costs
may be higher or lower, based on these assumptions
your costs would be:
1 Year 3 Years 5 Years 10 Years
Short Fund $105 $328 $568 $1,258
Intermediate Fund $111 $347 $601 $1,329
SMITH BREEDEN EQUITY FUNDS
Smith Breeden U.S. Equity Market Plus Fund
Smith Breeden Asian/Pacific Equity Market Fund
Smith Breeden European Equity Market Fund
Investment Objectives
6
The U.S. Equity Market Plus Fund 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 Asian/Pacific Equity Market Fund seeks capital appreciation
through investments in financial instruments related
to the major equity markets of Asia and the Pacific region.
The European Equity Market Fund seeks capital appreciation
through investments in securities related to the major
equity markets of Europe.
Principal Investment Strategies
The U.S. Equity Market Plus Fund does not invest principally in
the common stocks that make up the S&P 500 Index
or any other index. Instead, the Fund invests primarily in an
actively managed short duration fixed income portfolio and
maintains positions in S&P 500 futures, options and similar
instruments. The equity index futures and options positions
are designed to produce an exposure to the S&P 500 Index similar to
that which would be achieved if all the Fund's
assets were invested directly in the stocks comprising the S&P 500
Index. The Fund's investment strategy is designed to
produce a total return with a low tracking error relative to the S&P
500 Index.
Similarly, neither the Asian/Pacific Equity Market nor the European
Equity Market Fund invest principally in the
common stocks of the regions or indices whose returns they are
targeting. Instead, each Fund invests primarily in an
actively managed short duration fixed income portfolio and uses
futures, options and swaps to maintain its equity
exposure in its respective market. The Asian/Pacific Equity Market and
European Equity Market Funds may also employ
futures and forwards on the currency markets of their respective
regions to maintain the relevant market exposure. For
the Asian/Pacific Equity Market Fund, the futures, options and swap
positions are designed to produce an exposure
similar to that which would be achieved if all of the Fund's assets were
invested directly in the equity markets of the
Asia/Pacific region. For the European Equity Market Fund, the futures,
options and swap positions are designed to
produce an exposure similar to that which would be achieved if all
of the Fund's assets were invested directly in the
equity markets of Europe. Each Fund's investment strategy is designed
to produce a total return similar to that of the
relevant regional market it targets (i.e., the Asia/Pacific region
in the case of the Asian/Pacific Equity Market Fund and
Europe in the case of the European Equity Market Fund).
When futures contracts and/or swaps are, in the judgment of the
Adviser, relatively overpriced, a Fund may invest
directly in the common stocks represented by the index or in the
region being tracked. In these circumstances, 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 the movements in the index or market being tracked.
7
Each Fund's 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 Fund will employ hedging
techniques, with instruments such as interest rate
futures, options, floors, caps and swaps, designed to reduce the
interest-rate risk of its fixed-income portfolio. The Fund
will manage its fixed income portfolio effective duration to a target
of one year or less. The Fund may also engage in
loans of portfolio securities and dollar rolls to enhance income and
total return.
Each Fund has also applied for an exemptive order with the Securities
and Exchange Commission which would
permit the Fund to invest in the Short Fund for purposes of pursuing
its short duration fixed income strategy. There is no
assurance that such an order will be granted.
The U.S. Equity Market Plus Fund's equity market positions are
designed to produce a return similar to that which
would be achieved if all the Fund's assets were invested directly in
the stocks comprising the S&P 500 Index in
proportion to their respective weightings in the S&P 500 Index. The
Asian/Pacific Equity Market Fund's equity market
positions are designed to produce a return similar to that which
would be achieved if all the Fund's assets were invested
directly in the stocks comprising an index or indexes representative
of the equity markets of the Asia/Pacific region, as
determined by the Adviser, in proportion to their respective weightings
in such index or indexes. The European Equity
Market Fund's equity market positions are designed to produce a return
similar to that which would be achieved if all the
Fund's assets were invested directly in the stocks comprising an index
or indexes representative of the equity markets of
Europe, as determined by the Adviser, in proportion to their respective
weightings in such index or indexes.
In each case, this exposure will be maintained primarily with futures,
options, and swaps. When futures contracts are
purchased, only a small percentage of the notional value of the
contract must be posted as margin. No margin is
generally required when entering into a swap or option contract.
Each Fund therefore commits only a small percentage of
its net assets to purchasing the instruments that it uses to obtain
its equity market exposure. With the remainder of its
assets, the Funds invest in an actively managed short duration fixed
income portfolio.
Each Fund's success in achieving its performance objective depends
largely on whether the total return on the Fund's
fixed-income portfolio equals or exceeds a short term interest rate
plus the Fund's total operating expenses. The
operating expenses of each Fund include the transaction and financing
8
costs of entering into the futures, options and swap
contracts used for interest rate risk management and for S&P 500 or
other index replication. Other factors which will
impact the success of the Fund's strategies relate to how well the
returns of the equity index futures, swaps and options
track the underlying market or index.
Principal Investment Risks
An investor could lose money by investing in these Funds. These
Funds should be invested in by individuals seeking
the return of a stock market, specifically that of the S&P 500 Index,
Asia/Pacific region or Europe, as the case may be.
Although the Funds invest in bonds, they are not "bond" funds and
should not be invested in by someone seeking a fixed
income return. The movements in the S&P 500 Index and the Asian/Pacific
and European equity markets can be very
volatile from day-to-day and a person who invests in these Funds should
be aware that significant losses can be sustained
in one day, as well as over time.
Each Fund's use of derivative instruments such as futures, swaps and
options to track the market index raises
additional risks. A Fund's opportunity for gain or loss may be greater
than if the Fund invested directly in the stocks
represented by the market index because the notional value of the financial
instruments utilized may not match exactly
the Fund's net assets. For example, the total net notional amount of the
Fund's equity swap contracts, S&P 500 or other
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 Fund expects that such
variations in its exposure to the index will be up to
5% more or less than the Fund's net assets.)
Because the Asian/Pacific Equity Market and European Equity
Market Funds will be investing in foreign markets
and securities, these Funds may experience more rapid and extreme
changes in value than a Fund investing solely in U.S.
companies and markets. This is because the securities markets of
many foreign countries are relatively small, with a
limited number of companies representing a small number of industries.
In addition, foreign companies are usually not
subject to the same degree of regulation as U.S. companies. These
investments are also influenced by currency risk, the
risk that changes in foreign exchange rates will affect, favorably
or unfavorably, the value of a Fund's foreign securities.
Although the Asian/Pacific Equity Market and European Equity Market
Funds will enter into currency futures and
forwards to maintain the same currency exposure as the markets in
which they invest, there is no guarantee that the use of
such techniques will be successful. 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
9
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.
Other primary risks of investing in the Funds are:
Basis Risk
Credit Risk
Derivatives Risk
Interest Rate and Maturity Risk
Leveraging Risk
Liquidity Risk
Management Risk
Market Risk
Prepayment Risk
Year 2000 Risk
Please see "Summary of Principal Risks and Investment Strategies" for
a discussion of these and other risks of investing
in the Funds.
Annual Performance
The bar chart below shows how the U.S. Equity Market Plus Fund's
performance has varied from year to year by
illustrating the Fund's total calendar-year returns. The table
following the bar chart compares the Fund's average annual
returns for the periods indicated to those of a broad-based securities
market index. The chart and table are intended to
illustrate some of the risks of investing in the Fund by showing how
the Fund's performance can vary from year to year.
There are no charts and tables for the Asian/Pacific Equity Market
and European Equity Market Fund because the Funds
have no performance history. However, since these Funds' performance
can be expected to vary from year to year there
are risks of investing in these Fund as well. Past performance does
not guarantee future results.
<TABLE>
CALENDAR-YEAR TOTAL RETURNS
U.S. EQUITY MARKET PLUS FUND
<CAPTION>
[Plot points for bar chart]
<S> <C> <C> <C> <C> <C> <C>
U.S. Equity Market Plus Fund 13.22% 1.84% 36.76% 24.36% 32.29% 26.43%
1993 1994 1995 1996 1997 1998
</TABLE>
Best quarter: Fourth quarter 1998, 21.07%
Worst quarter: Third quarter 1998, (10.82)%
More recent return information: (January 1, 1999-June 30, 1999) 12.09%
AVERAGE ANNUAL TOTAL RETURNS
(for periods ended December 31, 1998)
10
1 Year 5 Years Fund Inception
(June 30, 1992)
U.S. Equity Market Plus Fund 26.43% 23.71% 21.89%
S&P 500 Index * 28.58% 24.03% 21.24%
* The S&P 500 Index is a widely recognized, unmanaged index of common
stocks of the 500 largest capitalized U.S. companies. The index
does not incur expenses and cannot be purchased directly by investors.
Your Expenses
The information below describes the fees and expenses you may pay if
you buy and hold shares of the Funds.
<TABLE>
U.S. Equity Asian/Pacific European
Market Plus Equity Market Equity Market
<S> <C> <C> <C>
Shareholder Fees <F1>(fees paid directly from your investment)
Annual Maintenance Fee for accounts less than $2,000 $16 $16 $16
Account Closing Fee $ 8 $ 8 $ 8
Annual Fund Operating Expenses
(expenses that are deducted from Fund assets) 0.70% 0.70% 0.70%
Management Fees <F2><F3>
Other Expenses <F3><F4> 0.34% 5.30% 5.30%
12b-1 Fee <F2> None None None
Total Fund Operating Expenses <F3><F4> 1.04% 6.00% 6.00%
<FN>
<F1>
For accounts of less than $2,000, each Fund assesses an annual account maintenance fee of $16. In addition,
a transaction charge of $9 may be imposed on redemptions by wire transfer and an account closing fee of $8 may be imposed.
<F2>
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 Fund's net assets out of its management fee.
<F3>
Expenses shown are before giving effect to expense limitations. The Adviser voluntarily reimburses the
Funds' expenses so that during the fiscal year ended March 31, 1999 total fund operating expenses were 0.88% for
the U.S. Equity Market Plus Fund and would be expected to be 0.98% for each of the European Equity Index and
Asian/Pacific Equity Index Funds had they been operational.
<F4>
Other expenses and Total Fund Operating expenses for the Asian/Pacific Equity Market and European Equity Market Funds
are based on estimated amounts for the first fiscal year of the Funds.
</FN>
</TABLE>
Examples
11
The example below is intended to help you compare the cost of investing in
the Funds with the cost of investing in other
mutual funds. The example assumes that you invest $10,000 in each Fund
for the time periods indicated, that your
investment earns a 5% return each year and that the Fund's operating
expenses remain the same and that the Adviser does
not reimburse any expenses. Although your actual costs may be
higher or lower, based on these assumptions your costs
would be:
1 Year 3 Years 5 Years 10 Years
U.S. Equity Market Plus $109 $ 341 $ 590 $1,305
Asian/Pacific Equity Market $630 $1,866 $3,069 $5,944
European Equity Market $630 $1,866 $3,069 $5,944
SUMMARY OF PRINCIPAL RISKS AND INVESTMENT STRATEGIES
PRINCIPAL RISKS
The value of your investment in a Fund changes with the values of that
Fund's holdings. Many factors can affect those
values. The "principal risks" identified in the fund descriptions
part of this Prospectus represent the factors that are most
likely to have a material effect on each Fund's portfolio as a
whole. Each Fund may be subject to additional principal
risks and other risks in addition to the risks described here.
The risks of a Fund may change over time because the types
of investments made by a Fund can change over time. The following
subsection on "Characteristics and Risks of the
Securities in Which the Funds May Invest" and the Statements of
Additional Information include more important
information about the Funds, their investment strategies and the
related risks.
Basis Risk. Basis risk is the risk that changes in the
value of a hedge transaction will not completely offset changes
in the value of the assets and liabilities being hedged.
Basis risk may occur in many ways. For example, a hedge
transaction may rise in value by $100 in response to higher
interest rates. At the same time, the security being hedged
could decline in value by $102 in response to the same market
factor--higher interest rates-- and other factors unique to
those assets including credit risks that might be reflected in
the assets' value. The hedge would therefore not fully cover
the loss in value of the security caused by higher rates since
a $2 differential would exist between the gain in value on
the hedge and the assets' loss in value. The $2 differential
reflects basis risk. Basis risk can manifest itself in other ways;
for example when a small change in interest rates occurs.
In that context, both the hedge transaction and the hedged
assets could decline in value, although by different amounts,
following an interest rate change. This means that a Fund
may not achieve, and may at times exceed, its targeted duration
or the return of the market it tracks.
12
Credit Risk. An issuer of securities may be unable to pay principal
and interest when due, or the value of the security
may suffer because investors believe the issuer is less able to
pay. Lower rated securities, while usually offering higher
yields, generally have more risk and volatility because of
reduced creditworthiness and greater chance of default.
While certain U.S. Government securities such as U.S. Treasury
obligations and GNMAs (discussed in the next
section) 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 credit risk by investing in securities of the highest
credit quality, while the U.S. Equity Market Plus, European
Equity Market and Asian/Pacific Equity Market Funds will
seek to minimize credit risk by investing in securities of at
least investment grade, except that its investment in
mortgage-backed securities will be rated at least A. 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.
Derivatives Risk. The Funds may use derivatives, which
are financial contracts whose value depends on, or is
derived from, the value of an underlying asset, interest rate or
index. Using derivatives, a Fund can 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. Techniques involving derivatives
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 Asian/Pacific Equity Market and
European Equity Market 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. The use of derivatives
involves costs and may result in losses. For example, the
losses from investing in futures transactions are potentially
unlimited.
The use of options and futures strategies 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.
In addition to other risks such as the credit risk of the
counterparty, market risk, liquidity risk, and basis risk,
derivatives involve the risk of mispricing or improper valuation.
In addition, the Funds' use of derivatives may also have the
effect of accelerating a Fund's recognition of gain.
13
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.
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.
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.
Interest Rate and Maturity Risk. The market prices of a Fund's
fixed-income investments may decline due to an
increase in market interest rates. Generally, the longer the
maturity or duration of a fixed-income security, the more
sensitive it is to changes in interest rates. The Short Fund
seeks to match the duration of a portfolio that invests
exclusively in six month U.S. Treasury securities on a constant
maturity basis, and the Intermediate Fund seeks to match
the duration of a portfolio that invests in mortgage-backed
securities as weighted in the major market indices (typically
ranging from three to five years). The Equity Market Plus,
Asian/Pacific Equity Market and European Equity Market
Funds seek a duration of one year or less. However, each Fund
expects that, under normal circumstances, the dollar-
weighted average life (or period until the next reset date) of
its portfolio securities will be significantly longer than its
duration objective.
14
Leveraging Risk. When a Fund is borrowing money or otherwise
leveraging its portfolio, the value of an investment in
that Fund will be more volatile and all other risks will tend
to be compounded. This is because leverage tends to
exaggerate the effect of any increase or decrease in the
value of a Fund's portfolio holdings. Each Fund may take on
leveraging risk by using reverse repurchase agreements,
dollar rolls and other borrowings, by investing collateral from
loans of portfolio securities, through the use of when-issued,
delayed-delivery or forward commitment transactions or by
using other derivatives. The use of leverage may also cause a
Fund to liquidate portfolio positions when it may not be
advantageous to do so to satisfy its obligations or meet
segregation requirements.
Liquidity Risk. Liquidity risk exists when particular
investments are difficult to sell. A Fund may not be able to sell
these illiquid investments at the best prices. Investments in
derivatives, and securities having small market capitalization,
substantial market and/or credit risk tend to involve greater
liquidity risk.
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 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.
Management Risk. Each Fund is subject to management risk because it
is an actively managed investment portfolio.
Management risk is the chance that poor security selection will cause
the Fund to underperform other funds with similar
objectives. The Adviser will apply its investment techniques and risk
analyses in making investment decisions for the
Funds, but there can be no guarantee that these will produce the
desired result.
Market Risk. The market price of securities held by a Fund may fall,
sometimes rapidly or unpredictably, due to
changing economic, political or market conditions, or due to the
financial condition of the issuer. The value of a security
may decline due to general market conditions which are not
specifically related to a company or industry, such as real or
perceived adverse economic conditions, changes in the general
outlook for corporate earnings, changes in interest or
currency rates or adverse investor sentiment generally.
15
Prepayment risk. Prepayment risk is the risk that principal
will be repaid at a different rate than anticipated, causing
the return on a security purchased to be less than expected.
Mortgage-backed securities, which represent an interest in a
pool of mortgages, present this risk, as do many asset-backed
securities. In general, when market interest rates decline,
many mortgages are refinanced, and mortgage-backed securities
are paid off earlier than expected, forcing a Fund to
reinvest the proceeds at current yields, which are lower than
those paid by the security that was paid off. When market
interest rates increase, the market values of mortgage-backed
securities declines. At the same time, however, mortgage
refinancing slows, which lengthens the effective maturities on
these securities. As a result, the negative effect of the rate
increase on the market value of mortgage securities is usually
more pronounced than it is for other types of fixed-income
securities. Asset-backed securities can present similar risks.
Year 2000 Risk. Like other mutual funds (and most organizations
around the world), the Funds could be adversely
affected by computer problems related to the year 2000. These
could interfere with operations of the Funds, the Adviser
and the Distributor or could impact the issuers of the securities
in which the Funds invest.
While no one knows if these problems will have any impact on the
Funds or on financial markets in general, the Adviser
is taking steps to protect fund investors. These include efforts
to determine that the problem will not directly affect the
systems used by major service providers.
Whether these steps will be effective can only be known for certain
in the year 2000.
CHARACTERISTICS OF CERTAIN 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. The
Statements of Additional Information also include
information on these and other securities and financial
instruments in which the Funds may invest.
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
16
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.
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, including residuals, stripped
mortgage-backed securities and other instruments.
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.
These securities are described in detail below and in the
Statement of Additional Information.
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 by the assets of
the particular instrumentality or the ability of the agency
to borrow.
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,
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. 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.
17
The Short and Intermediate 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, European Equity Market
and Asian/Pacific Equity Market 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
"Summary of Principal Risks and Investment Strategies"
and the Statements of Additional Information.
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
18
adjustable-rate securities backed by pools of mortgage
loans ("ARMs"). The fixed income portfolio of the U.S.
Equity Market Plus, Asian/Pacific Equity Market and
European Equity Market 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.
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
19
Funds' custodian. Subject to this requirement, the Funds
may purchase securities on such basis without limit.
Settlements in the ordinary course, which may be
substantially more than three business days for
mortgage-backed securities, are not treated as when-
issued or forward commitment transactions, and are not
subject to the foregoing limitations, although some of
the risks described above may exist.
Reverse Repurchase Agreements, Dollar Roll
Agreements and Borrowing. 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 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. 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.
20
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 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.
Portfolio Turnover
The Adviser buys and sells securities for a Fund
whenever it believes it is appropriate to do so. The
portfolio turnover rate for each Fund's previous fiscal
periods is shown in the table under the heading
"Financial Highlights".
The portfolio turnover rates reported in the
"Financial Highlights" for the each of the Funds for the
fiscal year ended March 31, 1999 were relatively high.
Because of their relatively frequent trading, the funds
will realize taxable capital gains frequently which must
be distributed yearly to shareholders. To the extent these
gains are short-term capital gains, such gains are
generally taxed at ordinary income tax rates. If a
shareholder holds an investment in a fund in something
other than a tax-deferred account (e.g. a retirement
account), the payment of any taxes will impact a
shareholder's net return from holding an investment in a
Fund. Portfolio turnover also 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. High
portfolio turnover could adversely impact a Fund's
performance. However, the mortgage securities in which
the Funds may invest are generally traded on a "net"
21
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 U.S. Equity Market Plus,
Asian/Pacific Equity Market and European Equity
Market Funds, in relation to any purchase of 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
Dr. Breeden, aged 49, the Chairman of the Board of
Smith Breeden Associates, co-founded the firm in 1982.
Dr. Breeden has served on business school faculties at
Duke University, Stanford University and the University
of Chicago, and as a visiting professor at Yale
University and at the Massachusetts Institute of
Technology. He is the Editor of The Journal of Fixed
Income. Dr. Breeden served as Associate Editor for five
journals in financial economics, and was elected to the
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. The address for Dr. Breeden is the same as that
of the Funds at 100 Europa Drive, Chapel Hill, North
Carolina, 27514.
Michael J. Giarla*
Trustee and President
22
Mr. Giarla, aged 41, is Chief Operating Officer,
President and Director of Smith Breeden Associates. He
also serves as a Director of Harrington Financial Group,
the holding company for Harrington Bank, F.S.B., of
Richmond, Indiana. Formerly Smith Breeden's Director
of Research, he was involved in research and
programming, particularly in the development and
implementation of models to evaluate and hedge
mortgage securities. He also consults with institutional
clients and conducts special projects. Before joining
Smith Breeden Associates, Mr. Giarla was a Summer
Associate in Goldman Sachs & Company's Equity
Strategy Group in New York. Mr. Giarla has published a
number of articles and book chapters regarding MBS
investment, risk management and hedging. He served as
an Associate Editor of The Journal of Fixed Income
from 1991-1993. Mr. Giarla holds a Master of Business
Administration with Concentration in Finance from the
Stanford University Graduate School of Business, where
he was an Arjay Miller Scholar. He earned a Bachelor of
Arts in Statistics, summa cum laude, from Harvard
University, where he was elected to Phi Beta Kappa and
was a Harvard Club of Boston Scholar. Mr. Giarla is a
Trustee of the Roxbury Latin School, West Roxbury,
Massachusetts. The address for Mr. Giarla is the same as
that of the Funds at 100 Europa Drive, Chapel Hill,
North Carolina, 27514
Stephen M. Schaefer Trustee
Stephen M. Schaefer, aged 52, is the Tokai Bank
Professor of Finance at the London Business School.
Previously on the Faculty of the Graduate School of
Business of Stanford University, he has also taught at
the Universities of California (Berkeley), Chicago,
British Columbia and Venice. His research interests
focus on capital markets and financial regulation. He
served on the editorial board of a number of professional
journals including, currently, The Journal of Fixed
Income, The Review of Derivative Research, and
Ricerche Economiche. He consults for a number of
leading financial institutions, including the Adviser, and
is a former Independent Board Member of the Securities
and Futures Authority of Great Britain. The address for
Dr. Schaefer is the same as that of the Funds at 100
Europa Drive, Chapel Hill, North Carolina, 27514.
Myron S. Scholes Trustee
Myron S. Scholes, aged 58, is the Frank E. Buck
Professor of Finance Emeritus at the Graduate School of
Business at Stanford University (since 1983). He is a
consultant to the Robert M. Bass organization. He is a
member of the Econometric Society. Professor Scholes
was formerly a limited partner and pricipal of Long
23
Term Capital Management (1993-1998). He 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). The address for Dr. Scholes is the same as that
of the Funds at 100 Europa Drive, Chapel Hill, North
Carolina, 27514.
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, aged 65, 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-
24
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. The address for Dr. Sharpe is the same
as that of the Funds at 100 Europa Drive, Chapel Hill,
North Carolina, 27514.
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 and has been
employed by Smith Breeden since 1986. 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 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
25
Timothy D. Rowe is a Principal, Director, and Vice
President of Smith Breeden Associates and has been
employed by Smith Breeden since 1988. Mr. Rowe, in
conjunction with Daniel C. Dektar, is responsible for the
day-to-day management of the Intermediate Fund, and
has been involved in managing the Fund since
December of 1997. 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
and has been employed by Smith Breeden since 1987.
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.
William F. Quinn
Vice President, Smith Breeden Trust
Portfolio Manager, Asian/Pacific Equity Market and
European Equity Market Funds
26
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. 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 Asian/Pacific Equity Market and
European Equity Market 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.
*Interested Person
Investment Adviser
Smith Breeden Associates, Inc., a registered
investment adviser, acts as investment adviser to the
Funds. Approximately 54% 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 the fiscal year ended
March 31, 1999, the Adviser was paid an advisory fee,
computed daily and payable monthly, based on a
percentage of average net assets as follows: 0.70% of
each of the Short, Intermediate, and, U.S. Equity Market
Plus Funds.
The Adviser places all orders for purchases and sales of
the Funds' securities. Subject to seeking the most
favorable price and execution available, the Adviser
may consider sales of shares of the Funds as a factor in
the selection of broker-dealers.
Distribution
First Data Distributors, Inc. (the "Principal
Underwriter") acts as 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
27
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, and a
fee of $8 may be charged when an account is closed. 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 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 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.
28
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 and Christmas Day. The Short and
Intermediate Bond 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 $ 1,000 $ 50
Automatic Investment None $ 50
Individual Retirement Account $ 250 $ 50
Gift to Minors $ 250 $ 50
The Funds reserve the right to deduct an annual
maintenance fee of $16 from accounts with a value of
less than $2,000. The fee applies to each account in each
fund that is of a value of less than $2,000 and is funded
by redeeming shares. It is expected that accounts will be
valued on the second Friday in September of each year.
The fee, which is payable to the transfer agent, is
designed to offset in part the relatively higher costs of
servicing smaller accounts.
29
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
211 South Gulph Road
P.O. Box 61767
King of Prussia, PA 19406
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:
Boston Safe Deposit & Trust
A.B.A. Number 011001234
For credit to (identify which Fund to purchase)
Account Number 011363
FBO (name or registration and account 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, 211 South Gulph Road, P.O. Box 61767, King of
Prussia, PA 19406. Shares will be redeemed with
Federal tax withheld if the Funds do not receive a
properly completed and executed Purchase Application.
30
Telephone Transactions. The privilege to initiate
redemption or exchange transactions by telephone is
made automatically available to shareholders when
opening an account, unless they indicate otherwise by
checking the appropriate boxes on the Purchase
Application. Each Fund will employ reasonable
procedures to ensure that instructions communicated by
telephone are genuine. If reasonable procedures are not
implemented, the Funds may be liable for any loss due
to unauthorized or fraudulent transactions. In all other
cases, you are liable for any loss due to unauthorized
transactions. The Funds reserve the right to refuse a
telephone transaction if they believe it is advisable to do
so.
If you have any questions, please call the Funds at 1-
800-221-3138.
How to Add to Your Account. You may make
additional investments by mail or by wire in an amount
equal to or greater than $50. When adding to an account
by mail, you should send the Funds your check, together
with the additional investment form from a recent
statement. If this form is unavailable, you should send a
signed note giving the full name of the account and the
account number. For additional investments made by
wire transfer, you should use the wiring instructions
listed above. Be sure to include your account number.
Automatic Investment Plan. You may make purchases
of shares of each Fund automatically on a regular basis
($50 minimum per transaction). You 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
31
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 $1,000 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.
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
32
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 211
South Gulph Road, P.O. Box 61767, 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.
33
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).
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, and a fee of $8 may be
charged when an account is closed. 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.
34
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.
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 charge an $8 fee when an
account is closed.
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.
35
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,
211 South Gulph Road, P.O. Box 61767, King of
Prussia, PA 19406.
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.
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 may not be
accepted for payment until 15 days after the account is
opened, if the shareholder opened the account by check.
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
36
agent for the check writing facility is Boston Safe
Deposit and Trust Company. Shareholders utilizing
check writing are subject to Boston Safe Deposit
Company'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.
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.
DIVIDENDS AND DISTRIBUTIONS
37
The Short and Intermediate Bond Funds intend to
pay monthly distributions to their shareholders of net
investment income. The U.S. Equity Market Plus,
Asia/Pacific Equity Market and European Equity Market
Funds intend to make quarterly distributions of net
investment income. All Funds will distribute net realized
gains at least annually. Each Fund may make additional
distributions if necessary to avoid imposition of a 4%
excise tax or other tax on undistributed income and
gains.
The monthly distributions for the Short Fund's shares
are quoted 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 Bond Fund will declare a daily
dividend for shareholders of record. The Intermediate
Fund's dividend payable date, and the day that dividends
are reinvested for shareholders who have made this
election, is the last business day of the month. Shares
begin accruing dividends on the business day after
federal funds (funds credited to a member bank's
account at the Federal Reserve Bank) are available from
the purchase payment for such shares, and continue to
accrue dividends through and including the day the
redemption order for the shares is executed. If an
investor closes his account, any accrued dividends
through and including the day of redemption will be
paid as part of the redemption proceeds.
Dividends and capital gains distributions may be
declared more or less frequently at the direction of the
Trustees. In order to be entitled to a dividend or a
distribution, an investor must acquire a Fund's shares on
or before the record date. Caution should be exercised,
however, before purchasing shares immediately prior to
a distribution record date. 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
38
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. Quarterly
statements will be sent to each shareholder. Additional
statements will only be sent if there is a direct purchase
or sale or if there is a cash dividend payment.
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, 211 South Gulph Road, P.O. Box 61767, King of
Prussia, PA 19406 or call 1-800-221-3137.
39
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. If your IRA account value is less than $10,000,
the $12 fee will automatically be deducted from your
account. To avoid having this fee taken from your
account, you may send a check for $12, postmarked no
later than August 31st. 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.
40
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 (generally taxed at a 20% rate in the
hands of non-corporate shareholders), regardless of how
long they have held their Fund shares. Each fund
provides federal tax information to its shareholders
annually about distributions paid during the preceding
year.
The use of certain synthetic instruments (including
certain futures contracts and options) by the U.S. Equity
Market Plus, Asian/Pacific Equity Market, and
European Equity Market Funds as a means of achieving
equity exposure in the Fund's market will require the
Fund to mark such instruments to market, a practice
which will accelerate the Fund's recognition of gain or
loss. With respect to such instruments, 60% of any gain
or loss recognized will be treated as long-term capital
gain or loss and 40% will be treated as short-term capital
gain or loss.
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,
only an insignificant amount of Funds' 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, or in certain other situations.
The foregoing is only a summary of some of the
important federal tax considerations generally affecting
41
each Fund and its shareholders. See "Taxes" in the
relevant Statement of Additional Information for further
discussion. There may be other foreign, 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.
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
42
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"), 211 South Gulph Road, P.O. Box
61767, King of Prussia, PA 19406, a wholly owned
subsidiary of First Data Corporation, which has its
principal place of business at 4400 Computer Drive,
Westborough, 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
The Short and Intermediate 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 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.
Further information on performance measurement may
be found in the relevant Statement of Additional
44
Information. The Asian/Pacific Equity Market 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 European
Equity Market 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, Switzerland, and the United
Kingdom).
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.
FINANCIAL HIGHLIGHTS
The financial highlights tables are intended to help you understand each Fund's
financial performance for the past 5 years or, if shorter, since the period
of the Fund's operations. Certain information reflects financial results for
a single Fund share. The total returns in the table represent the rate that an
investor would have earned or lost on an investment in the Fund (assuming
reinvestment of all dividends and distributions). This information has been
audited by Deloitte & Touche LLP, whose report, along with each Fund's
financial statements, are included in the annual report to shareholders,
which is available upon request.
45
<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 April 1, 1994 through March 31, 1999, 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
March 31, March 31, March 31, March 31, March 31,
1999 1998 1997 1996 1995
<S> <C> <C> <C> <C> <C>
Net Asset Value, $9.92 $9.83 $9.74 $9.90 $9.90
Beginning of Period....
Income From Investment
Operations
Net investment income.. 0.442 0.484 0.476 0.621 0.628
Net realized and
unrealized gain (loss) 0.020 0.114 0.146 (0.148) --
on investments.........
Total from investment 0.462 0.598 0.622 0.473 0.628
operations.............
Less Distributions
Dividends from net (0.447) (0.508) (0.476) (0.621) (0.628)
investment income......
Dividends in excess of
net investment income.. -- -- (0.056) (0.012) --
Total Distributions.... (0.447) (0.508) (0.532) (0.633) (0.628)
Net Asset Value, End of $9.94 $9.92 $9.83 $9.74 $9.90
Period.................
Total Return........... 4.83% 6.24% 6.57% 4.95% 6.58%
Ratios/Supplemental Data
Net assets, end of $60,807,449 $78,427,855 $118,988,609 $221,825,136 $218,431,665
period.................
Ratio of expenses to
average net assets
Before expense 1.00% 1.00% 0.93% 0.93% 0.92%
limitation.............
After expense 0.78% 0.78% 0.78% 0.78% 0.78%
limitation.............
Ratio of net income to
average net assets
Before expense 4.56% 5.06% 4.90% 6.13% 6.18%
limitation.............
After expense 4.78% 5.28% 5.04% 6.29% 6.33%
limitation.............
Portfolio turnover 298% 626% 556% 225% 47%
rate...................
</TABLE>
Additional performance information is presented in the Short Fund's Annual
Report, which is available without charge upon request.
46
<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 April 1, 1994 through March 31, 1999, 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
March 31, March 31, March 31, March 31, March 31,
1999 1998 1997 1996 1995
<S> <C> <C> <C> <C> <C>
Net Asset Value, $10.00 $9.73 $10.01 $9.83 $10.01
Beginning of Period....
Income From Investment
Operations
Net investment income.. 0.525 0.590 0.599 0.660 0.664
Net realized and
unrealized gain (loss) 0.030 0.419 (0.024) 0.277 (0.049)
on investments.........
Total from investment 0.555 1.009 0.575 0.937 0.615
operations..........
Less Distributions
Dividends from net (0.515) (0.561) (0.604) (0.656) (0.664)
investment income.....
Dividends in excess of
net investment income.. ---- ---- ---- ---- (0.108)
Distributions from net
realized gains on (0.130) (0.178) (0.251) (0.101) --
investments............
Distributions in excess
of net realized gains -- -- -- -- (0.022)
on investments.........
Total Distributions.... (0.645) (0.739) (0.855) (0.757) (0.794)
Net Asset Value, End of $9.91 $10.00 $9.73 $10.01 $9.83
Period...............
Total 5.73% 10.65% 5.92% 9.69% 6.10%
Return.................
Ratios/Supplemental
Data
Net assets, end of $55,125,797 $38,641,879 $37,735,525 $36,446,940 $34,797,496
period.................
Ratio of expenses to
average net assets
Before expense 1.06% 1.13% 1.16% 1.14% 2.33%
limitation.............
After expense 0.88% 0.88% 0.88% 0.90% 0.90%
limitation.............
Ratio of net income to
average net assets
Before expense 5.08% 5.36% 5.92% 6.26% 4.77%
limitation.............
After expense 5.25% 5.61% 6.19% 6.49% 6.20%
limitation.............
47
Portfolio turnover rate 423% 583% 409% 193% 557%
rate...................
</TABLE>
Additional performance information is presented in the Intermediate Fund's
Annual Report, which is available without charge upon request.
<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 April 1, 1994 through March 31, 1999, 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>
<S>
Year Ended Year Ended Year Ended Year Ended Year Ended
March 31, March 31, March 31, March 31, March 31,
1999 1998 1997 1996 1995
<C> <C> <C> <C> <C>
Net Asset Value, $16.86 $12.56 $12.27 $10.84 $9.88
Beginning of Period....
Income From Investment
Operations
Net investment 0.686 0.591 0.592 0.615 0.568
income.................
Net realized and
unrealized gain (loss) (1.765) 4.940 1.813 2.768 1.081
on
investments............
Total from investment 2.451 5.531 2.405 3.383 1.649
operations..........
Less Distributions
Dividends from net (0.624) (0.586) (0.590) (0.583) (0.568)
investment income.....
Dividends in excess of
net investment -- -- -- -- (0.001)
income.................
Distributions from net
realized gains on (1.905) (0.645) (1.525) (1.370) (0.047)
investments............
Distributions in excess
of net realized gains -- -- -- -- (0.073)
on
investments............
Total (2.529) (1.231) (2.115) (1.953) (0.689)
Distributions..........
Net Asset Value, End of $16.78 $16.86 $12.56 $12.27 $10.84
Period...............
Total 17.17% 45.71% 21.41% 32.30% 17.18%
Return.................
Ratios/Supplemental
Data
Net assets, end of $185,584,121 $136,667,439 $13,507,377 $4,766,534 $2,107,346
period..................
48
Ratio of expenses to
average net assets
Before expense 1.04% 1.23% 2.60% 4.58% 7.75%
limitation............
After expense 0.88% 0.88% 0.88% 0.90% 0.90%
limitation.............
Ratio of net income to
average net assets
Before expense 4.45% 4.44% 3.58% 1.85% 0.59%
limitation.............
After expense 4.62% 4.79% 5.30% 5.53% 7.44%
limitation.............
Portfolio turnover 527% 424% 182% 107% 120%
rate...................
</TABLE>
Additional performance information is presented in the Fund's Annual Report,
which is available without charge upon request.
[Back Cover]
SMITH BREEDEN MUTUAL FUNDS
The Statement of Additional Information ("SAI") and annual and
semi-annual reports to shareholders for each of the Smith Breeden
Series Fund and the Smith Breeden Trust include additional
information about the Funds. The SAIs and the financial
statements included in the Funds' most recent annual report to
shareholders are incorporated by reference into (legally a part
of) this Prospectus. You may get free copies of any of these
materials, request other information about the Funds and make
shareholder inquires by calling 1-800-221-3138 of by visiting the
Funds' website (www.smithbreeden.com).
You can review, for a fee, the reports of the Funds and the SAIs
by writing to the Public Reference Section of the Securities and
Exchange Commission, Washington, D.C. 20459-60091, or by calling
the SEC at 1-800-SEC-0330. You can get copies of thus
information for free on the SEC's Internet site (www.sec.gov).
49
Part B: Information Required in
Statement of Additional Information
N-1A
Item No. Item Location in the
Registration Statement
10. Cover Page and Cover Page and
Table of Contents Table of Contents
11. Fund History See Part A, Item 6
12. Description of the Miscellaneous
Fund and Its Investments Investment Practices and
and Risks Risk Considerations;
Investment Restrictions
of the Funds; Hedging
and Other Strategies
Using Derivative Contracts
13. Management of the Management of the
Fund Funds
14. Control Persons and Principal Holders of
Principal Holders of Securities and
Securities Controlling Persons
15. Investment Advisory The Investment Advisory
and Other Services Agreement and Other
Services
16. Brokerage Allocation The Investment Advisory
and Other Practices Agreement and Other
Services
17. Capital Stock and Additional Information
Other Securities Regarding Purchases and
Redemptions of Fund
Shares
18. Purchase, Redemption Additional Information
and Pricing of Regarding Purchases and
Securities Being Redemptions of Fund
Offered Shares
19. Taxation of the Fund Taxes
20. Underwriters Additional Information
Regarding Purchases and
and Redemptions of Fund
Shares
21. Calculation of Standard Performance
Performance Data Measures
22. Financial Statements Experts; Financial
Statements
SMITH BREEDEN TRUST
SMITH BREEDEN U.S. EQUITY MARKET PLUS FUND
SMITH BREEDEN ASIAN/PACIFIC EQUITY MARKET FUND
SMITH BREEDEN EUROPEAN EQUITY MARKET FUND
(the "Funds")
STATEMENT OF ADDITIONAL INFORMATION
JULY 31, 1999
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 July 31, 1999 as may be amended from time
to time. The Statement should be read
together with the Prospectus.
Contents Page
DEFINITIONS................................................... 2
INVESTMENT RESTRICTIONS OF THE FUNDS.......................... 2
MISCELLANEOUS INVESTMENT PRACTICES AND RISK CONSIDERATIONS.... 3
HEDGING AND OTHER STRATEGIES USING DERIVATIVE CONTRACTS....... 8
TAXES......................................................... 12
FUND CHARGES AND EXPENSES..................................... 14
MANAGEMENT OF THE FUNDS....................................... 14
THE INVESTMENT ADVISORY AGREEMENT AND OTHER SERVICES.......... 15
PRINCIPAL HOLDERS OF SECURITIES AND CONTROLLING PERSONS....... 18
DETERMINATION OF NET ASSET VALUE.............................. 18
ADDITIONAL INFORMATION REGARDING PURCHASES AND REDEMPTIONS OF
FUND SHARES................................................... 19
SHAREHOLDER INFORMATION....................................... 20
SUSPENSION OF REDEMPTIONS..................................... 20
SHAREHOLDER LIABILITY......................................... 20
STANDARD PERFORMANCE MEASURES................................. 20
EXPERTS....................................................... 22
FINANCIAL STATEMENTS.......................................... 22
1
SMITH BREEDEN TRUST
SMITH BREEDEN U.S. EQUITY MARKET PLUS FUND
SMITH BREEDEN ASIAN/PACIFIC EQUITY MARKET FUND
SMITH BREEDEN EUROPEAN EQUITY MARKET 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": First Data Distributors, Inc.
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
2
none of such transactions or
arrangements nor obligations of the Fund to Trustees pursuant to deferred
compensation arrangements are
deemed to be the issuance of a senior security.
2. Act as underwriter except to the extent that, in connection with
the disposition of portfolio securities, it may
be deemed to be an underwriter under certain federal securities laws.
3. 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:
3
1. 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.
In addition to the items listed above, the U.S. Equity Market Plus Fund,
the European Equity Market Fund and the
Asian/Pacific Equity Market 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.
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
4
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.
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.
5
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. 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
6
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.
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 European Equity and Asian/Pacific Equity
Market 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
7
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 be more
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.
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 in return 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
8
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.
Corporate Debt Securities. The 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.
Restricted Securities. The 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.
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
9
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.
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
10
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.
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
11
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 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.
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
12
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.
13
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.
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. The potential losses from investment
in futures contracts is unlimited.
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
14
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.
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.
15
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.
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
16
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.
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
17
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. The Funds thus assume the risk that
one of them 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
18
and foreign currencies, or other income
(including but not limited to gains from options, futures,
or forward contracts) derived with respect
to its business of investing in such stock, securities, or
currencies;
(b) distribute with respect to each taxable year at
least 90% 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 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
Fund intends 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.
19
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 or loss realized upon a taxable disposition of shares
will be treated as long-term capital gain or loss
if the shares have been held for more than a year. Otherwise the gain
or loss on the sale, exchange, or redemption of
Fund shares generally 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, convert long-term
capital gains into short-term capital gains, 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.
"Constructive sale" provisions apply to activities by a Fund which
lock-in gain on an "appreciated financial
position." Generally, a "position" is defined to include stock, a
debt instrument, or partnership interest, or an interest
in any of the foregoing, including through a short sale, a swap
contract, or a future or forward contract. The entry
into a short sale, a swap contract or a future or forward contract
relating to an appreciated direct position in any stock
or debt instrument, or the acquisition of stock or debt instrument
at a time when the Fund occupies an offsetting
20
(short) appreciated position in the stock or debt instrument, is
treated as a "constructive sale" that gives rise to the
immediate recognition of gain (but not loss). The application of
these new provisions may cause a Fund to recognize
taxable income from these offsetting transactions in excess of the
cash generated by such activities.
In addition, a Fund's use of derivative instruments (such as futures
and options) may cause the Fund to realize greater
amounts of short-term capital gains (generally taxed at ordinary
income tax rates) than it would realize if it did not
use such instruments.
THE TAX DISCUSSION SET FORTH ABOVE IS A SUMMARY INCLUDED FOR
GENERAL INFORMATION
PURPOSES ONLY. EACH SHAREHOLDER IS ADVISED TO CONSULT ITS OWN TAX
ADVISER WITH
RESPECT TO THE SPECIFIC TAX CONSEQUENCES TO IT OF AN INVESTMENT IN A
FUND,
INCLUDING THE EFFECT AND APPLICABILITY OF STATE, LOCAL, FOREIGN, AND
OTHER TAX LAWS
AND THE POSSIBLE EFFECTS OF CHANGES IN FEDERAL OR OTHER TAX LAWS.
THIS DISCUSSION IS
NOT INTENDED AS A SUBSTITUTE FOR CAREFUL TAX PLANNING.
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 Fund. Advisory fees paid by the Funds for the past three
fiscal years are as follows.
Advisory Fees Paid by Funds
U.S. Equity Asian/Pacific European
Fiscal Year Market Plus Equity Market Equity Market
Ended Fund Fund Fund
March 31, 1999 $1,090,372 N/A* N/A*
March 31, 1998 $ 423,706 N/A* N/A*
March 31, 1997 $ 53,341 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 Fund
Fiscal Year U.S. Equity Asian/Pacific European
Ended Market Plus Equity Market Equity Market
Fund Fund Fund Fund
March 31, 1999 $ 251,051 N/A* N/A*
March 31, 1998 $ 215,049 N/A* N/A*
March 31, 1997 $ 131,965 N/A* N/A*
21
The Asian/Pacific Equity Market, and European Equity Market Funds
each commenced operations October 15, 1998
and to date, neither Fund has paid advisory fees or been reimbursed
by the Adviser.
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
First Data Investor 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, 1999 and total fees paid by the entire Fund complex for
the fiscal year ended March 31, 1999.
There are two other funds in the complex besides the Funds of the
Smith Breeden Trust.
Total Compensation Paid to Independent Trustees by the Funds
U.S. Equity Asian/Pacific European Entire Smith
Trustee Market Equity Market Equity Market Breeden Fund
Plus Fund Fund Fund Complex
Stephen M. Schaefer $ 35,000.00 $ 0.00* $ 0.00* $ 70,000.00
Myron S. Scholes $ 0.00 $ 0.00* $ 0.00* $ 70,000.00
William F. Sharpe $ 70,000.00 $ 0.00* $ 0.00* $ 70,000.00
*The Asian/Pacific Equity Market and European Equity Market Funds
each commenced operations October 15,
1998 and, as such, have not yet made any compensation to the
Independent Trustees. Both of these Funds expects to
pay approximately $300 to each Trustee listed above prior to
March 31, 2000.
22
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.
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
23
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".
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
24
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.
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.
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,
25
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:
U.S. Equity Asian/Pacific European
Fiscal Year Market Plus Equity Market Equity Market
Ended Fund Fund Fund
March 31, 1999 $ 48,899 $ 0.00 $ 0.00
March 31, 1998 $ 26,251 N/A* N/A*
March 31, 1997 $ 3,000 N/A* N/A*
*The Asian/PacificEquity Market and European Equity Market Funds
each commenced operations October 15,
1998, and, to date, have paid no 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.
Consistent with the Rules of Fair Practice of the National
Association of Securities Dealers, Inc. and subject to
26
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 June 30, 1999, owned 5% or more of the shares of the Fund.
27
Charles Schwab & Co.
For the Beneficial Ownership of Its Accountholders
101 Montgomery Street
San Francisco, CA 94104 51.39%
Each Fund Trustee owns less than 1% of the shares of the U.S. Equity
Market Plus Fund as of June 30, 1999.
The Asian/Pacific Equity Market and European Equity Market Funds
commenced operations October 15, 1998,
and, as of April 30, 1999, do not 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
28
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 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 will be valued
at their fair market value following procedures approved
by the Trustees.
ADDITIONAL INFORMATION REGARDING PURCHASES
AND REDEMPTIONS OF FUND SHARES
All checks, drafts, wires and other payment mediums used for
purchasing or redeeming shares of 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.
29
Principal Underwriter. First Data Distributors, Inc.
(the "Principal Underwriter"), 4400 Computer Drive,
Westborough, MA 01581, is the principal underwriter for the
Funds and is acting on a best efforts basis. First Data
Distributors, Inc. is registered as a broker-dealer under the
Securities Exchange Act of 1934 and is a member of the
National Association of Securities Dealers, Inc.
The offering of the Funds' shares is continuous.
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 of the 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
Quarterly statements will be sent to each shareholder. In addition,
each time shareholders directly purchase or
redeem shares or receive a cash distribution, they will receive a
statement confirming the transaction and listing their
current share balance. Direct purchases and redemptions do not
include automatic investment plan purchases or
systematic withdrawal plan redemptions. 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
30
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.
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, 1999.
Average Annual Total Return
One Year Five Years Inception
U.S. Equity Market Plus Fund 17.17% 26.30% 21.99%
The U.S. Equity Market Plus Fund commenced operations June 30, 1992.
31
The Asian/Pacific Equity Market and European Equity Market Funds
commenced operations October 15, 1998,
and, to date, there is no 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.
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.
32
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) 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.
i) Lehman Brothers Government/Corporate Bond Index.
j) 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.
k) 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.
l) Donoghues's Money Fund Report--industry averages for seven-day
annualized and compounded yields
taxable, tax-free and government money funds.
m) Total returns and yields for Treasury Securities and fixed income
indices as published by Ryan Laboratories
or other suppliers.
n) Average of competitive funds as published by Lipper Analytical
Services, Inc.
o) 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.
p) 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).
q) The Keefe Bruyette & Woods Index.
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
33
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.
EXPERTS
The annual financial statements of the U.S. Equity Market Plus Fund
and related notes thereto attached to this
Statement of Additional Information have been so attached in reliance
upon the report of Deloitte & Touche LLP,
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, 1999.
SMITH BREEDEN TRUST
Smith Breeden U.S. Equity Market Plus Fund
FINANCIAL STATEMENTS
Fiscal Year Ended March 31, 1999
34
SMITH BREEDEN U.S. EQUITY MARKET PLUS FUND
- --------------------------------------------------------------------------------
PERFORMANCE REVIEW
The Smith Breeden U.S. Equity Market Plus Fund returned 17.17% in the year
ending March 31, 1999. The S&P 500 Index return was 18.49%, and the average
Growth and Income Fund, as tracked by Morningstar, returned 7.42%, over the
same period.
[GRAPHIC APPEARS HERE WITH THE FOLLOWING PLOT POINTS:]
CHANGE IN VALUE OF A $10,000 INVESTMENT
<TABLE>
<CAPTION>
12/22/97 12/31/97 03/31/98 06/30/98 09/30/98 12/31/98 03/31/99
-------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Smith Breeden Financial Services Fund(1) 10,000 10,100 11,178 11,149 8,135 9,614 9,972
Morningstar Avg. Financial Services Fund 10,000 10,201 11,247 11,421 9,207 10,783 11,067
S&P 500 10,000 10,181 11,601 11,984 10,794 13,093 13,746
- ------------
(1) Fund Returns are net fees and sales charges. Index returns are market returns without deduction of fees
or rebalancing transaction costs.
Past performance is no guarantee of future results.
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS
ENDING MARCH 31, 1999
-----------------------------------------
SINCE INCEPTION FINAL VALUE OF
1 YEAR 5 YEARS (6/30/92) $10,000 INVESTMENT
----------- ----------- ----------------- -------------------
<S> <C> <C> <C> <C>
Smith Breeden U.S. Equity Market Plus Fund 17.17% 26.30% 21.99% $38,263
S&P 500 ................................... 18.49% 26.26% 21.30% 36,808
Morningstar Avg. Growth and Income Fund ... 7.42% 20.31% 17.34% 29,432
</TABLE>
The U.S. Equity Fund is comprised of two segments. The equity segment
purchases S&P 500 futures contracts with a total value approximately equal to
Fund net assets. S&P 500 futures contracts have a price at expiration equal to
the value of the S&P Index at that time. Prior to expiration, S&P 500 index
futures are usually priced at the value of the S&P Index at such time, plus a
spread representing the funding cost paid by buyers of futures to sellers of
futures. The income segment invests in mortgage securities, and then reduces
the interest-rate and prepayment risk to a low level using interest-rate
futures and options. The income segment of the fund aims to exceed the funding
cost of the S&P 500 futures plus the Fund's operating expenses.
In the year ending March 31, 1999 the fixed income segment underperformed
the implied funding cost of the S&P 500 futures contracts by about 1.3% after
expenses. This was primarily due to the period from August to October 1998,
when the international financial crisis caused much turmoil in bond and equity
markets. The Fund benefited in the first quarter of 1999 from lower interest
rate volatility and reduced prepayment expectations, which caused mortgage
securities to outperform comparable Treasury securities, and in this period,
despite slowly rising interest rates, the fund outperformed the S&P 500 by
0.5%.
<PAGE>
SMITH BREEDEN U.S. EQUITY MARKET PLUS FUND
- --------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS MARCH 31, 1999
<TABLE>
<CAPTION>
MARKET
FACE AMOUNT SECURITY VALUE
- -------------- ---------------------------------------------------------------------------------- --------------
<S> <C> <C>
U.S. GOVERNMENT & AGENCY OBLIGATIONS -- 124.0%
FREDDIE MAC -- 56.5% (1)
Fixed-Rate
$ 19,965,620 Gold 6.00%, due 1/1/29 ........................................................... $ 19,419,931
19,000,000 Gold 6.00% 15 Year, due date to be announced ..................................... 18,873,086
63,900,000 Gold 6.50% 30 Year, due date to be announced ..................................... 63,533,074
38,386 9.50%, due 7/1/02 ................................................................ 39,331
Discount Notes
100,000 4.79%, due 5/7/99 (2),(3) ........................................................ 99,526
600,000 4.79%, due 5/20/99 (2),(3) ....................................................... 596,129
1,700,000 4.80%, due 5/26/99 (2),(3) ....................................................... 1,687,663
600,000 4.98%, due 4/19/99 (2),(3) ....................................................... 598,536
------------
104,847,276
------------
FANNIE MAE -- 43.2% (1)
Fixed-Rate
55,000,000 6.00%, due 5/1/28 to 3/1/29 ...................................................... 53,454,635
9,700,000 6.50% 30 Year, due date to be announced .......................................... 9,651,500
14,876,563 7.00%, due 8/1/11 to 11/1/28 ..................................................... 15,154,877
1,250,000 7.00% 30 Year, due date to be announced .......................................... 1,267,383
64,994 12.50%, due 9/1/12 ............................................................... 73,588
Adjustable-Rate
325,363 7.277%, due 9/1/18 ............................................................... 334,330
Discount Notes
200,000 4.81%, due 7/2/99 (2),(3) ........................................................ 197,507
100,000 5.00%, due 10/29/99 (2),(3) ...................................................... 97,193
------------
80,231,013
------------
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION -- 20.0% (1)
Fixed-Rate
4,820,668 7.00%, due 3/15/28 ............................................................... 4,897,596
Adjustable-Rate
24,504,314 5.00%, due 1/20/28 to 3/20/28 .................................................... 24,818,325
4,471,040 5.50%, due 3/20/28 ............................................................... 4,532,999
137,378 6.625%, due 9/20/21 to 9/20/22 ................................................... 140,230
2,621,396 6.875%, due 2/20/16 to 5/20/22 ................................................... 2,670,393
------------
37,059,543
------------
U.S. TREASURY OBLIGATIONS -- 4.3%
1,700,000 5.875% Note, due 7/31/99(3) ...................................................... 1,706,906
6,250,000 6.375% Note, due 5/15/99(3) ...................................................... 6,262,695
------------
7,969,601
------------
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(COST $230,560,698)............................................................... 230,107,433
------------
CONTRACTS OPTIONS CONTRACTS -- 0.2%
- ------------
142 Call on Ten-Year US Treasury Note Futures, expires 8/99, strike price $118........ 51,031
40 Call on Thirty-Year US Treasury Bond Futures, expires 5/99, strike price $136..... 625
150 Call on Thirty-Year US Treasury Bond Futures, expires 5/99, strike price $142..... 2,344
415 Put on Thirty-Year US Treasury Bond Futures, expires 8/99, strike price $114...... 272,344
------------
TOTAL OPTIONS CONTRACTS (COST $1,356,144)......................................... 326,344
------------
</TABLE>
<PAGE>
SMITH BREEDEN U.S. EQUITY MARKET PLUS FUND
- --------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS (CONTINUED) MARCH 31, 1999
<TABLE>
<CAPTION>
MARKET
FACE AMOUNT SECURITY VALUE
- ---------------- ------------------------------------------------------------------------------- ----------------
<S> <C> <C>
OPTION CONTRACTS ON THREE-MONTH LIBOR INTEREST-RATE SWAP
AGREEMENTS -- 0.6%
$ 30,000,000 Option to enter a pay-fixed 6.5% interest-rate swap with Deutsche Bank AG
beginning 9/29/03 and expiring 9/29/08 ........................................ $ 762,697
30,000,000 Option to enter a receive-fixed 5.25% interest-rate swap with Deutsche Bank
AG beginning 9/29/03 and expiring 9/29/08 ..................................... 361,239
-------------
TOTAL OPTION CONTRACTS ON THREE-MONTH LIBOR INTEREST-RATE
SWAP AGREEMENTS (COST $1,356,144).............................................. 1,123,936
COMMERCIAL MORTGAGE-BACKED SECURITIES -- 7.8% (1)
5,000,000 First Union-Lehman Brothers-Bank of America Commercial Mortage Trust
6.56%, due 11/18/08 ........................................................... 5,063,332
5,500,000 GMAC Commercial Mortgage Securities 6.42%, due 8/15/08 ........................ 5,518,850
4,000,000 Nomura Asset Securities Corporation Commercial Mortgage Trust 6.59%,
due 3/17/28 ................................................................... 4,014,298
-------------
TOTAL COMMERCIAL MORTGAGE-BACKED SECURITIES
(COST $14,714,492)............................................................. 14,596,480
-------------
TOTAL INVESTMENTS (COST $246,631,334)--132.6%.................................. 246,154,193
-------------
REPURCHASE AGREEMENTS -- 17.0%
27,500,000 Morgan Stanley Dean Witter, 4.83%, due 04/01/99 dated 03/25/99 ................ 27,500,000
4,000,000 Morgan Stanley Dean Witter, 4.88%, due 04/05/99 dated 03/29/99 ................ 4,000,000
-------------
31,500,000
-------------
FORWARD SALES -- (28.8%)
(55,000,000) Fannie Mae 6.00%, due date to be announced (4) ................................ (53,440,234)
-------------
(53,440,234)
-------------
LIABILITIES LESS CASH AND OTHER ASSETS -- (20.8%) ............................. (38,629,838)
-------------
NET ASSETS -- 100.00% ......................................................... $ 185,584,121
=============
</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. Adjustable-rate mortgages have coupon rates that adjust
periodically. The interest rate shown is the rate in effect at March 31,
1999. The adjusted rate is determined by adding a spread to a specified
index.
(2) The interest rate shown for discount notes is the discount rate paid at the
time of purchase by the fund.
(3) Security is held as collateral by Carr Futures, Inc.
(4) The forward sale position represents the unsettled sale of securities held
by the Fund.
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN U.S. EQUITY MARKET PLUS FUND
- --------------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES MARCH 31, 1999
<TABLE>
<S> <C>
ASSETS
Investments at market value (identified cost $246,631,334) (Note 1)...................... $ 246,154,193
Cash .................................................................................... 2,687,349
Repurchase agreements (Cost $31,500,000) (Note 1)........................................ 31,500,000
Receivables:
Subscriptions ......................................................................... 434,172
Interest and maturities ............................................................... 1,166,636
Securities sold ....................................................................... 117,419,101
-------------
TOTAL ASSETS .......................................................................... 399,361,451
-------------
LIABILITIES
Short sales at market value (proceeds $53,401,563)....................................... 53,440,234
Payables:
Variation margin on futures contracts (Note 2) ........................................ 2,905,661
Redemptions ........................................................................... 267,137
Securities purchased .................................................................. 156,924,382
Due to Advisor (Note 3) ................................................................. 112,703
Accrued expenses ........................................................................ 127,213
-------------
TOTAL LIABILITIES ..................................................................... 213,777,330
-------------
NET ASSETS
(Applicable to outstanding shares of 11,058,974; unlimited number of shares of beneficial
interest authorized; no stated par) ................................................... $ 185,584,121
=============
Net asset value, offering price and redemption price per share ($185,584,121 /
11,058,974)............................................................................. $ 16.78
SOURCE OF NET ASSETS
Paid in capital ......................................................................... $ 168,177,438
Undistributed net investment income ..................................................... 1,113,690
Accumulated net realized gain on investments and futures contracts ...................... 15,225,816
Net unrealized depreciation of investments .............................................. (515,812)
Net unrealized appreciation of futures contracts ........................................ 1,582,989
-------------
NET ASSETS ............................................................................ $ 185,584,121
=============
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN U.S. EQUITY MARKET PLUS FUND
- --------------------------------------------------------------------------------
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1999
<TABLE>
<S> <C>
INVESTMENT INCOME
Interest and discount earned, net of premium amortization and interest expense ($10,148)
(Note 1) .............................................................................. $ 8,548,332
EXPENSES
Advisory fees (Note 3) .................................................................. 1,090,372
Accounting and pricing services fees .................................................... 61,513
Custodian fees........................................................................... 46,928
Audit and tax preparation fees .......................................................... 49,057
Legal fees .............................................................................. 49,383
Transfer agent fees ..................................................................... 156,367
Registration fees ....................................................................... 47,991
Trustees fees and expenses .............................................................. 99,339
Insurance expense ....................................................................... 11,698
Other ................................................................................... 9,157
------------
TOTAL EXPENSES BEFORE REIMBURSEMENT ................................................... 1,621,805
Expenses reimbursed by Advisor (Note 3) ............................................... (251,051)
------------
NET EXPENSES .......................................................................... 1,370,754
------------
NET INVESTMENT INCOME ................................................................. 7,177,578
------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS
Net realized gain on investments ........................................................ 24,541,887
Change in unrealized depreciation of investments and futures contracts .................. (8,018,115)
------------
Net realized and unrealized gain on investments and futures contracts ................... 16,523,772
------------
Net increase in net assets resulting from operations .................................... $ 23,701,350
============
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN U.S. EQUITY MARKET PLUS FUND
- --------------------------------------------------------------------------------
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
MARCH 31, 1999 MARCH 31, 1998
---------------- ---------------
<S> <C> <C>
OPERATIONS
Net investment income .................................................... $ 7,177,578 $ 2,908,437
Net realized gain on investments ......................................... 24,541,887 9,514,596
Change in unrealized appreciation (depreciation) of investments .......... (8,018,115) 9,573,592
------------- -------------
Net increase in net assets resulting from operations ..................... 23,701,350 21,996,625
------------- -------------
DISTRIBUTIONS TO SHAREHOLDERS
Dividends from net investment income ..................................... (6,376,285) (2,632,273)
Distributions from net realized gains on investments ..................... (17,138,874) (2,556,880)
------------- -------------
Total distributions ...................................................... (23,515,159) (5,189,153)
------------- -------------
CAPITAL SHARE TRANSACTIONS
Shares sold .............................................................. 114,008,937 123,373,056
Shares issued on reinvestment of distributions ........................... 22,832,882 4,918,950
Shares redeemed .......................................................... (88,111,328) (21,939,416)
------------- -------------
Increase in net assets resulting from capital share transactions (a) ..... 48,730,491 106,352,590
------------- -------------
TOTAL INCREASE IN NET ASSETS ........................................... 48,916,682 123,160,062
NET ASSETS
Beginning of period ...................................................... 136,667,439 13,507,377
------------- -------------
End of period ............................................................ $ 185,584,121 $ 136,667,439
============= =============
(a) Transactions in capital shares were as follows:
Shares sold .............................................................. 7,288,068 8,130,007
Shares issued on reinvestment of distributions ........................... 1,546,502 330,714
Shares redeemed .......................................................... (5,883,230) (1,428,596)
------------- -------------
Net increase ............................................................. 2,951,340 7,032,125
Beginning balance ........................................................ 8,107,634 1,075,509
------------- -------------
Ending balance ........................................................... 11,058,974 8,107,634
============= =============
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN U.S. 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
ENDED ENDED ENDED ENDED ENDED
MARCH 31, 1999 MARCH 31, 1998 MARCH 31, 1997 MARCH 31, 1996 MARCH 31, 1995
---------------- ---------------- ---------------- ---------------- ---------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF
PERIOD ............................ $ 16.86 $ 12.56 $ 12.27 $ 10.84 $ 9.88
----------- ----------- ---------- --------- ---------
INCOME FROM INVESTMENT
OPERATIONS
Net investment income ............. 0.686 0.591 0.592 0.615 0.568
Net realized and unrealized
gain (loss) on investments ...... 1.765 4.940 1.813 2.768 1.081
------------ ------------ ----------- ---------- ----------
Total from investment
operations ...................... 2.451 5.531 2.405 3.383 1.649
------------ ------------ ----------- ---------- ----------
LESS DISTRIBUTIONS
Dividends from net investment
income .......................... ( 0.624) ( 0.586) ( 0.590) ( 0.583) ( 0.568)
Dividends in excess of net
investment income ............... -- -- -- -- ( 0.001)
Distributions from net realized
gains on investments ............ ( 1.905) ( 0.645) ( 1.525) ( 1.370) ( 0.047)
Distributions in excess of net
realized gains on
investments ..................... -- -- -- -- ( 0.073)
------------ ------------ ----------- ---------- ----------
Total distributions ............... ( 2.529) ( 1.231) ( 2.115) ( 1.953) ( 0.689)
------------ ------------ ----------- ---------- ----------
NET ASSET VALUE, END OF
PERIOD ............................ $ 16.78 $ 16.86 $ 12.56 $ 12.27 $ 10.84
------------ ------------ ----------- ---------- ----------
TOTAL RETURN ....................... 17.17% 45.71% 21.41% 32.30% 17.18%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period ......... $185,584,121 $136,667,439 $13,507,377 $4,766,534 $2,107,346
Ratio of net expenses to
average net assets .............. 0.88% 0.88% 0.88% 0.90% 0.90%
Ratio of net investment
income to average net
assets .......................... 4.62% 4.79% 5.30% 5.53% 7.44%
Portfolio turnover rate ........... 527% 424% 182% 107% 120%
Ratio of expenses to average
net assets before
reimbursement of expenses
by the Advisor .................. 1.04% 1.23% 2.60% 4.58% 7.75%
Ratio of net investment
income to average net
assets before
reimbursement of expenses
by the Advisor .................. 4.45% 4.44% 3.58% 1.85% 0.59%
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
The Board of Trustees and Shareholders,
Smith Breeden U.S. Equity Market Plus Fund of the Smith Breeden Trust:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of the Smith Breeden U.S. Equity Market
Plus Fund (formerly "Smith Breeden Equity Market Plus" Fund) of the Smith
Breeden Trust (the "Fund") as of March 31, 1999, and the related statement 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, 1999 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 U.S. Equity Market Plus Fund of the Smith
Breeden Trust as of March 31, 1999, 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 14, 1999
<PAGE>
SMITH BREEDEN FINANCIAL SERVICES FUND
- --------------------------------------------------------------------------------
PERFORMANCE REVIEW
Financial services funds significantly lagged the Standard and Poor's 500
stock index in performance in the year ended March 31, 1999, as Morningstar's
average financial services fund index returned -1.6%, while the S&P 500
returned +18.5%. The Smith Breeden Financial Services Fund lagged both of these
averages with a return of -10.8%. The graph below shows these results for the
year.
[GRAPHIC APPEARS HERE WITH THE FOLLOWING PLOT POINTS:]
CHANGE IN VALUE OF A $10,000 INVESTMENT
<TABLE>
<CAPTION>
10/15/98 10/31/98 11/30/98 12/31/98 01/31/99 02/26/99 03/31/99
-------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Smith Breeden High Yield Bond Fund 10,000 10,057 10,218 10,133 10,143 10,029 10,039
Merrill Lynch High Yield 175 Index 10,000 10,319 10,855 10,802 11,014 10,903 11,012
Morningstar Avg. High Yield Bond Fund 10,000 10,234 10,785 10,746 10,903 10,875 11,036
- ------------
(1) Fund Returns are net fees and sales charges. Index returns are market returns without deduction of fees
or rebalancing transaction costs.
Past performance is no guarantee of future results.
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL
RETURNS FOR PERIODS ENDING
MARCH 31, 1999
------------------------------
SINCE INCEPTION FINAL VALUE OF
1 YEAR (12/22/97) $10,000 INVESTMENT
------------ ----------------- -------------------
<S> <C> <C> <C>
Smith Breeden Financial Services Fund ........ -10.79% -0.22% $ 9,972
S&P 500 ...................................... 18.49% 28.44% 13,746
Morningstar Avg. Financial Services Fund ..... -1.60% 8.30% 11,067
</TABLE>
Our fund lagged the average financial services fund for two reasons: (1)
leverage and (2) overweighting of small capitalization (less than $200 million)
banks and thrifts, as well as some mid-sized takeover candidates. We will
discuss each of these factors in turn and then comment on the global
environment that caused the entire financial sector to lag the S&P 500 in
performance.
First, our fund employs some leverage, which averaged $1.19 of assets
purchased per $1.00 invested in the fund. As noted, the average financial
services fund lagged the S&P 500 by -20.1%, which means that 19% leverage in a
typical financial services portfolio resulted in incremental negative
performance of 0.19 times -20.1% = -3.8%. Leverage is a two-edged sword: when
financial services stocks underperform the S&P, leverage will hurt performance,
whereas it helps performance when financial services stocks outperform the S&P.
As we believe that financial services stocks are quite reasonably valued
relative to the S&P 500, we expect to continue to use leverage for some time.
The maximum leverage permitted in the fund is $1.50 assets per $1.00 NAV;
however, the maximum leverage used to date has been approximately $1.33 per
$1.00.
The second major reason the fund underperformed last year was its
overweighting of very small bank and thrift stocks, as well as some mid-sized
takeover candidates. We estimate that our overweighting in these stocks caused
the other 5.4% of our underperformance relative to financial sector funds. In
general, takeover premiums declined during the year. As many small bank and
thrift stocks are viewed as takeover candidates, this hurt their
<PAGE>
SMITH BREEDEN FINANCIAL SERVICES FUND
- --------------------------------------------------------------------------------
PERFORMANCE REVIEW (CONT.)
stock performance, as well as the performance of mid-sized bank takeover
candidates. One reason given by some analysts for this decline in potential
takeover stocks' prices is the lower likelihood of takeovers as the end of the
millenium nears, i.e., the "Year 2000" (Y2K) issue. As takeover premiums have
been reduced during this past year, the fund has increased its weighting in
stocks that are believed to have a greater than normal chance of takeovers. Our
view is that the takeover premiums are now small enough that these institutions
offer excellent values even if they are not taken over.
The financial sector lagged the entire stock market in the past year due
to increasing global economic turmoil. This began in Asia and quickly moved to
other global markets, including Eastern Europe and South America. Global
problems generally affect the quality of loans, as well as earnings growth at
financial companies. Additionally, there are concerns of "systemic risk" in
financial stocks, as the problems of a major international financial
institution could affect its dealings with other banks and thrifts, which may
not have any direct global exposure.
Market volatility and uncertainty reached a peak in late summer and early
fall of 1998 following the Russian bond default and currency devaluation. In
response to increased market volatility, the U.S. Federal Reserve reduced
short-term interest rates three times. The financial markets reacted positively
to these Fed moves, as financial stocks recovered much of their September 1998
quarter losses in the December 1998 quarter, but still ended the year well
behind the S&P 500.
In early 1999, the global financial markets have stabilized and the
environment appears to be better for financial sector stocks. Some markets in
Asia appear to have stabilized and have begun to grow again. However, Y2K
concerns periodically worry investors in financial sector equities, and these
concerns probably will not be totally allayed until the year 2000 is entered
and the problems are known and resolved. Aside from those concerns,
profitability of financial services firms is nearly the highest it has ever
been in the 20th century.
In summary, we are dismayed by the poor performance of our fund in the
past year. However, we continue to believe that our fund holds a portfolio of
excellent investments, which will provide a fine risk/reward combination in
coming years.
<PAGE>
SMITH BREEDEN FINANCIAL SERVICES FUND
- --------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS MARCH 31, 1999
<TABLE>
<CAPTION>
MARKET
SHARES SECURITY VALUE
- -------- ------------------------------------------------------------ ---------------
<S> <C> <C>
EQUITY HOLDINGS -- 127.9%
COMMERCIAL BANKING -- 54.7%
12,000 Bank One Corp. ............................................. $ 660,750
9,000 First Union Corp. .......................................... 480,938
13,000 KeyCorp .................................................... 394,062
9,000 Mercantile Bancorporation Inc. ............................. 427,500
18,000 Pacific Century Financial Corp. ............................ 375,750
11,000 PNC Bank Corp. ............................................. 611,188
12,000 U.S. Bancorp ............................................... 408,750
11,000 Wells Fargo Company ........................................ 385,687
------------
3,744,625
------------
INVESTMENT BANKING AND BROKERAGE -- 4.4%
5,000 Lehman Brothers, Inc. ...................................... 298,750
------------
298,750
------------
MONEY CENTER BANKING -- 19.3%
6,000 BankAmerica Corp. .......................................... 423,750
7,000 BankBoston Corporation ..................................... 303,188
5,000 Chase Manhattan Corp. ...................................... 406,562
1,000 Citigroup .................................................. 63,875
1,000 J.P. Morgan & Co. .......................................... 123,375
------------
1,320,750
------------
INVESTMENT MANAGEMENT AND ADVISORY -- 11.7%
10,000 Franklin Resources, Inc. ................................... 281,250
11,000 PIMCO Advisors Holdings LP (1) ............................. 345,813
5,000 Price (T. Rowe) Assoc., Inc. ............................... 171,875
------------
798,938
------------
CONSUMER FINANCE -- 5.3%
8,000 Household International, Inc. .............................. 365,000
------------
365,000
------------
SAVINGS & LOANS -- 32.5%
2,000 Community Bank Shares of Indiana, Inc. ..................... 32,750
1,000 First Oak Brook Bancshares, Inc. -- Class A ................ 17,438
22,000 First Security Corporation ................................. 424,874
14,500 Home Federal Bancorp ....................................... 319,906
18,500 Indiana United Bancorp ..................................... 388,500
11,000 Marion Capital Holdings, Inc. .............................. 242,000
26,700 Piedmont Bancorp, Inc. ..................................... 226,950
14,000 Washington Mutual, Inc. .................................... 572,250
------------
2,224,668
------------
TOTAL EQUITY HOLDINGS (COST $8,654,885)..................... 8,752,731
------------
LIABILITIES LESS CASH AND OTHER ASSETS -- (27.9%) .......... (1,910,317)
------------
NET ASSETS -- 100.0% ....................................... $ 6,842,414
============
</TABLE>
- ---------
(1) Limited partnership units
<PAGE>
SMITH BREEDEN FINANCIAL SERVICES FUND
- --------------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES MARCH 31, 1999
<TABLE>
<S> <C>
ASSETS
Investments at market value (identified cost $8,654,885) (Note 1)..................... $ 8,752,731
Cash ................................................................................. 59,057
Receivables:
Variation margin on futures contracts (Note 2) ..................................... 152,600
Dividends .......................................................................... 22,949
Due from Advisor (Note 3) .......................................................... 16,871
Other assets ......................................................................... 4,611
-----------
TOTAL ASSETS ....................................................................... 9,008,819
-----------
LIABILITIES
Bank loan (Note 5) ................................................................... 2,125,000
Payables:
Redemption ......................................................................... 12
Interest and loan fees ............................................................. 29,036
Accrued expenses ..................................................................... 12,357
-----------
TOTAL LIABILITIES .................................................................. 2,166,405
-----------
NET ASSETS
(Applicable to outstanding shares of 768,736; unlimited number of shares of beneficial
interest authorized; no stated par) ................................................ $ 6,842,414
===========
Net asset value, offering price and redemption price per share ($6,842,414 / 768,736). $ 8.90
===========
SOURCE OF NET ASSETS
Paid in capital ...................................................................... $ 7,048,508
Undistributed net investment income .................................................. 2,066
Accumulated net realized loss on investments and futures contracts ................... (248,379)
Net unrealized appreciation of investments ........................................... 97,846
Net unrealized depreciation of futures contracts ..................................... (57,627)
-----------
NET ASSETS ......................................................................... $ 6,842,414
===========
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN FINANCIAL SERVICES FUND
- --------------------------------------------------------------------------------
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1999
<TABLE>
<S> <C>
INVESTMENT INCOME
Dividends and interest earned net of interest expense ($87,491) (Note 1).... $ 112,276
EXPENSES
Advisory fees (Note 3) ..................................................... 107,863
Accounting and pricing services fees ....................................... 25,878
Custodian fees.............................................................. 8,440
Audit and tax preparation fees ............................................. 2,136
Legal fees ................................................................. 11,336
Transfer agent fees ........................................................ 25,270
Registration fees .......................................................... 31,236
Trustees fees and expenses ................................................. 4,701
Insurance expense .......................................................... 3,228
Other ...................................................................... 4,085
----------
TOTAL EXPENSES BEFORE REIMBURSEMENT ...................................... 224,173
Expenses reimbursed by Advisor (Note 3) .................................. (117,431)
----------
NET EXPENSES ............................................................. 106,742
----------
NET INVESTMENT INCOME .................................................... 5,534
----------
REALIZED AND UNREALIZED LOSS ON INVESTMENTS .................................
Net realized loss on investments and futures contracts ..................... (248,893)
Change in unrealized depreciation of investments and futures contracts ..... (638,575)
----------
Net realized and unrealized loss on investments and futures contracts ...... (887,468)
----------
Net decrease in net assets resulting from operations ....................... $ (881,934)
==========
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN FINANCIAL SERVICES FUND
- --------------------------------------------------------------------------------
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
YEAR ENDED PERIOD ENDED
MARCH 31, 1999 MARCH 31, 1998 (1)
---------------- -------------------
<S> <C> <C>
OPERATIONS
Net investment income .................................................... $ 5,534 $ 12,415
Net realized gain (loss) on investments .................................. (248,893) 50,408
Net unrealized appreciation (depreciation) of investments ................ (638,575) 678,794
------------ ----------
Net increase (decrease) in net assets resulting from operations .......... (881,934) 741,617
------------ ----------
DISTRIBUTIONS TO SHAREHOLDERS
Dividends from net investment income ..................................... (15,881) --
Distributions from net realized gains on investments ..................... (49,896) --
------------ ----------
Total distributions ...................................................... (65,777) --
------------ ----------
CAPITAL SHARE TRANSACTIONS
Shares sold .............................................................. 1,911,182 6,588,508
Shares issued on reinvestment of distributions ........................... 54,326 --
Shares redeemed .......................................................... (1,492,099) (13,409)
------------ ----------
Increase in net assets resulting from capital share transactions (a) ..... 473,409 6,575,099
------------ ----------
TOTAL INCREASE (DECREASE) IN NET ASSETS ................................. (474,302) 7,316,716
NET ASSETS
Beginning of period ...................................................... 7,316,716 --
------------ ----------
End of period ............................................................ $ 6,842,414 $7,316,716
============ ==========
(a) Transactions in capital shares were as follows:
Shares sold .............................................................. 206,371 729,112
Shares issued on reinvestment of distributions ........................... 5,482 --
Shares redeemed .......................................................... (170,725) (1,504)
------------ ----------
Net increase ............................................................. 41,128 727,608
Beginning balance ........................................................ 727,608 --
------------ ----------
Ending balance ........................................................... 768,736 727,608
============ ==========
</TABLE>
- ---------
(1) Commenced operations on December 22, 1997
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN FINANCIAL SERVICES FUND
- --------------------------------------------------------------------------------
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED MARCH 31, 1999
<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net decrease in net assets resulting from operations ................................ $ (881,934)
Change in net realized and unrealized loss on investments ........................... 887,468
-------------
Net investment income ............................................................. 5,534
ADJUSTMENTS TO RECONCILE NET INVESTMENT INCOME TO NET CASH PROVIDED BY
OPERATING ACTIVITIES
Increase in interest and dividends receivable ....................................... (9,796)
Limited partnership income accrual .................................................. (11,126)
Limited partnership distributions ................................................... 23,675
Decrease in other assets ............................................................ 11,813
Increase in other liabilities ....................................................... 25,351
-------------
Net cash provided by operating activities ......................................... 45,451
-------------
CASH FLOWS FROM INVESTING ACTIVITIES
Payments for futures variation ...................................................... (392,418)
Proceeds from sales of long-term investments ........................................ 8,965,506
Purchases of long-term investments .................................................. (11,055,264)
-------------
Net cash used in investing activities ............................................. (2,482,176)
-------------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase in bank borrowings ......................................................... 2,125,000
Proceeds from shares tendered ....................................................... 1,856,856
Payments for shares redeemed ........................................................ (1,492,111)
Cash paid for distributions of net investment income and realized capital gains ..... (11,451)
-------------
Net cash provided by financing activities ......................................... 2,478,294
-------------
Net increase in cash .............................................................. 41,569
CASH AT BEGINNING OF YEAR ............................................................ 17,488
-------------
CASH AT END OF YEAR .................................................................. $ 59,057
-------------
NONCASH FINANCING ACTIVITIES
Market value of shares issued to stockholders through reinvestment of dividends ..... $ 54,326
-------------
SUPPLEMENTAL DISCLOSURE
Interest and loan fees paid ......................................................... $ 87,491
-------------
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<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>
YEAR ENDED PERIOD ENDED
MARCH 31, 1999 MARCH 31, 1998 (1)
---------------- -------------------
<S> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD ......................................... $ 10.06 $ 9.00
--------- --------
INCOME FROM INVESTMENT OPERATIONS
Net investment income ....................................................... 0.006 0.017
Net realized and unrealized gain (loss) on investments ...................... ( 1.082) 1.043
---------- ---------
Total from investment operations ............................................ ( 1.076) 1.060
---------- ---------
LESS DISTRIBUTIONS
Dividends from net investment income ........................................ ( 0.020) --
Dividends in excess of net investment income ................................ -- --
Distributions from net realized gains on investments ........................ ( 0.063) --
Distributions in excess of net realized gains on investments ................ -- --
---------- ---------
Total distributions ....................................................... ( 0.083) --
---------- ---------
NET ASSET VALUE, END OF PERIOD ............................................... $ 8.90 $ 10.06
---------- ---------
TOTAL RETURN ................................................................. (10.79%) 11.78 %
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period ................................................... $6,842,414 $7,316,716
Ratio of net expenses to average net assets ................................. 1.48% 1.48%*
Ratio of net investment income to average net assets ........................ 0.08% 0.79%*
Portfolio turnover rate ..................................................... 105% 85%
Ratio of expenses to average net assets before reimbursement of expenses
by the Advisor ............................................................ 3.12% 3.20%*
Ratio of net investment income to average net assets before reimbursement
of expenses by the Advisor ................................................ ( 1.56%) ( 0.92 %)*
</TABLE>
- ---------
(1) Commenced operations on December 22, 1997.
* Annualized
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
The Board of Trustees and Shareholders,
Smith Breeden Financial Services Fund of the Smith Breeden Trust:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of the Smith Breeden Financial Services
Fund of the Smith Breeden Trust (the "Fund") as of March 31, 1999, and the
related statement of operations and statement of cash flows for the year then
ended, the statements of changes in net assets for each of the periods in the
two-year period then ended, and the financial highlights for each of the years
in the two-year periods 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, 1999 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
Trust as of March 31, 1999, 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 14, 1999
<PAGE>
SMITH BREEDEN HIGH YIELD BOND FUND
- --------------------------------------------------------------------------------
PERFORMANCE REVIEW
The Smith Breeden High Yield Bond Fund commenced operations on October 15,
1998. Through March 31, 1999, the Fund generated a total return of 0.39%. The
return of the Merrill Lynch High Yield 175 Index was 10.12% for the same
period. The graph below shows the return on the Fund compared to the Merrill
Lynch High Yield 175 Index, as well as the average High Yield Fund as measured
by Morningstar.
[GRAPHIC]
<TABLE>
<CAPTION>
TOTAL RETURN FROM 10/15/98 TO
3/31/99
--------------------------------
SINCE
INCEPTION FINAL VALUE OF
(10/15/98) $10,000 INVESTMENT
------------ -------------------
<S> <C> <C>
Smith Breeden High Yield Bond Fund ............ 0.39% $10,039
Merrill Lynch High Yield 175 Index ............ 10.12% 11,012
Morningstar Avg. High Yield Bond Fund ......... 10.36% 11,036
</TABLE>
The Fund opened on October 15, 1998 with a 100% cash weighting and with
the surprise announcement by the Federal Reserve that rates were being lowered
by 0.25%. The rate cut by the Fed sparked equities and high yield bonds to
record returns for the remainder of the year. The high yield market, where it
was difficult to sell a bond in August and September 1998 due to investor's
avoidance of risk, sprang to life quickly, reversing the trend and making it
difficult to find quality bonds for sale. The High Yield Fund, which continued
to selectively purchase securities, was fully invested in the high yield market
by the end of 1998, but missed most of the fourth quarter returns.
Returns in the first quarter of 1999 were negatively influenced by the
price movement of two of the Fund's investments: ForceEnergy and Iridium. The
remainder of the portfolio (without Iridium and ForceEnergy) performed
strongly.
<PAGE>
SMITH BREEDEN HIGH YIELD BOND FUND
- --------------------------------------------------------------------------------
PERFORMANCE REVIEW (CONT.)
ForceEnergy, an oil and gas exploration and production company, had a
planned equity cash infusion fall through in January and filed for Chapter 11
Bankruptcy reorganization in March. ForceEnergy was hurt by the prolonged
period of low oil prices. With the rise in energy prices, ForceEnergy's assets
are regaining their value and we are hopeful the company will emerge quickly
from bankruptcy protection.
Iridium, a satellite communications company, missed its revenue and
subscriber estimates in March 1999 which led to management changes at the top
of the organization. Iridium is a company in transition, changing its focus
from building and launching satellites to marketing the telecommunications
services it kicked off late last year.
Overall, we feel the high yield bond sector remains attractive. The sector
has regained a large portion of the losses associated with the August-September
1998 period, but junk bond yields continue to be offered at spreads to
comparable US Treasuries that are wide in relationship to their 1998 levels.
Spreads to US Treasuries peaked in October 1998 near 750 basis points* and as
of March 1999 were at 575 bps, still above their long term average of 500 bps
and well above their March 1998 level of 350 bps. We believe that the risk of
bond defaults is more than compensated by these higher yields. The last time
this risk was priced with yields of 750 bps above US Treasuries was in 1991,
when high yield bond defaults were over 10% annually. In 1998, high yield
defaults were 3.31%, according to Moody's. Although defaults have been
increasing, the increase has not been dramatic. Moody's trailing-twelve-month
default rate (percentage of issuers) reached 3.68% in March, the highest level
since April 1993, but well below 1990-1991 levels. We believe long term
investors are being well rewarded by the added yield spreads for taking on
these levels of default risk.
- ---------
* 100 basis points (bps) = 1%
<PAGE>
SMITH BREEDEN HIGH YIELD BOND FUND
- --------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS MARCH 31, 1999
<TABLE>
<CAPTION>
FACE MARKET
AMOUNT SECURITY VALUE
- --------- ---------------------------------------------------------------- -------------
<S> <C> <C>
CORPORATE BOND HOLDINGS -- 99.9%
MEDIA AND COMMUNICATIONS -- 37.4%
100,000 Chancellor Media 12/15/07 8.125% ............................... $ 102,250
100,000 Echostar DBS Corp. 2/1/09 9.375% (1) ........................... 104,375
100,000 Intermedia Communications 7/15/07 Step-up, 11.07% (3) .......... 76,250
100,000 Iridium LLC/CAP 7/15/05 10.875% ................................ 38,000
100,000 Level 3 Communications 5/1/08 9.125% ........................... 101,250
100,000 Pegasus Communication 12/1/06 9.75% (1) ........................ 104,000
100,000 PSINet Inc. 2/15/05 10.00% ..................................... 106,250
200,000 Qwest Communications Int. 10/15/07 Step-up, 8.02% (3) .......... 160,000
----------
792,375
----------
HOUSING -- 9.6%
100,000 American Standard Companies 2/15/10 7.625% ..................... 98,500
100,000 Kaufman & Broad 11/15/06 9.625% ................................ 105,250
----------
203,750
----------
INFORMATION TECHNOLOGY -- 9.5%
100,000 Apple Computer Inc. 2/15/04 6.50% .............................. 91,625
100,000 Unisys Corp. 4/15/03 12.00% .................................... 110,500
----------
202,125
----------
GAMING AND LEISURE -- 9.5%
100,000 HMH Properties 8/1/05 7.875% ................................... 98,250
100,000 Hollywood Park 8/1/07 9.50% .................................... 103,000
----------
201,250
----------
HEALTHCARE -- 9.4%
200,000 Tenet Healthcare Corp. 1/15/07 8.625% .......................... 201,000
----------
201,000
----------
ENERGY -- 6.6%
100,000 ForceEnergy, Inc. 11/1/06 9.50% (2) ............................ 47,500
100,000 Pogo Producing Co. 5/15/07 8.75% ............................... 92,500
----------
140,000
----------
AEROSPACE -- 4.7%
100,000 Atlas Air, Inc. 11/15/06 9.375% ................................ 100,500
----------
100,500
----------
FOOD AND DRUG -- 4.7%
100,000 Great Atlantic & Pacific 4/15/07 7.75% ......................... 99,107
----------
99,107
----------
FINANCIAL -- 4.4%
100,000 Conseco Financing 11/15/26 8.70% ............................... 92,738
----------
92,738
----------
INTERNATIONAL -- 4.1%
100,000 Asia Pulp & Paper Intl. 10/1/00 10.25% ......................... 88,250
----------
88,250
----------
TOTAL CORPORATE BOND HOLDINGS (COST $2,195,739)................. 2,121,095
----------
CASH AND OTHER ASSETS LESS LIABILITIES -- 0.1% ................. 291
----------
NET ASSETS -- 100.0% ........................................... $2,121,386
==========
</TABLE>
- ---------
(1) Security exempt from registration under Rule 144A of the Securities Act of
1933. Such securities may be resold in transactions exempt from
registration, normally to qualified insitutional buyers. In total, 144A
securities represent 9.8% of net assets.
(2) Security is in default on interest payments due to Chapter 11 bankruptcy
reorganization by the issuing company. The security in default represents
2.2% of net assets.
(3) Yield shown is the purchased yield to maturity for step-up bonds.
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN HIGH YIELD BOND FUND
- --------------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES MARCH 31, 1999
<TABLE>
<S> <C>
ASSETS
Investments at market value (identified cost $2,195,739) (Note 1)........................ $ 2,121,095
Cash .................................................................................... 11,780
Interest receivable ..................................................................... 49,964
Due from Advisor (Note 3) ............................................................... 12,068
Other assets ............................................................................ 91
-----------
TOTAL ASSETS .......................................................................... 2,194,998
-----------
LIABILITIES
Bank loan (Note 5) ...................................................................... 60,000
Interest and loan fees payable .......................................................... 637
Accrued expenses ........................................................................ 12,975
-----------
TOTAL LIABILITIES ..................................................................... 73,612
-----------
NET ASSETS:
(Applicable to outstanding shares of 243,392; unlimited number of shares of beneficial
interest authorized; no stated par) ..................................................... $ 2,121,386
===========
Net asset value, offering price and redemption price per share ($2,121,386 / 243,392).... $ 8.72
===========
SOURCE OF NET ASSETS
Paid in capital ......................................................................... $ 2,195,571
Accumulated net realized gain on investments ............................................ 459
Net unrealized depreciation of investments .............................................. (74,644)
-----------
NET ASSETS ............................................................................ $ 2,121,386
===========
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN HIGH YIELD BOND FUND
- --------------------------------------------------------------------------------
STATEMENT OF OPERATIONS
FOR THE PERIOD ENDED MARCH 31, 1999 (1)
<TABLE>
<S> <C>
INVESTMENT INCOME
Interest and discount earned, net of premium amortization and interest expense ($637) $ 79,890
(Note 1) ---------
EXPENSES
Advisory fees (Note 3) .................................................................. 6,058
Accounting and pricing services fees .................................................... 13,750
Custodian fees........................................................................... 1,962
Audit and tax preparation fees .......................................................... 5,220
Legal fees .............................................................................. 1,644
Transfer agent fees ..................................................................... 9,144
Registration fees ....................................................................... 17,875
Trustees fees and expenses .............................................................. 337
Insurance expense ....................................................................... 2,400
Other ................................................................................... 639
---------
TOTAL EXPENSES BEFORE REIMBURSEMENT ................................................... 59,029
Expenses reimbursed by Advisor (Note 3) ............................................... (50,547)
---------
NET EXPENSES .......................................................................... 8,482
---------
NET INVESTMENT INCOME ................................................................. 71,408
---------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS
Net realized gain on investments ........................................................ 459
Change in unrealized depreciation of investments ........................................ (74,644)
---------
Net realized and unrealized loss on investments ......................................... (74,185)
---------
Net decrease in net assets resulting from operations .................................... $ (2,777)
=========
</TABLE>
- ---------
(1) Commenced operations on October 15, 1998
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN HIGH YIELD BOND FUND
- --------------------------------------------------------------------------------
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
PERIOD ENDED
MARCH 31, 1999 (1)
-------------------
<S> <C>
OPERATIONS
Net investment income .................................................... $ 71,408
Net realized gain on investments ......................................... 459
Net unrealized depreciation of investments ............................... (74,644)
----------
Net decrease in net assets resulting from operations ..................... (2,777)
----------
DISTRIBUTIONS TO SHAREHOLDERS
Dividends from net investment income ..................................... (71,405)
----------
Total distributions ...................................................... (71,405)
----------
CAPITAL SHARE TRANSACTIONS
Shares sold .............................................................. 2,126,127
Shares issued on reinvestment of distributions ........................... 71,423
Shares redeemed .......................................................... (1,982)
----------
Increase in net assets resulting from capital share transactions (a) ..... 2,195,568
----------
TOTAL INCREASE IN NET ASSETS ........................................... 2,121,386
NET ASSETS
Beginning of period ...................................................... --
----------
End of period ............................................................ $2,121,386
==========
(a) Transactions in capital shares were as follows:
Shares sold .............................................................. 235,588
Shares issued on reinvestment of distributions ........................... 8,031
Shares redeemed .......................................................... (227)
----------
Net increase ............................................................. 243,392
Beginning balance ........................................................ --
----------
Ending balance ........................................................... 243,392
==========
</TABLE>
- ---------
(1) Commenced operations on October 15, 1998
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
SMITH BREEDEN HIGH YIELD BOND 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, 1999 (1)
-------------------
<S> <C>
NET ASSET VALUE, BEGINNING OF PERIOD ..................................................... $ 9.00
--------
INCOME FROM INVESTMENT OPERATIONS
Net investment income ................................................................... 0.318
Net realized and unrealized loss on investments ......................................... (0.280)
---------
Total from investment operations ........................................................ 0.038
---------
LESS DISTRIBUTIONS
Dividends from net investment income .................................................... (0.318)
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 ................................................................... (0.318)
---------
NET ASSET VALUE, END OF PERIOD ........................................................... $ 8.72
---------
TOTAL RETURN ............................................................................. 0.39 %
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period ............................................................... $2,121,386
Ratio of net expenses to average net assets ............................................. 0.98%*
Ratio of net investment income to average net assets .................................... 8.30%*
Portfolio turnover rate ................................................................. 12%
Ratio of expenses to average net assets before reimbursement of expenses by the
Advisor ............................................................................... 6.86%*
Ratio of net investment income to average net assets before reimbursement of expenses
by the Advisor ........................................................................ 2.43%*
</TABLE>
- ---------
(1) Commenced operations on October 15, 1998.
* Annualized
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
The Board of Trustees and Shareholders,
Smith Breeden High Yield Bond Fund of the Smith Breeden Trust:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of the Smith Breeden High Yield Bond
Fund of the Smith Breeden Trust (the "Fund") as of March 31, 1999, and the
related statement of operations, the statement of changes in net assets, and
the financial highlights for the period October 15, 1998 (commencement of
operations) to March 31, 1999. 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 audit.
We conducted our audit 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, 1999 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 audit provides 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
position of the Smith Breeden High Yield Bond Fund of the Smith Breeden Trust
as of March 31, 1999, the results of its operations, the changes in its net
assets, and the financial highlights for the respective stated period in
conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
May 14, 1999
<PAGE>
SMITH BREEDEN MUTUAL FUNDS
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Breeden Series Fund and the Smith Breeden Trust (the "Trusts") are
open-end, diversified management investment companies registered under the
Investment Company Act of 1940, as amended. The Smith Breeden Series Fund
offers shares in two series: the Smith Breeden Short Duration U.S. Government
Fund (the "Short Fund") and the Smith Breeden Intermediate Duration U.S.
Government Fund (the "Intermediate Fund"). The Smith Breeden Trust offers
shares in three series: the Smith Breeden U.S. Equity Market Plus Fund (the
"U.S. Equity Fund", formerly the Smith Breeden Equity Market Plus Fund), the
Smith Breeden High Yield Bond Fund (the "High Yield Fund"), and the Smith
Breeden Financial Services Fund (the "Financial Services Fund"). The following
is a summary of accounting policies consistently followed by the Short Fund,
the Intermediate Fund, the High Yield Fund, the U.S. Equity Fund and the
Financial Services Fund (collectively, the "Funds").
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: Each Fund may enter into repurchase agreements 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 Funds' Board of Trustees. In a repurchase agreement, a
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
Funds' 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 at least 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, a
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 AND REVERSE 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. When a Fund invests in a dollar roll, it 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.
A reverse dollar roll is agreement to buy securities for delivery in the
current month and to sell substantially similar (same type and coupon)
securities on a specified future date, typically at a lower price. During the
roll period, the fund receives the principal and interest on the securities
purchased in compensation for the cash invested in the transaction.
E. DISTRIBUTIONS AND TAXES: Dividends to shareholders are recorded on the
ex-dividend date. Each Fund intends to continue to qualify for and elect the
special tax treatment afforded to regulated investment companies under
Subchapter M of the Internal Revenue Code, thereby relieving the Funds of
Federal income taxes. To so qualify, the Funds intend to distribute
substantially all net investment income and net realized capital gains, if any,
less any available capital loss carryforward. The following table summarized
the available capital loss carryforwards for each Fund.
<PAGE>
SMITH BREEDEN MUTUAL FUNDS
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES -- CONTINUED
<TABLE>
<CAPTION>
CAPITAL LOSS CAPITAL LOSS CAPITAL LOSS
CARRYFORWARD CARRYFORWARD CARRYFORWARD
FUND EXPIRES 3/31/2004 EXPIRES 3/31/2005 EXPIRES 3/31/2007
- ---------------------------------- ------------------- ------------------- ------------------
<S> <C> <C> <C>
Short Duration Fund ........ $658,505 $829,556 $ 0
Intermediate Duration Fund . 0 0 126,641
U.S. Equity Fund ........... 0 0 0
Financial Services Fund .... 0 0 196,832
High Yield Bond Fund ....... 0 0 0
</TABLE>
F. SECURITIES TRANSACTIONS, INVESTMENT INCOME AND OPERATING 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 fixed-income securities purchased are
amortized over the life of the respective securities. Dividend income is
recorded on the ex-dividend 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 Trusts are
generally allocated among the funds comprising the Trusts based on the ratio of
net assets of each Fund to the combined net assets of each Trust. Other
expenses are charged to each Fund on a specific identification basis.
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. FUTURES CONTRACTS HELD OR ISSUED FOR PURPOSES OTHER THAN TRADING: The Short
Fund, Intermediate Fund, and U.S. Equity Fund use interest-rate futures
contracts for risk management purposes in order to reduce fluctuations in the
Funds' net asset values relative to the Funds' targeted option-adjusted
durations. The Financial Services Fund uses S&P 500 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 each day. The variation margin payments
equal the daily changes in the contract value and are recorded as unrealized
gains or losses. The Funds recognize 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.
<PAGE>
SMITH BREEDEN MUTUAL FUNDS
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. FINANCIAL INSTRUMENTS -- CONTINUED
The Short Fund had the following open futures contracts as of March 31, 1999:
<TABLE>
<CAPTION>
NUMBER OF EXPIRATION UNREALIZED
TYPE CONTRACTS POSITION MONTH GAIN/(LOSS)
- ---------------------------- ----------- ---------- ----------------- --------------
<S> <C> <C> <C> <C>
5 Year Treasury ............ 43 Short June, 1999 $ 7,791
10 Year Treasury ........... 113 Short June, 1999 53,226
3 Month Eurodollar ......... 31 Short June, 1999 (1,140)
3 Month Eurodollar ......... 55 Short September, 1999 (9,898)
3 Month Eurodollar ......... 12 Long December, 1999 (6,054)
3 Month Eurodollar ......... 12 Long March, 2000 (10,004)
3 Month Eurodollar ......... 12 Long June, 2000 (10,891)
3 Month Eurodollar ......... 12 Long September, 2000 (11,429)
3 Month Eurodollar ......... 12 Long December, 2000 (10,541)
3 Month Eurodollar ......... 12 Long March, 2001 (11,429)
3 Month Eurodollar ......... 12 Long June, 2001 (11,729)
3 Month Eurodollar ......... 62 Long September, 2001 94,284
3 Month Eurodollar ......... 12 Long December, 2001 (10,529)
3 Month Eurodollar ......... 12 Long March, 2002 (11,980)
3 Month Eurodollar ......... 12 Long June, 2002 (12,305)
3 Month Eurodollar ......... 12 Long September, 2002 (12,342)
3 Month Eurodollar ......... 12 Long December, 2002 (10,804)
3 Month Eurodollar ......... 12 Long March, 2003 (12,241)
3 Month Eurodollar ......... 12 Long June, 2003 (12,316)
3 Month Eurodollar ......... 12 Long September, 2003 (12,316)
3 Month Eurodollar ......... 12 Long December, 2003 (10,841)
3 Month Eurodollar ......... 12 Long March, 2004 (11,804)
3 Month Eurodollar ......... 12 Long June, 2004 (11,879)
3 Month Eurodollar ......... 12 Long September, 2004 (12,079)
3 Month Eurodollar ......... 12 Long December, 2004 (10,854)
3 Month Eurodollar ......... 12 Long March, 2005 (11,579)
3 Month Eurodollar ......... 12 Long June, 2005 (11,654)
3 Month Eurodollar ......... 12 Long September, 2005 (11,479)
3 Month Eurodollar ......... 4 Long December, 2005 (1,168)
3 Month Eurodollar ......... 2 Long March, 2006 (559)
---------
Total ($ 116,543)
=========
</TABLE>
The Intermediate Fund had the following open futures contracts as of March 31,
1999:
<TABLE>
<CAPTION>
NUMBER OF EXPIRATION UNREALIZED
TYPE CONTRACTS POSITION MONTH GAIN/(LOSS)
- -------------------------- ----------- ---------- --------------- ------------
<S> <C> <C> <C> <C>
5 Year Treasury .......... 32 Long June, 1999 ($ 10,246)
10 Year Treasury ......... 82 Short June, 1999 87,600
--------
Total $ 77,354
========
</TABLE>
<PAGE>
SMITH BREEDEN MUTUAL FUNDS
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. FINANCIAL INSTRUMENTS -- CONTINUED
The U.S. Equity Fund had the following open interest-rate futures contracts as
of March 31, 1999:
<TABLE>
<CAPTION>
NUMBER OF EXPIRATION UNREALIZED
TYPE CONTRACTS POSITION MONTH GAIN/(LOSS)
- ---------------------------- ----------- ---------- ----------------- --------------
<S> <C> <C> <C> <C>
5 Year Treasury ............ 126 Short June, 1999 $ 18,527
10 Year Treasury ........... 81 Short June, 1999 60,409
3 Month Eurodollar ......... 185 Long June, 1999 31,543
3 Month Eurodollar ......... 166 Short September, 1999 (214,510)
3 Month Eurodollar ......... 18 Short December, 1999 7,819
3 Month Eurodollar ......... 55 Short March, 2000 (31,048)
3 Month Eurodollar ......... 18 Short June, 2000 15,032
3 Month Eurodollar ......... 127 Short September, 2000 (164,284)
3 Month Eurodollar ......... 18 Short December, 2000 14,007
3 Month Eurodollar ......... 49 Short March, 2001 (3,208)
3 Month Eurodollar ......... 18 Short June, 2001 15,132
3 Month Eurodollar ......... 123 Short September, 2001 (148,704)
3 Month Eurodollar ......... 18 Short December, 2001 12,769
3 Month Eurodollar ......... 48 Short March, 2002 3,059
3 Month Eurodollar ......... 18 Short June, 2002 15,494
3 Month Eurodollar ......... 117 Short September, 2002 (35,589)
3 Month Eurodollar ......... 18 Short December, 2002 13,369
3 Month Eurodollar ......... 62 Short March, 2003 (3,129)
3 Month Eurodollar ......... 18 Short June, 2003 15,544
3 Month Eurodollar ......... 102 Short September, 2003 35,204
3 Month Eurodollar ......... 16 Short December, 2003 10,803
3 Month Eurodollar ......... 65 Short March, 2004 9,645
3 Month Eurodollar ......... 16 Short June, 2004 12,803
3 Month Eurodollar ......... 16 Short September, 2004 13,103
3 Month Eurodollar ......... 16 Short December, 2004 11,678
3 Month Eurodollar ......... 135 Short March, 2005 26,768
3 Month Eurodollar ......... 16 Short June, 2005 13,003
3 Month Eurodollar ......... 13 Short September, 2005 11,167
3 Month Eurodollar ......... 4 Short December, 2005 2,007
3 Month Eurodollar ......... 78 Short March, 2006 18,424
3 Month Eurodollar ......... 24 Short March, 2007 8,292
---------
Total ($ 204,874)
=========
</TABLE>
The Financial Services Fund had the following open futures contracts on the S&P
500 Index as of March 31, 1999:
<TABLE>
<CAPTION>
NUMBER OF UNREALIZED
TYPE CONTRACTS POSITION EXPIRATION MONTH GAIN/(LOSS)
- ----------------- ----------- ---------- ------------------ ------------
<S> <C> <C> <C> <C>
S&P 500 ......... 7 Short June, 1999 ($ 57,627)
--------
Total ($ 57,627)
========
</TABLE>
Futures transactions involve costs and may result in losses. The effective use
of futures depends on the Funds' ability to close futures positions at times
when the Funds' 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 Funds, of the
futures contract themselves, and of the securities that are the subject of a
hedge.
<PAGE>
SMITH BREEDEN MUTUAL FUNDS
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. FINANCIAL INSTRUMENTS -- CONTINUED
B. DERIVATIVE FINANCIAL INSTRUMENTS HELD OR ISSUED FOR TRADING PURPOSES: The
U.S. Equity 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 U.S. Equity Fund had the following open futures contracts on the S&P 500
Index as of March 31, 1999:
<TABLE>
<CAPTION>
NUMBER OF EXPIRATION UNREALIZED
TYPE CONTRACTS POSITION MONTH GAIN/(LOSS)
- ------------------- ----------- ---------- ------------ ------------
<S> <C> <C> <C> <C>
S&P 500 ......... 580 Long June, 1999 $1,787,863
----------
Total $1,787,863
==========
</TABLE>
C. ASSETS PLEDGED TO COVER MARGIN REQUIREMENTS FOR OPEN FUTURES POSITIONS: The
aggregate market value of assets pledged to cover margin requirements for the
open futures positions at March 31, 1999 was:
<TABLE>
<CAPTION>
FUND ASSETS PLEDGED
- ------------------------------- ---------------
<S> <C>
Short Fund .................. $ 353,496
Intermediate Fund ........... 215,792
U.S. Equity Fund ............ 11,246,155
Financial Services Fund ..... 115,500
</TABLE>
E. INTEREST-RATE SWAP CONTRACTS: The Funds may use interest-rate swap contracts
to help manage interest-rate risk. 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 Funds 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 or better by Standard & Poor's Corporation, or Aa or P-1 or
better by Moody's Investors Service, Inc. (or is otherwise acceptable to either
agency) at the time of entering into such a transaction. If the counterparty to
the swap transaction defaults, the Funds 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 Funds will succeed in pursuing contractual remedies. The Funds may thus
assume the risk that payments owed the Funds under a swap contract will be
delayed, or not received at all. Should interest rates move unexpectedly, the
Funds may not achieve the anticipated benefits of the interest-rate swaps, and
may realize a loss. The Funds recognize gains and losses under interest-rate
swap contracts as realized gains or losses on investments upon sale of the swap
contracts.
As of March 31, 1999, the Short Fund had two open interest-rate swap contracts.
In each of the contracts, the Short Fund has agreed to pay a fixed rate and
receive a floating rate. The Short 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 Short Fund receiving or paying, as the case may be, only the net
amount of the two payments. The floating rate on the contracts resets quarterly
and is the three-month London Inter-Bank Offered Rate ("LIBOR"). The Short
Fund's interest payable on the interest-rate swap contracts as of March 31,
1999 was $57,776. No collateral is required under these contracts.
F. INTEREST-RATE CAP 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 Short Fund had one
interest-rate cap contract open at March 31, 1999.
<PAGE>
SMITH BREEDEN MUTUAL FUNDS
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. FINANCIAL INSTRUMENTS -- CONTINUED
G. OPTIONS ON INTEREST-RATE SWAP CONTRACTS: The Funds may enter into
over-the-counter transactions swapping interest rates, or purchase options to
enter into such contracts. Purchased options on interest-rate swap contracts
("swaptions") give the right, but not the obligation, to enter into a swap
contract with the counterparty which has written the option on a date, at an
interest rate, and with a notional amount as specified in the swaption
agreement.
As of March 31, 1999, the U.S. Equity Fund had two open swaptions. In each of
the contracts, the Fund has paid a sum of money, called a premium, to the
counterparty, in return for the swaptions. These swaptions may be exercised by
entering into a swap contract with the counterparty only on the date specified
in each contract. If the swaptions are exercised, the Fund will enter into a
swap either to pay a specified fixed interest rate in return for receiving a
floating rate, or receive a fixed rate in return for paying a floating rate,
based on the respective contracts, or both. The floating rate on the swap
contracts as specified in the swaption agreements resets quarterly and is the
three-month London Inter-Bank Offered Rate ("LIBOR"). If the counterparty to
the swaption transaction defaults, the Fund will be limited to contractual
remedies pursuant to the agreements governing the transaction. There is no
assurance that the interest rate swap or swaption contract counterparty will be
able to meet its obligation under the 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 swaption, or swap contracts should the swaptions
be exercised. Should interest rates move unexpectedly, the Fund may not achieve
the anticipated benefits of the swaptions, and may realize a loss. The Fund
recognizes gains and losses under swaptions as realized gains or losses on
investments upon sale or expiration of the contracts.
3. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES
Smith Breeden Associates, Inc. (the "Advisor"), a registered Investment
Advisor, provides the Funds with investment management services. As
compensation for these services, the Funds pay the Advisor a fee computed daily
and payable monthly at a fixed annual rate based on the Funds' average daily
net assets.
The Advisor has voluntarily agreed to reimburse normal business expenses of the
Funds through August 1, 1999 so that total direct and indirect operating
expenses do not exceed the percentages listed below of each fund's 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 to these levels until August 1, 1999. The table below lists the fees
received by the Advisor and the expenses reimbursed by the Advisor to each Fund
during the year ending March 31, 1999.
<TABLE>
<CAPTION>
NET EXPENSE FEES RECEIVED EXPENSES REIMBURSED
FUND RATIO BY ADVISOR BY ADVISOR
- ------------------------------- ------------- --------------- --------------------
<S> <C> <C> <C>
Short Fund .............. 0.78% $ 508,343 $ 155,616
Intermediate Fund ....... 0.88% 355,620 83,434
U.S. Equity Fund ........ 0.88% 1,090,372 251,051
Financial Services Fund . 1.48% 107,863 117,431
High Yield Bond Fund .... 0.98% 6,058 50,547
</TABLE>
The Funds have 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 Funds, 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, which
may come out of the advisory fee, to dealers and other persons at the annual
rate of up to 0.25% of each 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.
<PAGE>
SMITH BREEDEN MUTUAL FUNDS
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES -- CONTINUED
Certain officers and trustees of the Fund are also officers and directors of
the Advisor.
4. INVESTMENT TRANSACTIONS
During the year ended March 31, 1999 purchases and proceeds from sales of
securities, other than short-term investments, aggregated:
<TABLE>
<CAPTION>
PURCHASES OF PROCEEDS FROM
FUND SECURITIES SALES OF SECURITIES
- ------------------------------- ---------------- --------------------
<S> <C> <C>
Short Fund .................. $ 257,690,659 $ 254,290,486
Intermediate Fund ........... 259,809,711 229,277,078
U.S. Equity Fund ............ 875,819,709 790,168,109
Financial Services Fund ..... 11,055,264 8,877,443
High Yield Bond Fund ........ 2,398,197 213,563
</TABLE>
The cost of securities held for Federal tax purposes, and the net unrealized
appreciation (depreciation) of investments, short sales and futures contracts
is as follows:
<TABLE>
<CAPTION>
COST OF SECURITIES NET UNREALIZED
FOR FEDERAL TAX GROSS UNREALIZED GROSS UNREALIZED APPRECIATION
FUND PURPOSES APPRECIATION DEPRECIATION (DEPRECIATION)
- ------------------------------ -------------------- ------------------ ------------------ -----------------
<S> <C> <C> <C> <C>
Short Fund .................. $ 93,524,013 $ 1,102,601 ($ 3,534,330) ($ 2,431,729)
Intermediate Fund ........... 66,373,425 213,025 (360,020) (146,995)
U.S. Equity Fund ............ 246,631,334 2,443,797 (1,376,620) 1,067,177
Financial Services Fund ..... 8,654,885 503,012 (462,793) 40,219
High Yield Bond Fund ........ 2,195,739 46,929 (121,573) (74,644)
</TABLE>
5. CREDIT FACILITY
The High Yield Bond Fund and the Financial Services Funds have available
unsecured lines of credit from Bank of New York, the Funds' custodian. Total
borrowing allowed under the lines of credit is limited to the lesser of:
a) The amount of the line of credit;
b) 33 1/3% of the amount by which each Fund's total assets exceed each Fund's
total liabilities at the time a borrowing request is made;
c) The maximum amount the Funds are permitted to borrow under the Investment
Company Act of 1940, as amended; or
d) The maximum amount the Bank of New York is permitted to loan to the Funds
under regulations promulgated by the Board of Governors of the Federal Reserve
System.
The Financial Services Fund pays a fee of 0.15% per annum, and the High Yield
Fund pays a fee of 0.25% per annum on the total line of credit, whether used or
unused. In addition, the Financial Services Fund pays interest at a rate per
annum equal to the overnight Federal Funds Rate plus 1%, and the High Yield
Fund pays interest at a rate per annum equal to the overnight Federal Funds
Rate plus 1 1/4%, on amounts borrowed under the lines of credit. The total
amount of the line of credit is $2,500,000 for the Financial Services Fund and
$1,000,000 for the High Yield Bond Fund. As of March 31, 1999, the Financial
Services Fund had borrowed $2,125,000 and the High Yield Bond Fund had borrowed
$60,000 under the Funds' respective lines of credit.
SMITH BREEDEN TRUST
FORM N-1A
PART C. OTHER INFORMATION
Item 23. Exhibits.
(a) Declaration of Trust: Incorporated by Reference
(b) By-Laws: Incorporated by Reference
(c) Instruments Defining Rights of Security Holders:
Incorporated by Reference
(d) Form of Investment Advisory Agreement for Smith
Breeden Trust: Incorporated by Reference
(e) Form of Underwriting or Distribution Agreement:
Incorporated by Reference
(f) Bonus, Profit Sharing, Pension and Other
Similar Arrangements: Not Applicable
(g) Custodian Agreement: Incorporated by Reference
(h) Other Material Contracts:
Accounting and Shareholder Services Agreement:
Incorporated by Reference for the
Smith Breeden U.S. Equity Market Plus
Fund; to be filed by an amendment
hereto for each of the Smith Breeden
Asian/Pacific Equity Market Fund, and the
Smith Breeden European Equity Market Fund
(i) Legal Opinion: Incorporated by Reference to
Pre-Effective Amendment Number 2 filed April
14, 1992
(j) Other Opinions:
Independent Auditors' Consent
(k) Financial Statements Omitted from Item 22: Not
Applicable
(l) Initial Capital Agreements: Incorporated by
Reference
(m) Form of Rule 12b-1 Plan for Smith Breeden
Trust: Incorporated by Reference
(n) Financial Data Schedule: Not Applicable
(o) Rule 18f-3 Multiclass Plan: Not Applicable
Item 24. Persons Controlled by or under Common Control
with Registrant.
As of 6/30/99, 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
Asian/Pacific Equity Market Fund, or the Smith
Breeden European Equity Market Fund.
Item 25. 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 26. 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 27. Principal Underwriters
(a) First Data Distributors, Inc. ("FDDI"), the
principal underwriter for the Registrant's
securities, currently acts as principal underwriter
for the following entities:
BT Insurance Funds Trust
CT&T Funds
First Choice Funds Trust
Forward Funds, Inc.
The Galaxy Fund
Galaxy Fund II
The Galaxy VIP Fund
The Govett Funds, Inc.
IAA Trust Asset Allocation Fund, Inc.
IAA Trust Growth Fund, Inc.
IAA Trust Taxable Fixed Income Series Fund, Inc.
IAA Trust Tax Exempt Bond Fund, Inc.
IBJ Funds Trust
ICM Series Trust
Light Index Funds, Inc.
LKCM Funds
Matthews International Funds
McM Funds
Metropolitan West Funds
Panorama Trust
The Potomac Funds
Rembrandt Funds
RWB/WPG U.S. Large Stock Fund
Smith Breeden Series Fund
Smith Breeden Trust
The Stratton Funds, Inc.
Stratton Growth Fund, Inc.
Stratton Monthly Dividend REIT Shares, Inc.
Tomorrow Funds Retirement Trust
Trainer, Wortham First Mutual Funds
Undiscovered Managers Funds
Weiss, Peck & Greer Funds Trust
Weiss, Peck & Greer International Fund
Wilshire Target Funds, Inc.
WorldWide Index Funds
WPG Growth Fund
WPG Growth and Income Fund
WPG Tudor Fund
(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 AND
BUSINESS ADDRESS WITH UNDERWRITER OFFICES WITH
REGISTRANT
Robert Guillocheau Director None
4400 Computer Drive
Westborough, MA 01581
Francis Koudelka President & Chief None
4400 Computer Drive Executive Officer
Westborough, MA 01581
Jack Kutner Director None
4400 Computer Drive
Westborough, MA 01581
Scott Hacker Vice President, None
4400 Computer Drive Treasurer & Chief
Westborough, MA 01581 Compliance Officer
Bruno DiStefano Vice President None
3200 Horizon Drive
King of Prussia, PA
19406-0903
Sue Moscaritolo Vice President None
4400 Computer Drive
Westborough, MA 01581
Bernard Rothman Vice President None
4400 Computer Drive
Westborough, MA 01581
Christine Ritch Chief Legal Officer None
4400 Computer Drive and Clerk
Westborough, MA 01581
Bradley Stearns Assistant Clerk None
4400 Computer Drive
Westborough, MA 01581
(c) Not Applicable.
Item 28. 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 29. Management Services.
There are no management-related service contracts
not discussed in Part A or Part B.
Item 30. 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 certifies that it meets all of
the requirements for effectiveness of this Registration
Statement pursuant to Rule 485(b) under the Securities Act
of 1933 and 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 30th
day of July, 1999.
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 30, 1999
Executive Officer, and Trustee
Douglas T. Breeden* Trustee July 30, 1999
Stephen M. Schaefer* Trustee July 30, 1999
Myron S. Scholes* Trustee July 30, 1999
William F. Sharpe* Trustee July 30, 1999
Marianthe S. Mewkill Principal Financial July 30, 1999
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. 18 to
Registration Statement
No. 33-44909 of our reports dated May 14, 1999 relating to
the Smith Breeden U.S. Equity
Market Plus Fund, Smith Breeden Financial Services Fund,
and Smith Breeden High Yield Bond
Fund of Smith Breeden Trust 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 28, 1999
