MENTOR BALANCED PORTFOLIO
ANNUAL REPORT
SEPTEMBER 30, 1997
Message from the Chairman and President
It is our privilege to provide the annual report for the year ended September
30, 1997 for the Mentor Balanced Portfolio.
The Balanced Portfolio, managed jointly by two Mentor investment teams-- the
large-capitalization equity growth and fixed-income management teams-- was
established in mid-1994, and today represents some $4 million in assets. The
objective of the Balanced Portfolio is to seek capital growth and current
income.
We appreciate the opportunity to introduce an additional proprietary management
program, sponsored by Mentor, that has the potential to grow to benefit a large
number of investors.
In the commentary that follows you will find the management teams' perspectives
on the markets and their strategies for investing your assets. Performance
information for the Portfolio, relative to a blended index is also included in
the report.
Please review the information carefully. Should you have questions, please
contact your consultant, or call us directly, at (800) 382-0016. We welcome
your communications. On behalf of all of us at Mentor Investment Group, thank
you for your commitment to our firm.
Sincerely,
/s/ Daniel J. Ludeman
- -----------------------
Daniel J. Ludeman
Chairman
/s/ Paul F. Costello
- ------------------------
Paul F. Costello
President
<PAGE>
MENTOR BALANCED PORTFOLIO
ANNUAL REPORT
SEPTEMBER 30, 1997
Commentary from the Balanced Management Team
Equity Commentary
Simply amazing! There is really no other way to adequately describe this
historic bull market. It has confounded virtually all of its observers. After a
37% return in 1995, and 23% in 1996, the S&P 500 has already gained more than
30% this year.* And who knows what lies ahead? With the fourth quarter already
off to a strong start, it looks as though many more records will be broken
before year-end.
More than the magnitude of its rise, the most incredible characteristic of the
1990's bull market has been its persistence. Since bottoming in the fall of
1990, the S&P 500 has gained better than 20% annually without a single 10%
decline. The S&P 500 returned 7.5% in the just-finished third quarter, its
eleventh consecutive quarterly advance, a period in which its average quarterly
gain has been 7.4%. This is clearly becoming the Cal Ripken of bull markets.
These yet-unfinished performances are unlikely to be repeated in our lifetimes,
if ever again.
The first two years of this bull market were supported mostly by falling
inflation and interest rates. The last five years have been driven by strong
corporate earnings growth and the absence of any resurgence in inflation. Over
the past five years corporate earnings, as measured by the companies in the S&P
500, have grown 18% annually. During this same period S&P 500 stock prices have
also compounded at 18%. As long as inflation remains low and corporate earnings
continue to expand at a double-digit rate, the stock market is likely to remain
strong.
The majority of this tremendous growth in corporate earnings is due to profit
margin expansion, not revenue growth. Low inflation and intense competition have
kept revenue trends below normal in the 1990s. In fact, annual revenue growth,
again as measured by the companies in the S&P 500, has been less than 5% during
<PAGE>
this decade. How have companies, on average, managed to turn such modest revenue
growth into such powerful earnings growth? The answer can be found mostly in
three popular strategies to boost profitability. The first is the huge
write-offs of assets that have become so commonplace in the past decade. This
elimination of previous investments that did not pan out has resulted in
one-time reductions in ongoing expenses, particularly depreciation and
amortization. Secondly, corporations have benefited from lower interest costs.
The pay-down of debt by many companies that became over-leveraged in the 1980s,
combined with generally lower interest rates in the 1990s, has resulted in a
much lower interest burden. Finally, skillful tax planning by many
mutli-national corporations has lowered their overall tax rates. These three
strategies account for most of the profit margin expansion, with the remainder
due to very low inflation in input costs and improving productivity.
We all know that earnings growth cannot continue to outpace revenue growth by
more than 10 percentage points indefinitely. At some point corporations will
exhaust the major profit margin opportunities. Our portfolio is very well
positioned for that eventuality. Although our current holdings have grown their
earnings at 16% annually over the past five years, slightly less than the S&P
500, their revenue growth rate has been considerably higher at 12%. Their
average dividend growth has also been significantly higher than the S&P 500
during this period, 13% versus 4.3%. Revenue growth and dividend growth are more
stable and dependable measures of long-term value growth than swings in profit
margins and earnings. We believe that the superior consistency of our typical
holding's growth will work in our favor when the winds inevitably shift in a
less favorable direction.**
Fixed Income Commentary
During the 12-month period ending September 30, 1997 the yield curve flattened.
While yields of three-month and six-month treasury bills were largely unchanged,
yields of treasury notes and bonds with maturities of one year and greater were
lower by 0.25% to 0.60%. Generally speaking, the greater the maturity of the
<PAGE>
security, the larger the decrease in its yield. Two and 10-year treasuries
closed the period at 5.78% and 6.11%, respectively, down 0.32% and 0.59% from
the beginning of the period. Rates trended lower during the period with the
exception of the first quarter of 1997. In the first quarter much stronger than
anticipated economic growth prompted the Federal Reserve to increase the federal
funds rate (the rate member banks charge each other on the inter-bank loans) by
0.25% in late March.
As noted, only once during the 12-month period did the Federal Reserve deem it
necessary to alter the level of the short-term fed fund rate, and then only
modestly. Otherwise the monetary authorities remained on the sidelines, content
to let the economy move unencumbered on a low-inflation and moderate-growth
progression. Annualized GDP (gross domestic product), the most comprehensive
measure of overall domestic economic growth, grew at annualized rate of 4.3%,
4.9%, 3.3%, and 3.3% for the fourth quarter of 1996, the first quarter of 1997,
the second quarter of 1997, and the third quarter of 1997 respectively.
Despite continued steady economic growth, inflation at both the wholesale and
retail levels has remained consistently benign. In seven of the 12 monthly
periods during the fiscal year ending September 30, the PPI (producer price
index) actually declined. The CPI-core (consumer price index minus the volatile
food and energy components), viewed by many as the most reliable and significant
of the inflation measures, only once during the period experienced a monthly
increase as much as 0.3%. Given the lack of current measurable inflationary
pressures and the Federal Reserve's growing credibility as an inflation fighting
institution, fixed-income buyers have scaled back the inflation premium they
have demanded from their fixed income investments. As a result, despite
continued economic growth and the lowest unemployment rate in the past 30 years,
rates on fixed-income securities have eased from levels of a year ago.
Since the Federal Reserve intervened to raise the federal funds rate in late
March, we have maintained a duration within 10% of the benchmark. Our sense has
been that despite the continued good inflationary news, an increasingly tight
job market will eventually lead to pricing pressures. At no point during the
12-month period ending September 30, did the unemployment level exceed 5.4%. In
fact, during the last half of the period the unemployment rate never surpassed
<PAGE>
5.0%. These are levels that as recently as a few years ago were considered below
"full employment." The good current inflation news has been tempered by tight
underlying labor market conditions, raising concerns regarding the long-term
sustainability of low prices.
The moderate growth, low unemployment, low inflation environment of recent years
continues intact. We believe, however, that this combination of economic growth
and job creation, if sustained, may eventually lead to inflationary pressures.
The outlook going forward is clouded by uncertainty over how much growth in the
Pacific rim will decline, and to what degree this slowdown in Asia will affect
the US economy. Given the stock market's complete recovery from October's
declines (events subsequent to the 12-month period ending September 30 but prior
to the publication of this commentary), we feel that the risks remain weighted
toward continued above-trend economic growth and an eventual Fed tightening.
This suggests that short rates are currently at risk of rising. However, the
prospects for continued low inflation make us comfortable that long rates, which
are more sensitive to inflation than economic growth, will not rise and may even
decline if the Fed acts to preserve the current low inflation environment.
* The Standard & Poor's (S&P) 500 Index is an unmanaged, market-value-weighted
index of 500 widely held domestic common stocks. An unmanaged index does not
reflect expenses and may not correspond to the performance of a managed
portfolio in which expenses are incurred. You cannot invest in the S&P 500.
** While the management team will endeavor to invest the Portfolio according
to their proprietary process, there is no guarantee of investment success.
<PAGE>
MENTOR BALANCED PORTFOLIO
PERFORMANCE COMPARISONS
SEPTEMBER 30, 1997
[GRAPH]
Mentor Balanced Mentor Balanced S&P 500 and Lehman Brothers
Portfolio Portfolio* Government/Corporate Bond
Aggregate Index**
6/21/94 10,000 10,000 10,000
6/30/94 9,872 9,782 10,000
10,064 9,564 10,278
10,352 9,852 10,534
10,192 9,692 10,319
10,232 9,732 10,457
10,024 9,524 10,218
12/31/94 10,108 9,610 10,336
10,352 9,852 10,579
10,701 10,201 10,926
10,822 10,322 11,146
10,969 10,469 11,405
11,350 10,850 11,852
6/30/95 11,561 11,161 12,054
11,732 11,332 12,284
11,837 11,437 12,364
9/30/95 12,085 11,685 12,723
12,020 11,620 12,762
12,378 11,978 13,176
12,587 12,187 13,396
12,911 12,511 13,708
13,130 12,730 13,692
13,209 12,809 13,732
13,463 13,063 13,823
13,638 13,238 14,026
13,778 13,478 14,135
13,480 13,180 13,772
13,647 13,347 13,939
9/30/96 14,260 13,960 14,506
14,505 14,205 14,873
15,188 14,888 15,652
14,741 14,668 15,410
15,522 15,222 16,003
15,522 15,222 16,096
15,255 14,955 15,623
15,767 15,467 16,276
16,269 15,969 16,937
16,771 16,571 17,465
18,021 17,821 18,485
17,560 17,360 17,808
9/30/97 18,042 17,842 18,496
* Includes maximum Contingent Deferred Sales Charge (CDSC) of 5%. ** This Index
represents asset allocation of 60% S&P 500 Stocks and 40% Lehman Brothers
Government/Corporate Bonds. The Standard & Poor's (S&P) 500 Index is an
unmanaged, market-value-weighted index of 500 widely held domestic common
stocks. An unmanaged index does not reflect expenses and may not correspond to
the performance of a managed portfolio in which expenses are incurred. You
cannot invest in the S&P 500. The Lehman Brothers Government/Corporate Bond
Index is commonly used to compare performance of income-oriented portfolios and
includes treasuries, agencies, and publicly-issued, fixed-rate, non-convertible,
investment-grade, dollar-denominated debt. Investors can not invest in the
Index.
Average Annual Return as of 9/30/97 Average Annual Return as of 9/30/97
Without Sales Charges Including Sales Charges
1 year Inception*** 1 year Inception***
- ----------------------------------- -----------------------------------
26.09% 19.59% 21.09% 19.18%
*** For the period from June 21, 1994 (commencement of operations) to
September 30, 1997
Performance Information for the Mentor Balanced Portfolio
This graph compares the investment performance of the Portfolio from its
inception date to the index that is most representative of the fund's portfolio.
The graph reflects the performance of a hypothetical $10,000 investment in the
Portfolio from the date the Portfolio started through September 30, 1997. Return
does not reflect taxes payable (if any) on distributions.
In comparing the performance of the Portfolio to an index, keep in mind that
market indexes do not take into account brokerage commissions that would be
incurred if you purchased the individual securities that make up the index. They
also do not include taxes payable on dividends and interest payments, or
operating expenses necessary to maintain a portfolio investing in the index.
The performance data quoted in this report is historical and does not guarantee
future investment results. Your investment return and principal value will
fluctuate so that shares, when redeemed, may be worth more or less than their
original cost.
Performance is as of September 30, 1997 and includes change in share price and
reinvestment of dividends and capital gains. The maximum contingent deferred
sales charge (CDSC) is 5% for the Balanced Portfolio.
<PAGE>
<TABLE>
<CAPTION>
Percent of Net Assets Shares Market Value
- ----------------------------------------------------------------------------------------------------------
Common Stocks 66.53%
- ----------------------------------------------------------------------------------------------------------
<S> <C>
Basic Materials 9.46%
Bemis Company 2,100 $ 93,975
Morton International, Inc. 2,900 102,950
Nalco Chemical Company 2,400 96,150
Sonoco Products Company 2,800 95,025
- ----------------------------------------------------------------------------------------------------------
388,100
- ----------------------------------------------------------------------------------------------------------
Capital Goods & Construction 2.11%
W.W. Grainger, Inc. 975 86,775
- ----------------------------------------------------------------------------------------------------------
Consumer Cyclical 16.89%
Carnival Corporation - Class A 2,200 101,750
Chanchelor Media Corporation * 2,200 115,775
Federated Department Stores * 2,100 90,563
Interpublic Group Companies, Inc. 2,000 102,625
Mattel, Inc. 2,650 87,781
Mirage Resorts, Inc.* 3,400 102,425
Newell Company 2,300 92,000
- ----------------------------------------------------------------------------------------------------------
692,919
- ----------------------------------------------------------------------------------------------------------
Consumer Staples 13.38%
Avon Products Company 1,250 77,500
CPC International, Inc. 900 83,362
McDonald's Corporation 1,925 91,678
Philip Morris Companies, Inc. 2,300 95,594
Sherwin Williams Company 3,550 104,503
Sysco Corporation 2,600 96,038
- ----------------------------------------------------------------------------------------------------------
548,675
- ----------------------------------------------------------------------------------------------------------
Energy 2.26%
Schlumberger, Ltd. 1,100 92,606
- ----------------------------------------------------------------------------------------------------------
Financial 11.17%
American Express Company 1,150 94,156
Banc One Corporation 1,700 94,881
Federal National Mortgage Association 2,000 94,000
General RE Corporation 450 89,325
Norwest Corporation 1,400 85,750
- ----------------------------------------------------------------------------------------------------------
458,112
- ----------------------------------------------------------------------------------------------------------
Common Stocks (continued)
- ----------------------------------------------------------------------------------------------------------
Health 2.26%
Schering-Plough 1,800 $ 92,700
- ----------------------------------------------------------------------------------------------------------
Technology 6.52%
Computer Sciences Corporation * 1,200 84,900
First Data Corporation 2,400 90,150
Intel Corporation 1,000 92,313
- ----------------------------------------------------------------------------------------------------------
267,363
- ----------------------------------------------------------------------------------------------------------
Transportation & Services 2.48%
Werner Enterprises, Inc. 4,200 101,850
- ----------------------------------------------------------------------------------------------------------
Total Common Stocks (cost $1,974,889) 2,729,100
- ----------------------------------------------------------------------------------------------------------
Fixed Income Securities 31.21%
- ----------------------------------------------------------------------------------------------------------
U.S. Government Securities and Agencies 23.05%
Federal National Mortgage Association, 7.50%, 8/01/27 $ 100,722 102,394
Government National Mortgage Association,
5.50% - 7.38%, 5/15/09 - 5/20/27 449,939 456,123
U.S. Treasury Notes, 6.00% - 7.50%, 4/30/99 - 2/15/26 145,000 145,323
U.S. Treasury Bonds, 6.88% - 7.50%, 2/15/23 - 8/15/25 220,000 241,654
- ----------------------------------------------------------------------------------------------------------
Total U.S. Government Securities and Agencies
(cost $918,014) 945,494
- ----------------------------------------------------------------------------------------------------------
Corporate Bonds 8.16%
CS First Boston, 7.18%, 2/25/18, CMO 25,000 25,322
Merrill Lynch, 6.64%, 9/19/02 45,000 45,317
Nationsbank Corporation, 7.50%, 9/15/06 35,000 36,673
Norwest Corporation, 6.80%, 5/15/02 60,000 60,938
PNC Student Loan Trust, 6.73%, 1/25/07 75,000 76,095
Travelers, Inc., 8.63%, 2/01/07 40,000 45,251
Union Acceptance Corporation, 6.48%, 5/10/04, CMO 45,000 45,141
- ----------------------------------------------------------------------------------------------------------
Total Corporate Bonds (cost $329,461) 334,737
- ----------------------------------------------------------------------------------------------------------
Total Fixed Income Securities (cost $1,247,475) $1,280,231
- ----------------------------------------------------------------------------------------------------------
Total Investments (cost $3,222,364) 97.74% 4,009,331
- ----------------------------------------------------------------------------------------------------------
Other Assets less Liabilities 2.26% 92,544
- ----------------------------------------------------------------------------------------------------------
Net Assets 100.00% $4,101,875
- ----------------------------------------------------------------------------------------------------------
</TABLE>
*Non-income producing.
CMO- Collateralized Mortgage Obligations
See notes to financial statements.
<PAGE>
Assets
Investments, at market value (Cost $3,222,364) $4,009,331
Cash 81,072
Collateral for securities loaned (Note 2) 106,913
Dividend and interest receivable 15,479
- -----------------------------------------------------------------------------
Total assets 4,212,795
- -----------------------------------------------------------------------------
Liabilities
Securities loaned (Note 2) 106,913
Accrued expenses and other liabilities 4,007
- -----------------------------------------------------------------------------
Total liabilities 110,920
- -----------------------------------------------------------------------------
Net Assets $4,101,875
- -----------------------------------------------------------------------------
Net Assets represented by:
Additional paid-in capital $2,859,867
Accumulated undistributed net investment income 67,864
Accumulated net realized gain on
investment transactions 387,177
Net unrealized appreciation of investments (Note 6) 786,967
- -----------------------------------------------------------------------------
Net Assets $4,101,875
Shares Outstanding 232,899
- -----------------------------------------------------------------------------
Net Asset Value and Offering Price per Share $ 17.61
- -----------------------------------------------------------------------------
See notes to financial statements.
<PAGE>
Investment Income
Dividends $ 36,209
Interest 90,840
- ----------------------------------------------------------------------------
Total investment income 127,049
- ----------------------------------------------------------------------------
Expenses
Management fee (Note 3) 28,926
Distribution fee (Note 4) 28,926
Shareholder servicing fee (Note 4) 9,642
Custodian and accounting fees 8,826
Administration fees 3,858
Registration expenses 840
Legal and audit fees 286
Shareholder reports and postage expenses 230
Directors' fees and expenses 88
Miscellaneous expenses 601
- ----------------------------------------------------------------------------
Total expenses 82,223
- ----------------------------------------------------------------------------
Deduct
Waiver of management fee (Note 3) 20,072
Waiver of distribution fee (Note 4) 28,926
Waiver of shareholder servicing fee (Note 4) 9,642
Waiver of administration fee (Note 3) 3,858
- ----------------------------------------------------------------------------
Net expenses 19,725
- ----------------------------------------------------------------------------
Net investment income 107,324
- ----------------------------------------------------------------------------
Realized and unrealized gain on investments
Net realized gain on investments 408,111
Change in unrealized appreciation
of investments 397,175
- ----------------------------------------------------------------------------
Net realized and unrealized gain on investments 805,286
- ----------------------------------------------------------------------------
Net increase in net assets resulting
from operations $912,610
- ----------------------------------------------------------------------------
See notes to financial statements.
<PAGE>
<TABLE>
<CAPTION>
Year Year
Ended Ended
9/30/97 9/30/96
------------- ------------
<S> <C>
Net Increase in Net Assets
Operations
Net investment income $ 107,324 $ 97,401
Net realized gain on investments 408,111 453,033
Change in unrealized appreciation
of investments 397,175 26,238
- ---------------------------------------------------------------------------------------------------------------------------
Increase in net assets resulting from operations 912,610 576,672
- ---------------------------------------------------------------------------------------------------------------------------
Distributions to Shareholders
Net investment income (108,705) (105,563)
Net realized gain on investments (449,369) (129,654)
- ---------------------------------------------------------------------------------------------------------------------------
Net decrease from distributions (558,074) (235,217)
- ---------------------------------------------------------------------------------------------------------------------------
Capital Share Transactions (Note 7)
Change in net assets resulting from capital
share transactions (78,062) 274,373
- ---------------------------------------------------------------------------------------------------------------------------
Increase in net assets 276,474 615,828
- ---------------------------------------------------------------------------------------------------------------------------
Net Assets
Beginning of year 3,825,401 3,209,573
- ---------------------------------------------------------------------------------------------------------------------------
End of year $4,101,875 $3,825,401
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
See notes to financial statements.
<PAGE>
<TABLE>
<CAPTION>
Year Year Period Period
Ended Ended Ended Ended
9/30/97 9/30/96 9/30/95* 12/31/94**
------- ------- -------- ----------
<S> <C>
Per Share Operating Performance
Net asset value, beginning of period $ 16.28 $ 14.85 $ 12.44 $ 12.50
from investment operations
Net investment income 0.43 0.42 0.36 0.22
Net realized and unrealized
gain (loss) on investments 3.35 2.09 2.08 (0.09)
- ---------------------------------------------------------------------------------------------------------------------------
Total from investment operations 3.78 2.51 2.44 0.13
- ---------------------------------------------------------------------------------------------------------------------------
Less distributions
Dividends from net investment income (0.43) (0.48) (0.03) (0.19)
Distributions from capital gains (2.02) (0.60) - -
- ---------------------------------------------------------------------------------------------------------------------------
Total distributions (2.45) (1.08) (0.03) (0.19)
- ---------------------------------------------------------------------------------------------------------------------------
Net asset value, end of period $ 17.61 $ 16.28 $ 14.85 $ 12.44
- ---------------------------------------------------------------------------------------------------------------------------
Total Return 26.09% 18.00% 19.28% 1.00%
- ---------------------------------------------------------------------------------------------------------------------------
Ratios / Supplemental Data
- ---------------------------------------------------------------------------------------------------------------------------
Net assets, end of period (in thousands) $ 4,102 $ 3,825 $ 3,210 $ 2,911
Ratio of expenses to
average net assets 0.50% 0.50% 0.50%(a) 0.50%(a)
Ratio of expenses to average
net assets excluding waiver 2.13% 2.06% 2.12%(a) 2.72%(a)
Ratio of net investment income
to average net assets 2.78% 2.83% 3.26%(a) 3.32%(a)
Portfolio turnover rate 80% 103% 65% 71%
Average commission rate on
portfolio transactions $ 0.0696 $ 0.0694
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Annualized.
* For the period from January 1, 1995 to September 30, 1995.
**For the period from June 21, 1994 (commencement of operations) to December 31,
1994. See notes to financial statements.
<PAGE>
Note 1: Organization
The Mentor Funds is registered under the Investment Company Act of 1940, as
amended, as an open-end management investment company. Mentor Funds consists of
ten separate Portfolios (hereinafter each individually referred to as a
"Portfolio" or collectively as the "Portfolios") at September 30, 1997 as
follows:
<TABLE>
<S><C>
Mentor Growth Portfolio ("Growth Portfolio") Mentor Perpetual Global
Portfolio ("Global Portfolio") Mentor Capital Growth Portfolio ("Capital
Growth Portfolio") Mentor Strategy Portfolio ("Strategy Portfolio") Mentor
Income and Growth Portfolio ("Income and Growth Portfolio") Mentor
Municipal Income Portfolio ("Municipal Income Portfolio") Mentor Quality
Income Portfolio ("Quality Income Portfolio")
Mentor Short-Duration Income Portfolio ("Short-Duration Income Portfolio")
Mentor Balanced Portfolio ("Balanced Portfolio")
Mentor Institutional U.S. Government Money Market Portfolio ("Government Portfolio")
</TABLE>
The assets of each Portfolio are segregated and a shareholder's interest is
limited to the Portfolio in which shares are held.
The financial statements included in this report are for the Balanced Portfolio
only (hereinafter referred to as the "Portfolio"). The Balanced Portfolio
invests in common stocks and fixed income securities.
Shares of the Portfolio are sold without an initial sales charge, although a
contingent deferred sales charge may be imposed if shares are redeemed within 5
years of purchase. Shares of the Portfolio are not currently being offered to
the public.
Note 2: Significant Accounting Policies
The following is a summary of significant accounting policies consistently
followed by the Portfolio in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles which
require management to make estimates and assumptions that affect amounts
reported therein. Although actual results could differ from these estimates, any
such differences are expected to be immaterial to the net assets of the
Portfolio.
(a) Valuation of Securities- Listed securities held by the Portfolio are traded
on national securities exchanges and over-the-counter securities quoted on the
NASDAQ National Market System are valued at the last reported sales price or,
lacking any sales, at the last available bid price. In cases where securities
are traded on more than one exchange, the securities are valued on the exchange
designated by the Board of Trustees of the Portfolio as the primary market.
Securities traded in the over-the-counter market, other than those quoted on the
NASDAQ National Market System, are valued at the last available bid price.
Short-term investments with remaining maturities of 60 days or less are carried
at amortized cost, which approximates market value. Securities for which market
quotations are not readily available are valued at fair value as determined in
good faith under procedures established by and under the general supervision of
the Board of Trustees.
U.S. Government obligations held by the Portfolio are valued at the mean between
the over-the-counter bid and asked prices as furnished by an independent pricing
service. Listed corporate bonds, other fixed income securities, mortgage backed
securities, mortgage related, asset-backed and other related securities are
valued at the prices provided by an independent pricing service. Security
valuations not available from an independent pricing service are provided by
dealers approved by the Portfolio's Board of Trustees. In determining value, the
dealers use information with respect to transactions in such securities, market
transactions in comparable securities, various relationships between securities,
and yield to maturity.
(b) Repurchase Agreements- It is the policy of the Portfolio to require the
custodian bank to take possession, to have legally segregated in the Federal
Reserve Book entry system, or to have segregated within the custodian bank's
vault all securities held as collateral in support of repurchase agreement
investments. Additionally, procedures have been established by Mentor Funds to
monitor, on a daily basis, the market value of each repurchase agreement's
underlying securities to ensure the existence of a proper level of collateral.
The Portfolio will only enter into repurchase agreements with banks and other
recognized financial institutions such as broker/dealers which are deemed by the
Portfolio's advisor to be creditworthy pursuant to guidelines established by the
Portfolio's Trustees. Risks may arise from the potential inability of
counterparties to honor the terms of the repurchase agreement. Accordingly, the
Portfolio could receive less than the repurchase price on the sale of collateral
securities.
(c) Portfolio Securities Loaned- The Portfolio is authorized by the Board of
Trustees to participate in securities lending transactions.
The Portfolio may receive fees for participating in lending securities
transactions. During the period that a security is out on loan, Portfolio
continues to receive interest or dividends on the securities loaned. The
Portfolio receives collateral in an amount at least equal to, at all times, the
fair value of the securities loaned plus interest. When cash is received as
collateral, the Portfolio records an asset and obligation for the market value
of that collateral. Cash received as collateral may be reinvested, in which case
that security is recorded as an asset of the Portfolio. Variations in the market
value of the securities loaned occurring during the term of the loan are
reflected in the value of the Portfolio.
At September 30, 1997, the Portfolio had loaned securities to brokers which were
collateralized by cash. Income from securities lending activities amounted to
$30 for the year ended September 30, 1997. The risks to the Portfolio from
securities lending are that the borrower may not provide additional collateral
when required or return the securities when due. At September 30, 1997, the
market value of the securities on loan and the related cash collateral were
$102,454, and $106,913, respectively.
(d) Security Transactions and Investment Income- Security transactions for the
Portfolio are accounted for on a trade date basis. Dividend income is recorded
on the ex-dividend date and interest is recorded on the accrual basis. Interest
income includes interest and discount earned (net of premium) on short term
obligations, and interest earned on all other debt securities including original
issue discounts as required by the Internal Revenue Code. Realized and
unrealized gains and losses on investment security transactions are calculated
on an identified cost basis.
(e) Federal Income Taxes- No provision for federal income taxes has been made
since it is the Portfolio's policy to comply with the provisions applicable to
regulated investment companies under the Internal Revenue Code and to distribute
to its shareholders within the allowable time limit substantially all taxable
income and realized capital gains, if any.
(f) Distributions to Shareholders- Distributions from net investment income and
net realized capital gains, after offsetting capital loss carryovers are
distributed annually for the Portfolio.
Note 3: Investment Advisory and Management and Administration Agreements
The Portfolio has entered into an Investment Advisory Agreement with Mentor
Investment Advisors, LLC ("Mentor Advisors") a wholly-owned subsidiary of Mentor
Investment Group, LLC ("Mentor") which is in turn a partially owned subsidiary
of Wheat First Butcher Singer, Inc., ("Wheat") and EVEREN Capital Corporation.
Under this agreement, Mentor Advisors' management fee is accrued daily and paid
monthly at an annual rate of 0.75% applied to the daily average net assets of
the Portfolio. In order to limit the Portfolio's expenses, during the year ended
September 30, 1997, Mentor Advisors has agreed to reduce its compensation to the
extent expenses of the Portfolio (exclusive of brokerage, interest, taxes,
deferred organization expenses, and payments under the Portfolio's Distributions
Plan) exceed an annual rate of 0.50% of the Portfolio's average net assets. For
the year ended September 30, 1997, Mentor Advisors earned management fees of
$28,926 and voluntarily waived $20,072 of such fees.
Administrative personnel and services are provided by Mentor to the Portfolio,
under an Administration Agreement, at an annual rate of 0.10% of the average
daily net assets of the Portfolio. In order to limit the Portfolio's expenses,
Mentor agreed to waive its fees for the year ended September 30, 1997.
Acquisition of Advisor
On August 20, 1997, Wheat entered into an Agreement and Plan of Merger
("Merger") with First Union Corporation ("First Union"), pursuant to which Wheat
would be merged into First Union. First Union is a bank holding company that as
of September 30, 1997, had assets of $144 billion. Upon consummation of the
Merger (expected to occur as early as of December of this year), First Union
will become the owner of a majority of the beneficial interest in Mentor
Advisors and Mentor Perpetual Advisors, LLC (Mentor Perpetual).
At a meeting held on October 14, 1997, the Trustees of Mentor Funds approved new
Investment Advisory, Sub-Advisory and Administration Agreements which will
replace the existing agreements. Each of the existing agreements will by its
terms terminate upon the consummation of the Merger, since the Merger will
constitute a change in control of Mentor Advisors and Mentor Perpetual for
purposes of the Investment Company Act of 1940, as amended ("1940 Act"). The
shareholders of each Portfolio at a meeting to be held on December 22, 1997,
will vote to approve the new Investment Advisory Agreements with Mentor Advisors
and Mentor Perpetual. Each new agreement is substantially identical to the
existing agreements it replaces, other than its effective and termination dates.
Note 4: Distribution Agreement and Other Transactions with Affiliates
Under a Distribution Agreement between the Portfolio and Mentor Distributors,
LLC ("Mentor Distributors") a wholly-owned subsidiary of Mentor, Mentor
Distributors was appointed distributor of the Portfolio. To compensate Mentor
Distributors for the services it provides and for the expenses it incurs under
the Distribution Agreement, the Portfolio has adopted a Plan of Distribution
pursuant to Rule 12b-1 under the Investment Company Act of 1940, under which the
Portfolio pays a distribution fee, which is accrued daily and paid monthly at
the annual rate of 0.75% of the Portfolio's average daily net assets.
Mentor Funds has adopted a Shareholder Servicing Plan (the "Service Plan") with
respect to each Portfolio. Under the Service Plan, financial institutions will
enter into shareholder service agreements with the Portfolio to provide
administrative support services at an annual rate of 0.25% of the Portfolio's
average daily net assets. The total charges to be borne by the Portfolio, under
the Distribution and Shareholder Service Agreements is expected to remain at an
annual rate of 1% of the Portfolio's average daily net assets. For the year
ended September 30, 1997 distribution and shareholder services fees were as
follows:
<TABLE>
<CAPTION>
Shareholder
Distribution Fee Shareholder Servicing Fee
Distribution Fee Waived Servicing Fee Waived
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C>
Balanced Portfolio $28,926 $(28,926) $9,642 $(9,642)
</TABLE>
Note 5: Investment Transactions
Purchases and sales of investments, exclusive of short-term securities,
aggregated $2,966,662 and $3,204,851, respectively, for the year ended September
30, 1997.
Note 6: Unrealized Appreciation and Depreciation of Investments
At September 30, 1997, the cost of investments for federal income tax purposes
amounted to $3,222,839 and net unrealized appreciation aggregated $786,492, of
which $798,336 related to appreciated securities and $11,844 related to
depreciated securities.
Note 7: Capital Share Transactions
The Declaration of Trust permits the Trustees to issue an unlimited number of
full and fractional shares of beneficial interest. Transactions in capital
shares were as follows:
<TABLE>
<CAPTION>
Year Year
Ended Ended
9/30/97 9/30/96
Shares Dollars Shares Dollars
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C>
Shares sold $ - $ - $48,575 $734,947
Shares issued upon reinvestment of distributions 37,773 558,075 16,321 235,217
Shares redeemed (39,915) (636,137) (45,946) (695,791)
- ---------------------------------------------------------------------------------------------------------------------------
Change in net assets from capital share
transactions (2,142) $(78,062) 18,950 $274,373
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
The Trustees and Shareholders
Mentor Balanced Portfolio
We have audited the accompanying statement of assets and liabilities of Mentor
Balanced Portfolio, a portfolio of Mentor Funds, including the portfolio of
investments, as of September 30, 1997, 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 two-year period then ended, and the periods from January 1,
1995 to September 30, 1995 and June 21, 1994 (commencement of operations) to
December 31, 1994. These financial statements and financial highlights are the
responsibility of the Funds' management. Our responsibility is to express an
opinion on these financial statements and 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 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 and financial highlights. Our procedures included confirmation of
securities owned as of September 30, 1997 by correspondence with the custodian.
An audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of Mentor
Balanced Portfolio, as of September 30, 1997, the results of its operations for
the year then ended, the changes in its 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 two-year period then ended, and the periods from January 1, 1995 to
September 30, 1995 and June 21, 1994 (commencement of operations) to December
31, 1994, in conformity with generally accepted accounting principles.
/s/ KPMG PEAT MARWICK LLP
Boston, Massachusetts
November 12, 1997
<PAGE>
MENTOR BALANCED PORTFOLIO
SHAREHOLDER INFORMATION
Trustees
Daniel J. Ludeman, Trustee & Chairman
Chairman and Chief Executive Officer
Mentor Investment Group, LLC
Arnold H. Dreyfuss, Trustee
Former Chairman and Chief Executive Officer
Hamilton Beach/Proctor-Silex, Inc.
Thomas F. Keller, Trustee
Former Dean, Fuqua School of Business
Duke University
Louis W. Moelchert, Jr., Trustee
Vice President for Business & Finance
University of Richmond
Stanley F. Pauley, Jr., Trustee
Chairman and Chief Executive Officer
Carpenter Company
Troy A. Peery, Jr., Trustee
President
Heilig-Meyers Company
Peter J. Quinn, Jr., Trustee
Managing Director
Mentor Investment Group. LLC
Officers
Paul F. Costello, President
Managing Director
Mentor Investment Group, LLC
Terry L. Perkins, Treasurer
Senior Vice President
Mentor Investment Group, LLC
John M. Ivan, Secretary
Managing Director and Assistant General Counsel
Wheat First Butcher Singer, Inc.
MENTOR BALANCED PORTFOLIO
901 East Byrd Street
Richmond, VA 23219
(800) 382-0016
MENTOR BALANCED
PORTFOLIO
-------------
ANNUAL REPORT
-------------
September 30, 1997
[MENTOR INVESTMENT GROUP LOGO]
