A N N U A L R E P O R T
1997
1997
1997
1997
1997
[GRAPHIC]
SMITH BARNEY
ADJUSTABLE RATE
GOVERNMENT
INCOME FUND
- ----------------------------------
May 31, 1997
[LOGO] SMITH BARNEY MUTUAL FUNDS
Investing for your future.
Every day.
<PAGE>
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SMITH BARNEY ADJUSTABLE RATE GOVERNMENT INCOME FUND
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Dear Shareholder:
We are pleased to present the annual report for the Smith Barney Adjustable Rate
Government Income Fund ("Fund") for the year ended May 31, 1997. The period's
prevailing economic and market conditions and an outline of our investment
strategy appear in this report. In addition, a detailed summary of the Fund's
historical performance as well as its current holdings and portfolio management
strategy can be found in the appropriate sections that follow.
Fund Performance Update
The Fund's investment objective is to seek high current income and to limit the
degree of fluctuation of its net asset value (NAV) resulting from movements in
interest rates. The Fund seeks these objectives by investing primarily in a
portfolio of adjustable rate mortgage-backed securities (ARMs), U.S. government
securities and asset-backed securities (ABS). The Fund calculates an NAV daily
and Class A share's NAV is reported in the mutual funds listing in national
newspapers under the heading Smith Barney Funds A as "AdjGvA."
As of May 31, 1997, the Fund's Class A shares had an NAV of $9.84. For the
year-to-date period ended May 31, 1997, the Fund's Class A shares outperformed
the Merrill Lynch 1-3 Year U.S. Treasury Index by posting a total return of
2.21% versus 1.46%. The Fund's outperformance reflects the strong performance of
ARMs and other short duration alternatives to U.S. Treasuries. (The Merrill
Lynch 1-3 Year U.S. Treasury Index is a market capitalization weighted index
including all U.S. Treasury Notes and Bonds with maturities greater than or
equal to one year and less than three years.)
For the year ended May 31, 1997, the Class A shares of the Fund had a total
return of 5.31%. In comparison, the Fund's Lipper Analytical Services, Inc. peer
group generated an average return of 6.50% for the same period. (Lipper
Analytical Services, Inc. is a major fund tracking organization.)
Bond Market Update
In our view, the domestic bond market's performance during the last year was
driven by two factors: the pace of economic growth and resulting investor
concerns over potential rising inflation. After a strong second quarter of 1996,
1
<PAGE>
the pace of economic growth slowed during the remainder of last year to a
2%-2.5% annual level, which is viewed by many economists as a non-inflationary
growth rate. Economic data indicating slow growth and continued moderation in
broad inflation measures, such as consumer spending, enabled the Federal Reserve
Board ("Fed") to leave short-term interest rates unchanged at their August and
September policy meetings. However, stronger economic data from the government
and growing concerns about inflation caused U.S. Treasury yields to rise in late
1996 and for much of 1997. After reaching their lowest levels since March of
1996, U.S. Treasury yields began rising in December 1996 after Fed Chairman Alan
Greenspan's much publicized concerns of "irrational exuberance" in the financial
markets. Although inflationary measures such as commodity and producer prices
have remained relatively stable, employment growth remained strong.
The combination of a robust economy, relatively low unemployment and strong
consumer confidence prompted the Fed to raise the federal funds rate by 25 basis
points (0.25%) at their March 25, 1997, monetary policy meeting. (The federal
funds rate is the interest rate banks charge each other for overnight loans and
is a closely watched indicator of the direction of interest rates.) However,
government reports released in April and May appeared to indicate moderate
economic growth and relatively tame inflation causing the bond market to
subsequently rally. Particularly important during these two months were the
Fed's lack of action at its May 20, 1997 meeting and a lower-than-expected
upward revision to the first quarter's Gross Domestic Product (GDP) figure.
Despite experiencing significant swings, the yield of the 2-year U.S. Treasury
Note ended the year at 6.20%, which is slightly lower then where it began on May
31, 1996. Over the year, investor demand for spread product (i.e., bonds that
offer higher yields compared to U.S. Treasuries) enabled most other taxable
fixed income asset classes to outperform U.S. Treasuries. For instance,
mortgage-backed securities (MBS), which represent a major portion of the Fund's
holdings, posted good relative performance primarily due to low interest rate
volatility and relatively low refinancing risk. Over the period, the MBS market
as measured by the Lehman Mortgage Index (The Lehman Mortgage Index covers all
fixed-rate securities backed by mortgage pools of the Government National
Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC), and
Federal National Mortgage Association (FNMA).) generated a total return of 2.63%
versus the U.S. Treasury market's return as measured by the Merrill Lynch 5-7
Year U.S. Treasury Index of 1.04%. (The Merrill Lynch 5-7 Year U.S. Treasury
Index is a market capitalization weighted index including all U.S. Treasury
Notes and Bonds with maturities greater than or equal to five years and less
than seven years.)
2
<PAGE>
Within the short maturity sector of the market, ARMs and ABS also posted
excellent relative performance. We believe that the ARM market has benefited
from improving fundamental conditions over the past two years, as interest rate
volatility has generally remained at historically low levels. This has resulted
in some portions of the ARM market, particularly "seasoned," or older production
securities, to reform particularly well versus comparable maturity U.S.
Treasuries. In our view, the ABS market also has benefited from low interest
rate volatility as the best performing ABS in 1996 were those securities backed
by home equity loans.
Fund's Investment Strategy
Duration is a rough measure of the price sensitivity of a fixed income security
relative to a given change in interest rates. The Fund uses a "targeted
duration" approach which strives for a duration of roughly 1 to 1.5 years and
should result in a fund whose NAV performance is similar to that of a 1- or
2-year U.S. Treasury security. Changes in the prices and yields of these U.S.
Treasury securities affect the value of the Fund's securities. In addition to
interest rates, the prepayment rates of the mortgage-backed securities held in
the portfolio usually affects the Fund's NAV.
The Fund's assets are actively managed based on our relative value analysis of
individual securities and sectors. In searching for relative value
opportunities, we target securities and market sectors within the short duration
market that have underperformed and have strong potential for price
appreciation. During the reporting period, the Fund substantially increased its
exposure to the floating-rate ABS and collateralized mortgage obligations
(CMOs). We increased the weightings to these sectors by selling ARMs and fixed
rate ABS, both of which had performed well during the period under review.
Bond Market Outlook
Our outlook for the bond market is cautiously optimistic. Over the short term,
we believe that the recent rally may continue, since inflation news has been
positive (Consumer Price Index registered a year-over-year increase of just
2.3%) and U.S. securities appear inexpensive relative to their global
counterparts. Additionally, Fed Chairman Alan Greenspan appears to be
comfortable with the "new paradigm" that productivity gains may allow the
economy to expand at a faster clip without igniting price pressures. Thus, we do
not foresee another Fed tightening in 1997 in the absence of a visible inflation
shock.
However, the tight labor market is still a cause for concern. Many investors
anxiously await the turning point when low unemployment and lean staffing levels
led many employees to shed the insecurity from the corporate
3
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restructurings of the early 1990s and demand higher wages. Moreover, recent wage
increases, the buoyant stock market and record levels of consumer confidence are
expected to lead to stronger consumer spending and overall economic growth in
the third quarter. Therefore, we think an uninterrupted decline in yields is by
no means a certainty.
In closing, thank you for investing in the Smith Barney Adjustable Rate
Government Income Fund. We look forward to continuing to help you achieve your
financial goals.
Sincerely,
/s/ Heath B. McLendon
Heath B. McLendon
Chairman
June 23, 1997
4
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Historical Performance -- Class A Shares
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<TABLE>
<CAPTION>
Net Asset Value
-----------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
========================================================================================
<S> <C> <C> <C> <C> <C> <C>
5/31/97 $9.84 $9.84 $0.46 $0.00 $0.05 5.31%
- ----------------------------------------------------------------------------------------
5/31/96 9.88 9.84 0.56 0.00 0.00 5.48
- ----------------------------------------------------------------------------------------
5/31/95 9.78 9.88 0.49 0.01 0.00 6.39
- ----------------------------------------------------------------------------------------
5/31/94 9.96 9.78 0.38 0.00 0.00 2.05
- ----------------------------------------------------------------------------------------
Inception* - 5/31/93 10.00 9.96 0.43 0.00 0.00 3.89+
========================================================================================
Total $2.32 $0.01 $0.05
========================================================================================
</TABLE>
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Historical Performance -- Class B Shares
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<TABLE>
<CAPTION>
Net Asset Value
-----------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
========================================================================================
<S> <C> <C> <C> <C> <C> <C>
5/31/97 $9.84 $9.82 $0.46 $0.00 $0.05 5.10%
- ----------------------------------------------------------------------------------------
5/31/96 9.88 9.84 0.56 0.00 0.00 5.48
- ----------------------------------------------------------------------------------------
5/31/95 9.78 9.88 0.49 0.01 0.00 6.39
- ----------------------------------------------------------------------------------------
5/31/94 9.96 9.78 0.38 0.00 0.00 2.05
- ----------------------------------------------------------------------------------------
Inception* - 5/31/93 9.96 9.96 0.25 0.00 0.00 2.56+
========================================================================================
Total $2.14 $0.01 $0.05
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</TABLE>
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Historical Performance -- Class C Shares
================================================================================
<TABLE>
<CAPTION>
Net Asset Value
-----------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
5/31/97 $9.82 $9.84 $0.46 $0.00 $0.05 5.53%
- ----------------------------------------------------------------------------------------
5/31/96 9.88 9.82 0.56 0.00 0.00 5.27
- ----------------------------------------------------------------------------------------
5/31/95 9.78 9.88 0.45 0.01 0.00 5.93
- ----------------------------------------------------------------------------------------
Inception* - 5/31/94 9.98 9.78 0.38 0.00 0.00 1.83+
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Total $1.85 $0.01 $0.05
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</TABLE>
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Historical Performance -- Class I Shares
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<TABLE>
<CAPTION>
Net Asset Value
-----------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
========================================================================================
<S> <C> <C> <C> <C> <C> <C>
Inception* - 5/31/97 $9.79 $9.85 $0.06 $0.00 $0.00 1.20%+
========================================================================================
</TABLE>
IT IS THE FUND'S POLICY TO DISTRIBUTE DIVIDENDS MONTHLY AND CAPITAL GAINS, IF
ANY, ANNUALLY.
5
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Average Annual Total Return
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<TABLE>
<CAPTION>
Without Sales Charge(1)
---------------------------------------------
Class A Class B Class C Class I
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<S> <C> <C> <C> <C>
Year Ended 5/31/97 5.31% 5.10% 5.53% N/A
- --------------------------------------------------------------------------------
Inception* through 5/31/97 4.67 4.72 4.74 1.20%+
================================================================================
<CAPTION>
Without Sales Charge(2)
---------------------------------------------
Class A Class B Class C Class I
================================================================================
<S> <C> <C> <C> <C>
Year Ended 5/31/97 5.31% 0.10% 5.53% N/A
- --------------------------------------------------------------------------------
Inception* through 5/31/97 4.67 4.53 4.74 1.20%+
================================================================================
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Cumulative Total Return
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<CAPTION>
Without Sales Charge(1)
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<S> <C>
Class A (Inception* through 5/31/97) 25.30%
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Class B (Inception* through 5/31/97) 23.44
- --------------------------------------------------------------------------------
Class C (Inception* through 5/31/97) 20.35
- --------------------------------------------------------------------------------
Class I (Inception* through 5/31/97) 1.20
================================================================================
</TABLE>
(1) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value and does not reflect the deduction of the
applicable contingent deferred sales charges ("CDSC") with respect to Class
B shares.
(2) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value. Class B shares reflect the deduction of a maximum
5.00% CDSC, which applies if shares are redeemed within one year from
initial purchase and declines thereafter by 1.00% per year until no CDSC is
incurred.
* Inception dates for Class A, B, C and I shares are June 22, 1992, November
6, 1992, June 2, 1993 and April 14, 1997, respectively.
+ Total return is not annualized, as it may not be representative of the
total return for the year.
6
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Historical Performance (unaudited)
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Growth of $10,000 Invested in Class A Shares of the
Smith Barney Adjustable Rate Government Income Fund vs.
U.S. Government 1-Year Treasury Bill Index+
- --------------------------------------------------------------------------------
June 1992 -- May 1997
[GRAPHIC]
<TABLE>
<CAPTION>
Smith Barney U.S. Government 1-Year
Adjustable Rate Treasury Bill Index
Government Income Fund
<S> <C> <C>
6/22/92 $10,000 $10,000
5/93 10,389 10,306
5/94 10,602 10,691
5/95 11,280 11,329
5/96 11,898 11,927
5/31/97 12,530 12,587
</TABLE>
+ Hypothetical illustration of $10,000 invested in Class A shares at
inception on June 22, 1992, assuming reinvestment of dividends and capital
gains, if any, at net asset value through May 31, 1997, compared to the
U.S. Government 1-Year Treasury Bill Index. The index is comprised of U.S.
Treasury Bills with a maturity of one year. The index is unmanaged and is
not subject to the same management and trading expenses as a mutual fund.
The performance of the Fund's other classes may be greater or less than the
Class A shares' performance indicated on this chart, depending on whether
greater or lesser sales charges and fees were incurred by shareholders
investing in the other classes.
All figures represent past performance and are not a guarantee of future
results. Investment returns and principal value will fluctuate, and
redemption value may be more or less than original cost. No adjustment has
been made for shareholder tax liability on dividends or capital gains.
7
<PAGE>
================================================================================
Portfolio Highlights (unaudited) May 31, 1997
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Portfolio Breakdown
[PIE CHART]
<TABLE>
<CAPTION>
<S> <C>
Adjustable Rate Mortgage-Backed Securities 61.0%
Asset-Backed Securities 17.5%
Fixed Rate Collateralized Mortgage Obligations 11.6%
U.S. Treasury Obligations 6.1%
Short-Term Security 0.7%
Fixed Rate Mortgage Pass-Through Securities 3.1%
</TABLE>
Adjustable Rate Mortgage-Backed Securities (ARMs) are instruments that bear
interest at rates that adjust at periodic intervals at a fixed amount over the
market levels of interest rates as reflected in specified indexes. ARMs directly
or indirectly represent an interest in, or are backed by and are payable from
mortgage loans secured by real property.
Asset-Backed Securities are similar in structure to Mortgage-Backed Securities,
except that the underlying asset pools consist of credit card, automobile or
other types of receivables, or of commercial loans.
Collateralized Mortgage Obligations (CMOs) are Mortgage-Backed Securities
collateralized by mortgage loans or mortgage pass-through securities. Typically,
CMOs are collateralized by GNMA, FNMA or FHLMC Mortgage Pass-Through
Certificates, but also may be collateralized by whole loans or private mortgage
pass-through securities.
Planned Amortization Class Interest Only (PAC IOs) are CMO IOs which have
repayment schedules that are guaranteed if the actual speed of the prepayments
is within a designated range. PAC classes typically are combined with companion
classes that reduce the risk of the variation of the amount and timing of the
prepayments. Should the prepayments fall outside of the PAC band or ranges, the
class will not pay the prepayment as scheduled.
8
<PAGE>
================================================================================
Schedule of Investments May 31, 1997
================================================================================
<TABLE>
<CAPTION>
FACE
AMOUNT SECURITY VALUE
================================================================================
ADJUSTABLE RATE MORTGAGE-BACKED SECURITIES -- 61.0%
================================================================================
<S> <C> <C>
U.S. GOVERNMENT AGENCY OBLIGATIONS -- 49.5%
Federal Home Loan Bank (FHLB) -- 1.3%
$2,500,000 FHLB CPI Floater, 5.970% due 2/15/02+
(Cost -- $2,456,836) $ 2,457,825
================================================================================
Federal Home Loan Mortgage Corporation (FHLMC) -- 20.7%
6,015,901 FHLMC COFI, 6.107% due 9/1/20+ 5,918,745
8,534,629 FHLMC COFI, 6.092% due 11/1/20+ 8,396,710
4,296,981 FHLMC COFI, 6.092% due 3/1/30+ 4,226,038
5,092,032 FHLMC One Year, 7.524% due 6/1/24+ 5,219,333
6,413,281 FHLMC One Year, 7.357% due 5/1/25+ 6,637,746
7,749,075 FHLMC Strip, 6.517% due 6/1/28+ 7,816,880
- --------------------------------------------------------------------------------
Total Federal Home Loan Mortgage Corporation
(Cost -- $38,268,618) 38,215,452
================================================================================
Federal National Mortgage Association (FNMA) -- 6.6%
2,516,228 FNMA Series 1991-127, Class F Shares, 6.269% due 9/25/98+ 2,524,934
3,281,591 FNMA Six Month Treasury, 7.176% due 9/1/28+ 3,366,190
4,434,574 FNMA Ten Year CMT ARM, 6.500% due 1/1/04+ 4,318,167
1,883,735 FNMA Thirty Year CMT ARM, 8.500% due 12/1/10+ 1,970,858
- --------------------------------------------------------------------------------
Total Federal National Mortgage Association
(Cost -- $12,178,570) 12,180,149
================================================================================
Government National Mortgage Association (GNMA) -- 18.1%
1,681,826 GNMA II One Year, 7.125% due 6/20/17+ 1,726,260
7,797,645 GNMA II One Year, 7.000% due 3/20/21+ 8,016,045
2,883,283 GNMA II One Year, 7.125% due 9/20/22+ 2,964,275
5,522,179 GNMA II One Year, 6.875% due 10/20/22+ 5,649,557
5,335,639 GNMA II One Year, 6.875% due 11/20/22+ 5,457,238
2,283,227 GNMA II One Year, 6.875% due 12/20/22+ 2,329,600
1,930,758 GNMA II One Year, 7.000% due 1/20/23+ 1,973,003
3,614,019 GNMA II One Year, 7.125% due 5/20/23+ 3,707,839
1,589,038 GNMA II One Year, 7.125% due 9/20/23+ 1,629,509
- --------------------------------------------------------------------------------
Total Government National Mortgage Association
(Cost -- $33,215,124) 33,453,326
================================================================================
Student Loan Marketing Association (SLMA) -- 2.8%
3,770,357 SLMA Series 1996-4, Class A1 Shares, 5.711% due 7/25/04+ 3,769,189
1,400,000 SLMA Series 1997-1, Class A2 Shares, 5.840% due 1/25/10+ 1,399,342
- --------------------------------------------------------------------------------
Total Student Loan Marketing Association
(Cost -- $5,172,079) 5,168,531
================================================================================
TOTAL U.S. GOVERNMENT AGENCY OBLIGATIONS
(Cost -- $91,291,227) 91,475,283
================================================================================
</TABLE>
See Notes to Financial Statements.
9
<PAGE>
================================================================================
Schedule of Investments (continued) May 31, 1997
================================================================================
<TABLE>
<CAPTION>
FACE
AMOUNT SECURITY VALUE
================================================================================
<S> <C> <C>
NON-AGENCY ADJUSTABLE RATE MORTGAGE OBLIGATIONS -- 11.5%
$1,833,093 Bear,Stearns & Co., Series 1992-3B, Class A2 Shares,
8.337% due 5/25/23+ $ 1,858,867
MLCC Mortgage Investors, Inc., Class A Shares:
6,821,452 Series 1996-A, 5.930% due 2/15/21+ 6,856,650
3,531,350 Series 1996-B, 5.900% due 7/15/21+ 3,547,348
4,460,000 Resolution Trust Corp., Series 1992-4, Class A4 Shares,
7.089% due 6/25/24+ 4,478,821
Salomon Brothers:
1,764,202 Series 1992-5, Class A1 Shares, 8.232% due 11/25/22+ 1,794,511
1,340,259 Series 1996-6B, Class A1 Shares, 6.100% due 6/30/20+ 1,336,909
1,308,694 Series 1996-6G, Class A1 Shares, 6.000% due 9/30/27+ 1,305,422
- --------------------------------------------------------------------------------
TOTAL NON-AGENCY ADJUSTABLE RATE MORTGAGE
OBLIGATIONS (Cost -- $21,183,604) 21,178,528
================================================================================
TOTAL ADJUSTABLE RATE MORTGAGE-BACKED SECURITIES
(Cost -- $112,474,831) 112,653,811
<CAPTION>
================================================================================
FIXED RATE COLLATERALIZED MORTGAGE OBLIGATIONS -- 11.6%
================================================================================
<S> <C> <C>
Non-Agency Fixed Rate CMOs -- 2.2%
3,871,962 Salomon Brothers Inc., Series 1983-1, Class Z Shares,
12.000% due 12/1/13+
(Cost -- $4,257,450) 4,129,331
================================================================================
Stripped Pass-Through -- 4.8%
1,979,884 FNMA Strips, 11.500% due 3/1/09+ 2,207,571
2,416,660 FNMA Strips, 11.000% due 4/1/09+ 2,684,740
890,075 FNMA Strips, 11.500% due 4/1/09+ 984,360
2,719,007 FNMA Strips, 11.500% due 5/1/09+ 3,033,379
- --------------------------------------------------------------------------------
Total Stripped Pass-Through (Cost -- $8,791,040) 8,910,050
================================================================================
PAC -- 1.2%
2,198,288 FNMA REMIC 1994-39, Class B Shares, 5.750% due 6/25/12+
(Cost -- $2,191,229) 2,190,198
================================================================================
PAC IOs -- 0.5%
11,177 FNMA REMIC 1990-106, Class K Shares, 928.95% due 9/25/20+ 351,472
5,799,232 FNMA REMIC 1993-101, Class A Shares, 7.000% due 6/25/08+ 563,105
- --------------------------------------------------------------------------------
Total PAC IOs (Cost -- $924,159) 914,577
================================================================================
PAC POs -- 2.9%
5,459,247 FNMA REMIC 1992-157, Class ABShares, due 3/25/04+
(Cost -- $5,287,388) 5,268,174
================================================================================
TOTAL FIXED RATE COLLATERALIZED MORTGAGE
OBLIGATIONS (Cost -- $21,451,266) 21,412,330
================================================================================
</TABLE>
See Notes to Financial Statements.
10
<PAGE>
================================================================================
Schedule of Investments (continued) May 31, 1997
================================================================================
<TABLE>
<CAPTION>
FACE
AMOUNT SECURITY VALUE
================================================================================
<S> <C> <C>
FIXED RATE MORTGAGE PASS-THROUGH SECURITIES -- 3.1%
$1,017,571 FHLMC Fifteen Year, 9.000% due 11/1/05+ $ 1,027,431
4,786,304 FNMA Grantor Trust 1996-T6, Class C Shares,
6.200% due 2/26/01+ 4,690,578
- --------------------------------------------------------------------------------
TOTAL FIXED RATE MORTGAGE PASS-THROUGH SECURITIES
(Cost -- $5,778,802) 5,718,009
================================================================================
ASSET-BACKED SECURITIES -- 17.5%
1,961,629 Advanta Mortgage Loan Trust, Series 1994-4,
Class A3 Shares, 6.238% due 1/25/26+# 1,978,793
4,030,883 AFC Home Equity Loan Trust, Series 1997-1,
5.908% due 3/25/27+# 4,030,883
Discover Card Master Trust I:
2,500,000 Series 1994-A2, 6.038% due 10/16/04+# 2,521,100
2,500,000 Series 1996-A4, 6.063% due 10/16/13+# 2,534,375
497,317 Fifth Third Auto Grantor Trust, Series 1996-A,
6.200% due 9/15/01+ 496,537
First USA Credit Card Master Trust:
4,000,000 Series 1994-4, 6.058% due 8/15/03+# 4,035,000
3,000,000 Series 1994-6, 6.038% due 10/15/03+# 3,024,390
2,000,000 Series 1997-2, 5.898% due 2/17/10+@# 2,000,940
2,468,556 The Money Store Business Loan Backed Certificates,
Series 1997-1, Class A Shares, 5.286% due 4/15/28+## 2,473,197
1,500,000 People's Bank Credit Card Master Trust, Series 1996-1,
Class A Shares, 5.838% due 11/15/04+# 1,501,635
Residential Asset Securitization Trust, Class A1 Shares:
1,790,821 Series 1996-A8, 8.000% due 12/25/26+ 1,816,000
2,347,349 Series 1997-A1, 7.000% due 3/25/27+ 2,334,885
3,600,000 SMS Student Loan Trust, Series 1997-A, Class A Shares,
5.960% due 10/27/25+ ++ 3,593,268
- --------------------------------------------------------------------------------
TOTAL ASSET-BACKED SECURITIES
(Cost -- $32,332,542) 32,341,003
================================================================================
U.S. TREASURY OBLIGATIONS-- 6.1%
2,750,000 U.S. Treasury Notes, 6.625% due 7/31/01+ 2,762,265
2,850,000 U.S. Treasury Notes, 6.500% due 8/31/01+ 2,849,943
5,600,000 U.S. Treasury Notes, 6.500% due 5/31/02+ 5,599,888
- --------------------------------------------------------------------------------
TOTAL U.S. TREASURY OBLIGATIONS
(Cost -- $11,274,924) 11,212,096
================================================================================
</TABLE>
See Notes To Financial Statements.
11
<PAGE>
================================================================================
Schedule of Investments (continued) May 31, 1997
================================================================================
<TABLE>
<CAPTION>
FACE
AMOUNT SECURITY VALUE
================================================================================
<S> <C> <C>
SHORT-TERM SECURITY -- 0.7%
$1,220,000 FHLB Discount Note, 5.452% due 6/2/97
(Cost-- $1,219,815) $ 1,219,815
================================================================================
TOTAL INVESTMENTS -- 100%
(Cost-- $184,532,180*) $184,557,064
================================================================================
</TABLE>
+ Security segregated by custodian for reverse repurchase agreements and/or
futures contract commitments.
@ Security is traded on a "to-be-announced" basis (see Note 8).
# Variable rate security -- rate resets monthly.
## Variable rate security -- rate resets quarterly.
++ Variable rate security -- rate resets weekly.
* Aggregate cost for Federal income tax purposes is substantially the same.
Key to Abbreviations
-------------------------------------------------------
ARM -- Adjustable Rate Mortgage
CMO -- Collateralized Mortgage Obligation
CMT -- Constant Maturity Treasury
COFI -- Cost of funds for member institutions for the
Federal Home Loan Bank of San Francisco
CPI -- Consumer Price Index
IO -- Interest Only
PAC -- Planned Amortization Class
PO -- Principal Only
REMIC -- Real Estate Mortgage Investment Conduit
See Notes to Financial Statements.
12
<PAGE>
===============================================================================
Statement of Assets and Liabilities May 31, 1997
===============================================================================
<TABLE>
<S> <C>
ASSETS:
Investments, at value (Cost -- $184,532,180) $ 184,557,064
Interest receivable 1,764,747
Receivable for Fund shares sold 776,614
Other receivables 352,351
- --------------------------------------------------------------------------------
Total Assets 187,450,776
- --------------------------------------------------------------------------------
LIABILITIES:
Reverse repurchase agreement (Note 6) 45,632,250
Payable for securities purchased 9,546,027
Payable for Fund shares purchased 1,983,699
Interest payable 62,337
Payable to broker--variation margin 58,150
Investment advisory fees payable 47,878
Dividends payable 41,484
Administration fees payable 22,810
Distribution fees payable 19,794
Accrued expenses 375,997
- --------------------------------------------------------------------------------
Total Liabilities 57,790,426
- --------------------------------------------------------------------------------
Total Net Assets $ 129,660,350
================================================================================
NET ASSETS:
Par value of shares of beneficial interest $ 13,177
Capital paid in excess of par value 136,368,786
Overdistributed net investment income (46,196)
Accumulated net realized loss on security transactions,
options and futures contracts (6,653,936)
Net unrealized depreciation on investments and
futures contracts (21,481)
- --------------------------------------------------------------------------------
Total Net Assets $ 129,660,350
================================================================================
Shares Outstanding:
Class A 12,578,205
- --------------------------------------------------------------------------------
Class B 346,689
- --------------------------------------------------------------------------------
Class C 7,010
- --------------------------------------------------------------------------------
Class I 245,215
- --------------------------------------------------------------------------------
Net Asset Value:
Class A (and redemption price) $9.84
- --------------------------------------------------------------------------------
Class B* $9.82
- --------------------------------------------------------------------------------
Class C (and redemption price) $9.84
- --------------------------------------------------------------------------------
Class I (and redemption price) $9.85
================================================================================
</TABLE>
* Redemption price is NAV of Class B shares reduced by a maximum 5.00% CDSC
if shares are redeemed within one year from initial purchase (See Note 2).
See Notes to Financial Statements.
13
<PAGE>
================================================================================
Statement of Operations For the Year Ended May 31, 1997
================================================================================
<TABLE>
<S> <C>
INVESTMENT INCOME:
Interest $ 10,910,153
Less: Interest expense (Note 6) (2,055,152)
- --------------------------------------------------------------------------------
Total Investment Income 8,855,001
- --------------------------------------------------------------------------------
EXPENSES:
Distribution fees (Note 2) 1,085,551
Investment advisory fees (Note 2) 579,582
Administration fees (Note 2) 289,791
Registration 146,685
Shareholder communications 97,760
Shareholder and system servicing fees 82,978
Audit and legal 63,849
Amortization of deferred organization costs 31,672
Trustees' fees 24,944
Custody 24,148
Other 22,993
- --------------------------------------------------------------------------------
Total Expenses 2,449,953
- --------------------------------------------------------------------------------
Net Investment Income 6,405,048
- --------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS,
OPTIONS AND FUTURES CONTRACTS (NOTES 3, 9 AND 10):
Realized Gain (Loss) From:
Security transactions (excluding short-term securities) 766,458
Options purchased 73,506
Futures contracts (130,856)
- --------------------------------------------------------------------------------
Net Realized Gain 709,108
- --------------------------------------------------------------------------------
Change in Net Unrealized Depreciation of Investments
and Futures Contracts:
Beginning of year (338,149)
End of year (21,481)
- --------------------------------------------------------------------------------
Decrease in Net Unrealized Depreciation 316,668
- --------------------------------------------------------------------------------
Net Gain on Investments, Options and Futures Contracts 1,025,776
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations $ 7,430,824
================================================================================
</TABLE>
See Notes to Financial Statements.
14
<PAGE>
================================================================================
Statements of Changes in Net Assets For the Years Ended May 31,
================================================================================
<TABLE>
<CAPTION>
1997 1996
================================================================================
<S> <C> <C>
OPERATIONS:
Net investment income $ 6,405,048 $ 9,951,704
Net realized gain 709,108 173,691
Increase in net unrealized
appreciation (depreciation) 316,668 (960,688)
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations 7,430,824 9,164,707
- --------------------------------------------------------------------------------
DISTRIBUTION TO SHAREHOLDERS FROM:
Net investment income (6,667,389) (9,931,014)
Capital (804,871) --
- --------------------------------------------------------------------------------
Decrease in Net Assets From
Distribution to Shareholders (7,472,260) (9,931,014)
- --------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 13):
Net proceeds from sale of shares 149,127,584 179,468,808
Net asset value of shares issued for
reinvestment of dividends 6,819,197 9,402,283
Cost of shares reacquired (187,612,850) (205,722,546)
- --------------------------------------------------------------------------------
Decrease in Net Assets From
Fund Share Transactions (31,666,069) (16,851,455)
- --------------------------------------------------------------------------------
Decrease in Net Assets (31,707,505) (17,617,762)
NET ASSETS:
Beginning of year 161,367,855 178,985,617
================================================================================
End of year* $129,660,350 $161,367,855
================================================================================
* Includes overdistributed net investment
income of: $(46,196) $(79,911)
================================================================================
</TABLE>
See Notes to Financial Statements.
15
<PAGE>
================================================================================
Statement of Cash Flows For the Year Ended May 31, 1997
================================================================================
<TABLE>
<S> <C>
NET DECREASE IN CASH:
Cash Flows From Operating and Investing Activities:
Interest received $ 11,040,463
Operating expenses paid (2,711,377)
Purchases of short-term securities and purchased options, net (943,487)
Purchases of long-term securities (523,724,004)
Proceeds from disposition of long-term securities 563,508,777
Proceeds from short sale transactions, net 46,634
Payments for futures transactions, net (8,368)
- --------------------------------------------------------------------------------
Net Cash Provided By Operating and Investing Activities 47,208,638
- --------------------------------------------------------------------------------
Cash Flows From Financing Activities:
Proceeds from shares sold 149,120,140
Payments on shares redeemed (185,836,162)
Cash dividends paid to shareholders* (712,935)
Decrease in reverse repurchase agreements outstanding (7,809,844)
Interest expense (1,992,815)
- --------------------------------------------------------------------------------
Net Cash Used By Financing Activities (47,231,616)
- --------------------------------------------------------------------------------
Net Decrease in Cash (22,978)
Cash - Beginning of Year 22,978
- --------------------------------------------------------------------------------
Cash - End of Year $ 0
================================================================================
RECONCILIATION OF INCREASE IN NET ASSETS FROM
OPERATIONS TO NET CASH PROVIDED BY OPERATING AND
INVESTING ACTIVITIES:
Increase in Net Assets From Operations $ 7,430,824
- --------------------------------------------------------------------------------
Decrease in investments 29,794,941
Decrease in options purchased 102,069
Decrease in variation margin 168,853
Decrease in receivable for securities sold 9,074,413
Decrease in interest receivable 119,636
Decrease in other assets 316,270
Decrease in payable for securities purchased (1,560,424)
Decrease in accrued expenses and other payables (293,096)
Interest expense 2,055,152
- --------------------------------------------------------------------------------
Total Adjustments 39,777,814
- --------------------------------------------------------------------------------
Net Cash Provided By Operating and Investing Activities $ 47,208,638
================================================================================
</TABLE>
* Exclusive of dividend reinvestment of $6,819,197.
See Notes to Financial Statements.
16
<PAGE>
================================================================================
Notes to Financial Statements
================================================================================
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Barney Adjustable Rate Government Income Fund ("Fund"), a
Massachusetts business trust, is registered under the Investment Company Act of
1940, as amended, as a diversified, open-end management investment company.
The significant accounting policies followed by the Fund are: (a) security
transactions are accounted for on trade date; (b) U.S. government agencies and
obligations are valued at the quoted bid price in the over-the-counter market;
corporate debt securities, mortgage-backed securities and asset-backed
securities are valued on the basis of valuations provided by dealers in those
instruments or by an independent pricing service approved by the Fund's Board of
Trustees; (c) securities maturing within 60 days are valued at cost plus
accreted discount, or minus amortized premium, which approximates value; (d)
interest income, adjusted for accretion of original issue discount, is recorded
on an accrual basis; (e) dividends and distributions to shareholders are
recorded on the ex-dividend date; (f) gains or losses on the sale of securities
are calculated by using the specific identification method; (g) direct expenses
are charged to each class; management fees and general fund expenses are
allocated on the basis of relative net assets; (h) the Fund intends to comply
with the requirements of the Internal Revenue Code of 1986, as amended,
pertaining to regulated investment companies and to make distributions of
taxable income sufficient to relieve it from substantially all Federal income
and excise taxes; (i) the character of income and gains to be distributed are
determined in accordance with income tax regulations which may differ from
generally accepted accounting principles. Accordingly, overdistributed income of
$804,871 at May 31, 1997 have been reclassified to paid-in capital. Net
investment income, net realized gains and net assets were not affected by this
change; and (j) estimates and assumptions are required to be made regarding
assets, liabilities and changes in net assets resulting from operations when
financial statements are prepared. Changes in the economic environment,
financial markets and any other parameters used in determining these estimates
could cause actual results to differ.
In addition, organization costs have been deferred and amortized on a
straight-line basis over a five year period, beginning with the commencement of
the Fund's operations in June 1992.
2. INVESTMENT ADVISORY AGREEMENT, ADMINISTRATION AGREEMENT AND OTHER
TRANSACTIONS
Smith Barney Strategy Advisers Inc. ("SBSA"), a wholly owned subsidiary of
Smith Barney Mutual Funds Management Inc. ("SBMFM"), which, in turn, is a
subsidiary of Smith Barney Holdings Inc. ("SBH"), acts as
17
<PAGE>
================================================================================
Notes to Financial Statements (continued)
================================================================================
investment adviser to the Fund. The Fund pays SBSA an investment advisory fee
calculated at the annual rate of 0.40% of the average daily net assets. This fee
is calculated daily and paid monthly.
SBSA has entered into a sub-advisory agreement with BlackRock Financial
Management Inc. ("BlackRock"), a wholly owned subsidiary of PNC Bank, N.A.
Pursuant to the sub-advisory agreement, BlackRock is responsible for the
day-to-day portfolio operations and investment decisions for the Fund. SBSA pays
BlackRock a monthly fee calculated at an annual rate of 0.20% of the average
daily net assets of the Fund. This fee is calculated daily and paid monthly.
SBMFM also acts as the Fund's administrator for which the Fund pays a fee
calculated at an annual rate of 0.20% of the average daily net assets. This fee
is calculated daily and paid monthly.
Smith Barney Inc. ("SB"), another subsidiary of SBH, acts as distributor of
the Fund's shares.
There is a maximum contingent deferred sales charge ("CDSC") of 5.00% on
Class B shares, which applies if redemption occurs within one year from initial
purchase and declines thereafter by 1.00% per year until no CDSC is incurred.
For the year ended May 31, 1997, CDSCs paid to SB for Class B shares were
approximately $22,000.
Pursuant to a Distribution Plan, the Fund pays a service fee with respect
to Class A, B, C, and I shares calculated at the annual rate of 0.25% of the
average daily net assets of each respective class. The Fund also pays a
distribution fee with respect to Class A, B and C shares calculated at an annual
rate of 0.50% of the average daily net assets of each class. For the year ended
May 31, 1997, total Distribution Plan fees incurred were:
<TABLE>
<CAPTION>
Class A Class B Class C Class I
================================================================================
<S> <C> <C> <C> <C>
Distribution Plan Fees $1,045,571 $39,076 $321 $583
================================================================================
</TABLE>
All officers and one Trustee of the Fund are employees of SB.
3. INVESTMENTS
During the year ended May 31, 1997, the aggregate cost of purchases and
proceeds from sales of investments (including maturities, but excluding
short-term securities) were as follows:
<TABLE>
================================================================================
<S> <C>
Purchases $521,870,344
- --------------------------------------------------------------------------------
Sales 511,761,454
================================================================================
</TABLE>
18
<PAGE>
================================================================================
Notes to Financial Statements (continued)
================================================================================
At May 31, 1997, aggregate gross unrealized appreciation and depreciation
of investments for Federal income tax purposes were substantially as follows:
<TABLE>
================================================================================
<S> <C>
Gross unrealized appreciation $ 522,519
Gross unrealized depreciation (497,635)
- --------------------------------------------------------------------------------
Net unrealized appreciation $ 24,884
================================================================================
</TABLE>
4. CASH FLOW INFORMATION
Cash, as used in the Statement of Cash Flows, is the amount reported in the
Statement of Assets and Liabilities. The Fund issues and redeems its shares,
invests in securities and distributes dividends from net investment income and
net realized gains (which are either paid in cash or reinvested into the Fund at
the discretion of shareholders). These activities are reported in the Statement
of Changes in Net Assets. Information on cash payments is presented in the
Statement of Cash Flows. Accounting practices that do not affect reporting
activities on a cash basis include unrealized gain or loss on investment
securities, accretion income recognized on investment securities and
amortization of deferred organization costs.
5. REPURCHASE AGREEMENTS
The Fund purchases (and its custodian takes possession of) U.S. government
securities from banks and securities dealers subject to agreements to resell the
securities to the sellers at a future date (generally, the next business day) at
an agreed-upon higher repurchase price. The Fund requires continual maintenance
of the market value of the collateral in amounts equal to the repurchase price.
As of May 31, 1997, the Fund had no open repurchase agreements.
6. REVERSE REPURCHASE AGREEMENTS
The Fund may enter into reverse repurchase agreement transactions for
leveraging purposes. A reverse repurchase agreement involves a sale by the Fund
of securities that it holds with an agreement by the Fund to repurchase the same
securities at an agreed upon price and date. A reverse repurchase agreement
involves the risk that the market value of the securities sold by the Fund may
decline below the repurchase price of the securities. The Fund will establish a
segregated account with its custodian, in which the Fund will maintain cash,
U.S. government securities or other liquid high grade debt obligations equal in
value to its obligations with respect to the reverse repurchase agreements.
19
<PAGE>
================================================================================
Notes to Financial Statements (continued)
================================================================================
At May 31, 1997, the Fund had the following reverse repurchase agreements
outstanding:
<TABLE>
<CAPTION>
FACE
AMOUNT SECURITY VALUE
=========================================================================================
<S> <C> <C>
$32,227,000 Reverse Repurchase Agreement with Salomon Brothers,
dated 5/22/97 bearing 5.580% to be repurchased
at $32,386,846 on 6/23/97, collateralized by $788,000
GNMA II One Year, 6.875% due 12/20/22, and by $4,653,000
GNMA II One Year, 7.125% due 5/20/23, and by $5,000,000
GNMA II One Year, 6.875 due 10/20/22, and by $7,132,244
GNMA II One Year, 7.000% due 3/20/21, and by $6,934,041
GNMA II One Year, 7.000% due 3/20/21, and by $12,681,782
FHLMC COFI, 6.107% due 9/1/20, and by $14,654,000
FHLMC COFI, 6.092% due 11/1/20, and by $6,979,988
FHLMC One Year, 7.357% due 5/1/25.
$32,227,000
2,323,000 Reverse Repurchase Agreement with Aubrey Lanston,
dated 5/22/97 bearing 5.450% to be repurchased
at $2,327,220 on 6/3/97, collateralized by $2,300,000
U.S. Treasury Note, 6.500% due 8/31/01. 2,323,000
7,426,000 Reverse Repurchase Agreement with Merrill Lynch,
dated 5/22/97 bearing 5.620% to be repurchased
at $7,464,256 on 6/24/97, collateralized by $8,000,000
FHLMC Strip, 6.517% due 6/1/28. 7,426,000
2,556,250 Reverse Repurchase Agreement with Aubrey Lanston,
dated 5/23/97 bearing 5.450% to be repurchased
at $2,560,507 on 6/3/97, collateralized by $2,500,000
U.S. Treasury Note, 6.625% due 7/31/01. 2,556,250
1,100,000 Reverse Repurchase Agreement with Merrill Lynch,
dated 5/27/97 bearing 5.620% to be repurchased
at $1,104,808 on 6/24/97, collateralized by $3,023,000
GNMA II One Year, 7.125% due 6/20/17. 1,100,000
- -----------------------------------------------------------------------------------------
TOTAL REVERSE REPURCHASE AGREEMENTS $45,632,250
=========================================================================================
</TABLE>
During the year ended May 31, 1997, the maximum and average amount of
reverse repurchase agreements outstanding were as follows:
<TABLE>
=========================================================================================
<S> <C>
Maximum amount outstanding $62,032,000
- -----------------------------------------------------------------------------------------
Average amount outstanding $37,684,776
=========================================================================================
</TABLE>
Interest rates ranged from 4.75% to 6.00% during the year. Total market
value of the collateral for the reverse repurchase agreements is $47,152,041.
Interest expense for the year ended May 31, 1997 on borrowings by the Fund
under reverse repurchase agreements totalled $2,055,152.
20
<PAGE>
================================================================================
Notes to Financial Statements (continued)
================================================================================
7. DOLLAR ROLL TRANSACTIONS
The Fund may enter into dollar roll transactions. A dollar roll transaction
involves a sale by the Fund of securities that it holds with an agreement by the
Fund to repurchase similar securities at an agreed upon price and date. The
securities repurchased will bear the same interest as those sold, but generally
will be collateralized by pools of mortgages with different prepayment histories
than those securities sold. Proceeds of the sale will be invested and the income
from these investments, together with any additional income for the Fund
exceeding the yield on the securities sold.
As of May 31, 1997, the Fund had no open dollar roll transactions.
8. SECURITIES TRADED ON A TO-BE-ANNOUNCED BASIS
The Fund may trade securities on a "to-be-announced" ("TBA") basis. In a
TBA transaction, the Fund commits to purchasing or selling securities for which
specific information is not yet known at the time of the trade, particularly the
face amount and maturity date in GNMA transactions. Securities purchased on a
TBA basis are not settled until they are delivered to the Fund, normally 15 to
45 days later. These transactions are subject to market fluctuations and their
current value is determined in the same manner as for other securities.
As of May 31, 1997, the Fund held one TBA security with a cost of
$2,000,000.
9. OPTIONS CONTRACTS
Premiums paid when put or call options are purchased by the Fund, represent
investments, which are marked-to-market daily and are included in the schedule
of investments. When a purchased option expires, the Fund will realize a loss in
the amount of the premium paid. When the Fund enters into a closing sales
transaction, the Fund will realize a gain or loss depending on whether the sales
proceeds from the closing sales transaction are greater or less than the premium
paid for the option. When the Fund exercises a put option, it will realize a
gain or loss from the sale of the underlying security and the proceeds from such
a sale will be decreased by the premium originally paid. When the Fund exercises
a call option, the cost of the security which the Fund purchases upon exercise
will be increased by the premium originally paid.
As of May 31, 1997, the Fund had no open purchased put or call option
contracts.
21
<PAGE>
================================================================================
Notes to Financial Statements (continued)
================================================================================
When a Fund writes a covered call or put option, an amount equal to the
premium received by the Fund is recorded as a liability, the value of which is
marked-to-market daily. When a written option expires, the Fund realizes a gain
equal to the amount of the premium received. When the Fund enters into a closing
purchase transaction, the Fund realizes a gain (or loss if the cost of the
closing purchase transaction exceeds the premium received when the option was
written) without regard to any unrealized gain or loss on the underlying
security, and the liability related to such an option is eliminated. When a
written call option is exercised, the cost of the security sold will be
decreased by the premium originally received. When a written put option is
exercised, the amount of the premium originally received will reduce the cost of
the security which the Fund purchased upon exercise. When written index options
are exercised, settlement is made in cash.
The risk associated with purchasing options is limited to the premium
originally paid. The Fund enters into options for hedging purposes. The risk in
writing a covered call option is that the Fund gives up the opportunity to
participate in any increase in the price of the underlying security beyond the
exercise price. The risk in writing a put option is that the Fund is exposed to
the risk of loss if the market price of the underlying security declines.
During the year ended May 31, 1997, the Fund did not write any options.
10. FUTURES CONTRACTS
Initial margin deposits made upon entering into futures contracts are
recognized as assets. Securities equal to the initial margin amount are
segregated by the custodian in the name of the broker. Additional securities are
also segregated up to the current market value of the futures contracts. During
the period the futures contract is open, changes in the value of the contract
are recognized as unrealized gains or losses by "marking-to-market" on a daily
basis to reflect the market value of the contract at the end of each day's
trading. Variation margin payments are received or made and recognized as assets
due from or liabilities due to broker, depending upon whether unrealized gains
or losses are incurred. When the contract is closed, the Fund records a realized
gain or loss equal to the difference between the proceeds from (or cost of) the
closing transactions and the Fund's basis in the contract. The Fund enters into
such contracts to hedge a portion of its portfolio. The Fund bears the market
risk that arises from changes in the value of the financial instruments and
securities indices (futures contracts) and the credit risk should a counterparty
fail to perform under such contracts.
22
<PAGE>
================================================================================
Notes to Financial Statements (continued)
================================================================================
At May 31, 1997, the Fund had the following open futures contracts:
<TABLE>
<CAPTION>
Expiration # of Basis Market Unrealized
Month/Year Contracts Value Value Gain (Loss)
================================================================================
Future contracts to buy:
<S> <C> <C> <C> <C> <C>
U.S. 10 Year Note 9/97 64 $ 6,802,288 $6,850,000 $ 47,712
- --------------------------------------------------------------------------------
Future contracts to sell:
U.S. 5 Year Note 9/97 214 22,457,901 22,546,906 (89,005)
U.S. Long Bond 9/97 16 1,748,928 1,754,000 (5,072)
- --------------------------------------------------------------------------------
(94,077)
Net Unrealized Loss $ (46,365)
================================================================================
</TABLE>
11. SHORT SALES OF SECURITIES
A short sale is a transaction in which the Fund sells securities it does
not own (but has borrowed) in anticipation of a decline in the market price of
the securities. To complete a short sale, the Fund may arrange through a broker
to borrow the securities to be delivered to the buyer. The proceeds received by
the Fund for the short sale are retained by the broker until the Fund replaces
the borrowed securities. In borrowing the securities to be delivered to the
buyer, the Fund becomes obligated to replace the securities borrowed at their
market price at the time of replacement, whatever that price may be.
During the year ended May 31, 1997, the Fund did enter into several short
sale transactions; however, at the end of the year all these transactions had
closed and there were no open transactions.
12. CAPITAL LOSS CARRYFORWARD
As of May 31, 1997, the Fund had, for Federal income tax purposes,
approximately $6,685,000 of capital loss carryforwards available to offset any
future capital gains. To the extent that these carryforward losses are used to
offset capital gains, it is probable that the gains so offset will not be
distributed. The amount and expiration of the carryforwards are indicated below.
Expiration occurs on May 31 of the year indicated:
<TABLE>
<CAPTION>
2003 2004 2005
================================================================================
<S> <C> <C> <C>
Carryforward Amounts $5,259,000 $570,000 $856,000
================================================================================
</TABLE>
13. SHARES OF BENEFICIAL INTEREST
At May 31, 1997, the Fund had an unlimited amount of shares of beneficial
interest authorized with a par value of $0.001 per share. The Fund has the
ability to issue multiple classes of shares. Class B and C shares are available
for
23
<PAGE>
================================================================================
Notes to Financial Statements (continued)
================================================================================
purchase to investors in the Smith Barney 401(k) Program. In addition, Class B
shares can be purchased through exchanges. Each share represents an identical
interest in the Fund and has the same rights except that each class bears
certain expenses specifically related to the distribution of its shares.
At May 31, 1997, total paid-in capital amounted to the following for each
class:
<TABLE>
<CAPTION>
Class A Class B Class C Class I
================================================================================
<S> <C> <C> <C> <C>
Total Paid-in Capital $130,417,098 $3,489,956 $70,714 $2,404,195
================================================================================
</TABLE>
Transactions in shares of each class were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
May 31, 1997 May 31, 1996
----------------------- -------------------------
Shares Amount Shares Amount
======================================================================================
<S> <C> <C> <C> <C>
Class A
Shares sold 8,490,645 $ 83,712,514 10,827,229 $ 106,653,375
Shares issued on reinvestment 671,821 6,619,602 930,447 9,166,413
Shares redeemed (12,402,672) (122,143,557) (13,597,487) (133,909,251)
- --------------------------------------------------------------------------------------
Net Decrease (3,240,206) $ (31,811,441) (1,839,811) $ (18,089,463)
======================================================================================
Class B
Shares sold 6,379,831 $ 62,813,921 7,388,624 $ 72,782,060
Shares issued on reinvestment 19,196 189,004 23,848 234,910
Shares redeemed (6,632,928) (65,297,021) (7,289,395) (71,810,764)
- --------------------------------------------------------------------------------------
Net Increase (Decrease) (233,901) $ (2,294,096) 123,077 $ 1,206,206
======================================================================================
Class C
Shares sold 4,602 $ 45,366 3,388 $ 33,372
Shares issued on reinvestment 223 2,191 98 960
Shares redeemed (1,250) (12,284) (256) (2,530)
- --------------------------------------------------------------------------------------
Net Increase 3,575 $ 35,273 3,230 $ 31,802
======================================================================================
Class I*
Shares sold 260,643 $ 2,555,783 -- --
Shares issued on reinvestment 853 8,400 -- --
Shares redeemed (16,281) (159,988) -- --
- --------------------------------------------------------------------------------------
Net Increase 245,215 $ 2,404,195 -- --
======================================================================================
</TABLE>
* For the period from April 14, 1997 (inception date) to May 31, 1997.
24
<PAGE>
================================================================================
Financial Highlights
================================================================================
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class A Shares 1997 1996 1995(1) 1994 1993(2)
================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value,
Beginning of Year $9.84 $9.88 $9.78 $9.96 $10.00
- --------------------------------------------------------------------------------
Income From Operations:
Net investment income (3) 0.43 0.56 0.47 0.37 0.44
Net realized and unrealized
gain (loss) 0.08 (0.04) 0.13 (0.17) (0.05)
- --------------------------------------------------------------------------------
Total Income From Operations 0.51 0.52 0.60 0.20 0.39
- --------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.46) (0.56) (0.49) (0.38) (0.43)
Net realized gains -- -- (0.01) -- --
Capital (0.05) -- -- -- --
- --------------------------------------------------------------------------------
Total Distributions (0.51) (0.56) (0.50) (0.38) (0.43)
- --------------------------------------------------------------------------------
Net Asset Value, End of Year $9.84 $9.84 $9.88 $9.78 $9.96
- --------------------------------------------------------------------------------
Total Return 5.31% 5.48% 6.39% 2.05% 3.89%++
- --------------------------------------------------------------------------------
Net Assets, End of Year (000s) $123,769 $155,622 $174,463 $283,627 $313,184
- --------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses (3)(4) 1.57% 1.58% 1.60% 1.53% 1.50%+
Net investment income 4.42 5.66 4.94 3.72 4.36+
- --------------------------------------------------------------------------------
Portfolio Turnover Rate 288% 273% 524% 525% 236%
================================================================================
</TABLE>
(1) Per share amounts have been calculated using the monthly average shares
method rather than the undistributed net investment income method, because
it more accurately reflects the per share data for the period.
(2) For the period from June 22, 1992 (inception date) to May 31, 1993.
(3) The Investment adviser waived a portion of its fees for the period ended
May 31, 1993. If such fees were not waived, the per share decrease on net
investment income would have been $0.01 and the expense ratio would have
been 2.03% (annualized).
(4) For the years ended May 31, 1995 and May 31, 1994 and the period ended May
31, 1993, the annualized expense ratios were calculated excluding interest
expense. The ratios including interest expense were 2.47%, 2.31% and 1.92%
(annualized), respectively.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
25
<PAGE>
================================================================================
Financial Highlights (continued)
================================================================================
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class B Shares 1997 1996 1995(1) 1994 1993(2)
=======================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $9.84 $9.88 $9.78 $9.96 $9.96
- ---------------------------------------------------------------------------------------
Income From Operations:
Net investment income (3) 0.39 0.56 0.47 0.37 0.25
Net realized and unrealized
gain (loss) 0.10 (0.04) 0.13 (0.17) --
- ---------------------------------------------------------------------------------------
Total Income From Operations 0.49 0.52 0.60 0.20 0.25
- ---------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.46) (0.56) (0.49) (0.38) (0.25)
Net realized gains -- -- (0.01) -- --
Capital (0.05) -- -- -- --
- ---------------------------------------------------------------------------------------
Total Distributions (0.51) (0.56) (0.50) (0.38) (0.25)
- ---------------------------------------------------------------------------------------
Net Asset Value, End of Year $9.82 $9.84 $9.88 $9.78 $9.96
- ---------------------------------------------------------------------------------------
Total Return 5.10% 5.48% 6.39% 2.05% 2.56%++
- ---------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $3,406 $5,712 $4,521 $8,422 $3,569
- ---------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses (3)(4) 1.61% 1.60% 1.63% 1.57% 1.50%+
Net investment income 4.32 5.64 4.92 3.68 4.36+
- ---------------------------------------------------------------------------------------
Portfolio Turnover Rate 288% 273% 524% 525% 236%
=======================================================================================
</TABLE>
(1) Per share amounts have been calculated using the monthly average shares
method rather than the undistributed net investment income method, because
it more accurately reflects the per share data for the period.
(2) For the period from November 6, 1992 (inception date) to May 31, 1993.
(3) The Investment adviser waived a portion of its fees for the period ended
May 31, 1993. If such fees were not waived, the per share effect on net
investment income would have been a decrease of $0.01 and the expense ratio
would have been 2.03% (annualized).
(4) For the years ended May 31, 1995 and May 31, 1994 and the period ended May
31, 1993, the annualized expense ratios were calculated excluding interest
expense. The ratios including interest expense were 2.49%, 2.35% and 1.92%
(annualized), respectively.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
26
<PAGE>
================================================================================
Financial Highlights (continued)
================================================================================
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class C Shares 1997 1996 1995(1)(2) 1994(3)
===================================================================================
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $9.82 $9.88 $9.78 $9.98
- -----------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.40 0.56 0.46 0.37
Net realized and unrealized gain (loss) 0.13 (0.06) 0.10 (0.19)
- -----------------------------------------------------------------------------------
Total Income From Operations 0.53 0.50 0.56 0.18
- -----------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.46) (0.56) (0.45) (0.38)
Net realized gains -- -- (0.01) --
Capital (0.05) -- -- --
- -----------------------------------------------------------------------------------
Total Distributions (0.51) (0.56) (0.46) (0.38)
- -----------------------------------------------------------------------------------
Net Asset Value, End of Year $9.84 $9.82 $9.88 $9.78
- -----------------------------------------------------------------------------------
Total Return 5.53% 5.27% 5.93% 1.83%++
- -----------------------------------------------------------------------------------
Net Assets, End of Year (000s) $69 $34 $2 $113
- -----------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses (4) 1.52% 1.59% 1.59% 1.55%+
Net investment income 4.67 5.66 4.95 3.69+
- -----------------------------------------------------------------------------------
Portfolio Turnover Rate 288% 273% 524% 525%
===================================================================================
</TABLE>
(1) Per share amounts have been calculated using the monthly average shares
method rather than the undistributed net investment income method, because
it more accurately reflects the per share data for the period.
(2) On November 7, 1994, the former Class D shares were renamed Class C shares.
(3) For the period from June 2, 1993 (inception date) to May 31, 1994.
(4) For the year ended May 31, 1995 and the period ended May 31, 1994, the
annualized expense ratios were calculated excluding interest expense. The
ratios including interest expense were 2.46% and 2.34% (annualized),
respectively.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
27
<PAGE>
================================================================================
Financial Highlights (continued)
================================================================================
For a share of each class of beneficial interest outstanding throughout the
period:
<TABLE>
<CAPTION>
Class I Shares 1997(1)
================================================================================
<S> <C>
Net Asset Value, Beginning of Period $9.79
- --------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.10
Net realized and unrealized gain 0.02
- --------------------------------------------------------------------------------
Total Income from Operations 0.12
- --------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.06)
Capital (0.00)*
- --------------------------------------------------------------------------------
Total Distribution (0.06)
- --------------------------------------------------------------------------------
Net Asset Value, End of Period $9.85
- --------------------------------------------------------------------------------
Total Return 1.20%++
- --------------------------------------------------------------------------------
Net Assets, End of Period (000s) $2,416
- --------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.10%+
Net investment income 5.60+
- --------------------------------------------------------------------------------
Portfolio Turnover Rate 288%
================================================================================
</TABLE>
(1) For the period from April 14, 1997 (inception date) to May 31, 1997.
* Amount represents less than $0.01 per share
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
================================================================================
Tax Information (unaudited)
================================================================================
A total of 13.18% of the ordinary dividends paid by the Fund have been
derived from federal obligations and may be exempt from taxation at the state
level.
28
<PAGE>
================================================================================
Independent Auditors' Report
================================================================================
The Shareholders and Board of Trustees of the
Smith Barney Adjustable Rate Government Income Fund:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of the Smith Barney Adjustable Rate
Government Income Fund as of May 31, 1997, the related statements of operations
and cash flows for the year then ended, and the statements of changes in net
assets and financial highlights for each of the years in the two-year period
then ended. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits. The financial highlights for the two-year period ended May 31, 1995 and
for the period from June 22, 1992 (commencement of operations) to May 31, 1993,
were audited by other auditors whose report thereon, dated July 26, 1995,
expressed an unqualified opinion on those financial highlights.
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. Our procedures included confirmation of securities owned as of May
31, 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 the
Smith Barney Adjustable Rate Government Income Fund as of May 31, 1997, the
results of its operations and cash flows for the year then ended, and the
changes in its net assets and financial highlights for each of the years in the
two-year period then ended, in conformity with generally accepted accounting
principles.
/s/ KMPG Peat Marwick LLP
New York, New York
July 14, 1997
29
<PAGE>
SMITH BARNEY
ADJUSTABLE RATE
GOVERNMENT
INCOME FUND
Trustees
Allan J. Bloostein
Martin Brody
Dwight B. Crane
Robert A. Frankel
William R. Hutchinson
Heath B. McLendon, Chairman
Charles F. Barber, Emeritus
Officers
Heath B. McLendon
Chief Executive Officer
Lewis E. Daidone
Senior Vice President
and Treasurer
Thomas M. Reynolds
Controller
Christina T. Sydor
Secretary
Investment Adviser
Smith Barney Strategy Advisers Inc.
Administrator
Smith Barney Mutual Funds
Management Inc.
SMITH BARNEY
- ---------------------------------
A Member of TravelersGroup [LOGO]
Sub-Investment Adviser
BlackRock Financial
Management Inc.
345 Park Avenue
New York, New York 10154
Distributor
Smith Barney Inc.
Custodian
PNC Bank, N.A.
Shareholder
Servicing Agent
First Data Investor Services Group, Inc.
P.O. Box 9134
Boston, MA 02205-9134
This report is submitted for the general information of the shareholders of
Smith Barney Adjustable Rate Government Income Fund. It is not authorized for
distribution to prospective investors unless accompanied or preceded by an
effective Prospectus for the Fund, which contains information concerning the
Fund's investment policies and expenses as well as other pertinent information.
SMITH BARNEY
ADJUSTABLE RATE
GOVERNMENT
INCOME FUND
388 Greenwich Street
New York, New York 10013
FD2224 7/97
