PROSPECTUS
SMITH BARNEY
Adjustable Rate
Government
Income Fund
SEPTEMBER 25, 1998
Prospectus begins on page one
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Prospectus September 25, 1998
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Smith Barney Adjustable Rate
Government Income Fund
388 Greenwich Street
New York, New York 10013
1-800-451-2010
Smith Barney Adjustable Rate Government Income Fund (the "Fund") is a
mutual fund that seeks to provide high current income and to limit the degree of
fluctuation of its net asset value resulting from movements in interest rates by
investing primarily in a portfolio of adjustable rate securities ("Adjustable
Rate Securities") and securities issued or guaranteed by the United States
government, its agencies or instrumentalities ("U.S. government securities").
This Prospectus sets forth concisely certain information about the Fund,
including distribution and service fees and expenses, that prospective investors
will find helpful in making an investment decision. Investors are encouraged to
read this Prospectus carefully and retain it for future reference.
Additional information about the Fund is contained in a Statement of
Additional Information dated September 25, 1998 (the "SAI"), as amended or
supplemented from time to time, that is available upon request and without
charge by calling or writing the Fund at the telephone number or address set
forth above, or by contacting your Salomon Smith Barney Financial Consultant.
The SAI has been filed with the Securities and Exchange Commission (the "SEC")
and is incorporated by reference into this Prospectus in its entirety.
SALOMON SMITH BARNEY INC.
Distributor
SMITH BARNEY STRATEGY ADVISERS INC.
Investment Adviser
BLACKROCK FINANCIAL MANAGEMENT, INC.
Sub-Investment Adviser
MUTUAL MANAGEMENT CORP.
Administrator
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE
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Prospectus (continued)
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(continued from page 1)
ALTHOUGH CERTAIN OF THE SECURITIES IN THE FUND'S PORTFOLIO ARE ISSUED OR
GUARANTEED BY THE UNITED STATES GOVERNMENT, AN INVESTMENT IN THE FUND IS NEITHER
INSURED NOR GUARANTEED BY THE UNITED STATES GOVERNMENT. IN ADDITION, ALTHOUGH
THE FUND'S PORTFOLIO MAY BE EXPECTED TO EXPERIENCE LOW VOLATILITY DUE TO THE
UNIQUE CHARACTERISTICS OF ADJUSTABLE RATE SECURITIES, THE FUND IS NOT A MONEY
MARKET FUND THAT ATTEMPTS TO MAINTAIN A CONSTANT NET ASSET VALUE AND THE FUND'S
INVESTMENT PORTFOLIO CAN BE EXPECTED TO EXPERIENCE GREATER VOLATILITY THAN THAT
OF A MONEY MARKET FUND.
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Table of Contents
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Prospectus Summary 4
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Financial Highlights 10
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Investment Objectives and Management Policies 13
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Valuation of Shares 31
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Dividends, Distributions and Taxes 32
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Purchase of Shares 33
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Exchange Privilege 36
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Redemption of Shares 39
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Minimum Account Size 42
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Performance 43
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Management of the Fund 43
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Distributor 46
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Additional Information 47
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No person has been authorized to give any information or to make any
representations in connection with this offering other than those contained in
this Prospectus and, if given or made, such other information and
representations must not be relied upon as having been authorized by the Fund or
the Distributor. This Prospectus does not constitute an offer by the Fund or the
Distributor to sell or a solicitation of an offer to buy any of the securities
offered hereby in any jurisdiction to any person to whom it is unlawful to make
such offer or solicitation in such jurisdiction.
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Prospectus Summary
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The following summary is qualified in its entirety by detailed information
appearing elsewhere in this Prospectus and in the Statement of Additional
Information. Cross-references in this summary are to headings in the Prospectus.
See "Table of Contents."
INVESTMENT OBJECTIVES The Fund is a diversified, open-end, management
investment company that seeks to provide high current income and to limit the
degree of fluctuation of its net asset value resulting from movements in
interest rates by investing primarily in a portfolio of Adjustable Rate
Securities and U.S. government securities. See "Investment Objectives and
Management Policies."
ALTERNATIVE PURCHASE ARRANGEMENTS The Fund offers several classes of
shares ("Classes") to investors designed to provide them with the flexibility of
selecting an investment best suited to their needs. The Fund offers three
classes of shares: Class A shares and Class B shares, which differ principally
in terms of sales charges and rate of expenses to which they are subject, and
Class I shares which are offered only to investors meeting an initial investment
minimum of $100,000. See "Purchase of Shares" and "Redemption of Shares."
Class A Shares. Class A shares are sold at net asset value and are subject
to annual distribution and service fees aggregating 0.75% of the average daily
net assets of the Class.
Class B Shares. Class B shares are offered through exchange purchases at
net asset value and are also subject to annual distribution and service fees
aggregating 0.75%. In addition, Class B shares are subject to a contingent
deferred sales charge ("CDSC)" based upon the CDSC of the fund from which an
exchange purchase transaction is made. This CDSC may be waived for certain
redemptions. Class B shares are no longer available to investors in the Smith
Barney 401(k) and ExecChoice(TM) Program.
Class B Shares Conversion Feature. Class B shares will convert
automatically to Class A shares, based on relative net asset value, eight years
after the date of the original purchase. In addition, a certain portion of Class
B shares that have been acquired through the reinvestment of dividends and
distributions ("Class B Dividend Shares") will be converted at that time. See
"Purchase of Shares -- Deferred Sales Charge Alternatives."
Class I Shares. Class I shares are available only to investors meeting an
initial investment minimum of $100,000. Class I shares are sold at net asset
value with no initial sales charge or CDSC. They are subject to an annual
service fee of 0.25%.
Salomon Smith Barney Financial Consultants may receive different
compensation for selling different Classes of shares. Investors should
understand that the purpose of the CDSC on the Class B shares is the same as
that of an initial sales charge. See "Purchase of Shares" and "Management of the
Fund" for a complete description of the sales charges and service and
distribution fees for each
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Prospectus Summary (continued)
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class of shares and "Valuation of Shares," "dividends, Distributions and Taxes"
and "Exchange Privilege" for other differences between the classes of shares.
SMITH BARNEY 401(K) AND EXECCHOICE(TM) PROGRAMS Investors may be eligible
to participate in the Smith Barney 401(k) Program, which is generally designed
to assist plan sponsors in the creation and operation of retirement plans under
Section 401(a) of the Internal Revenue Code of 1986, as amended (the "Code"), as
well as other types of participant directed, tax-qualified employee benefit
plans. Investors may also be eligible to participate in the Smith Barney
ExecChoice(TM) Program. Class A and Class B shares are available without a sales
charge as investment alternatives under both of these programs. See "Purchase of
Shares Smith Barney 401(k) and ExecChoice(TM) Programs."
PURCHASE OF SHARES Shares may be purchased through the Fund's distributor,
Salomon Smith Barney Inc. ("Salomon Smith Barney"), a broker that clears
securities transactions through Smith Barney on a fully disclosed basis (an
"Introducing Broker") or an investment dealer in the selling group. In addition,
certain investors, including qualified retirement plans and certain other
institutions, may purchase shares directly from the Fund through the Fund's
transfer agent, First Data Investor Services Group, Inc. (the "Tranfer Agent").
See "Purchase of Shares."
INVESTMENT MINIMUMS Investors in Class A and Class B shares (through
exchange purchases) may open an account by making an initial investment of at
least $1,000 and subsequent investments must be at least $50. Investors in Class
A shares through the Smith Barney 401(k) and ExecChoice(TM) Program may open an
account and make subsequent investments at a minimum of $25. Investors in Class
I shares may open an account for an initial investment of $100,000 and make
subsequent investments of at least $50. The minimum investment requirements for
purchases of Fund shares through the Systematic Investment Plan are described
below. See "Purchase of Shares."
SYSTEMATIC INVESTMENT PLAN The Fund offers Class A and Class I
shareholders a Systematic Investment Plan under which they may authorize the
automatic placement of a purchase order each month or quarter for Fund shares.
The minimum investment requirements for Class A and Class I shares and the
subsequent investment requirement for all classes for shareholders purchasing
shares through the Systematic Investment Plan on a monthly basis is $25 and on a
quarterly basis is $50. See "Purchase of Shares."
REDEMPTION OF SHARES Shares may be redeemed on each day the New York Stock
Exchange, Inc. ("NYSE") is open for business. See "Purchase of Shares" and
"Redemption of Shares."
MANAGEMENT OF THE FUND Smith Barney Strategy Advisers Inc. ("Strategy
Advisers") serves as the Fund's investment adviser. Strategy Advisers is a
wholly owned subsidiary of Mutual Management Corp. ("MMC"), an affiliate of
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Prospectus Summary (continued)
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Salomon Smith Barney. See "Management of the Fund."
BlackRock Financial Management Inc. ("BlackRock") serves as sub-investment
adviser. BlackRock is a wholly owned corporate subsidiary of BlackRock, Inc.,
the holding company for PNC Bank's asset management businesses. PNC Bank is a
commercial bank offering a wide range of domestic and international commercial
banking, retail banking and trust services to its customers. PNC Bank also
serves as the Fund's custodian. See "Management of the Fund."
MMC serves as the Fund's Administrator. MMC provides investment advisory
and administrative services to investment companies in the Smith Barney Mutual
Funds family of funds and is a wholly owned subsidiary of Salomon Smith Barney
Holdings Inc. ("Holdings"). Holdings is a wholly owned subsidiary of Travelers
Group Inc. ("Travelers"), a diversified financial services holding company
engaged through its subsidiaries principally in four business segments:
Investment Services including Asset Management, Consumer Finance Services, Life
Insurance Services and Property & Casualty Insurance Services. Travelers expects
to merge with Citicorp on or about October 8, 1998, creating an entity to be
called Citigroup. See "Management of the Fund."
EXCHANGE PRIVILEGE Shares of Class A and B may be exchanged for shares of
the same Class of certain other Smith Barney Mutual Funds at the respective net
asset values next determined. Class I shares do not have Exchange Privileges.
See "Exchange Privilege."
VALUATION OF SHARES Net asset value of the Fund for the prior business day
generally is quoted daily in the financial section of most newspapers and is
also available from a Smith Barney Financial Consultant. See "Valuation of
Shares."
DIVIDENDS AND DISTRIBUTIONS Dividends from net investment income are
generally paid monthly, on the last Friday of each month, to shareholders of
record as of three business days prior thereto. Distributions of net realized
long and short-term capital gains, if any, are paid at least annually. See
"Dividends, Distributions and Taxes."
REINVESTMENT OF DIVIDENDS Dividends and distributions paid on shares of
any Class will be reinvested automatically in additional shares of the same
Class at net asset value unless otherwise specified by an investor. Shares
acquired through dividend and distribution reinvestments will not be subject to
any sales charge or CDSC. Class B shares acquired through dividend and
distribution reinvestments will become eligible for conversion to Class A shares
on a proportionate basis. See "Dividends, Distributions and Taxes."
RISK FACTORS AND SPECIAL CONSIDERATIONS No assurance can be given that the
Fund will achieve its investment objective. Although the Fund will invest
principally in securities issued or guaranteed by the United States government,
its agencies or instrumentalities, shares of the Fund, unlike certain bank
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Prospectus Summary (continued)
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deposit accounts, are not insured or guaranteed by the United States government.
Changes in interest rates generally will result in increases or decreases in the
market value of the obligations held by the Fund and, unlike that of a money
market fund, the Fund's net asset value per share will fluctuate. The Fund's net
asset value will be subject to greater fluctuation to the extent, if any, that
the Fund invests in zero coupon U.S. Treasury securities.
Certain of the instruments held by the Fund, and certain of the investment
techniques that the Fund may employ, might expose the Fund to special risks.
These instruments include mortgage backed securities ("MBSs") (which include
adjustable rate mortgage securities and collateralized mortgage obligations),
asset backed securities ("ABSs") and zero coupon securities. MBSs and ABSs are
subject to prepayment or early payout risks, which are affected by changes in
prevailing interest rates and numerous economic, geographic, social and other
factors. The investment techniques presenting special risks include futures
contracts, options on futures contracts, repurchase agreements, reverse
repurchase agreements and dollar rolls, engaging in short sales, lending
portfolio securities and entering into securities transactions on a when-issued
or delayed delivery basis. See "Investment Objectives and Management Policies."
THE FUND'S EXPENSES The following expense table lists the costs and
expenses an investor will incur either directly or indirectly as a shareholder
of the Fund, based on the maximum CDSC that may be incurred at the time of
redemption and the Fund's operating expenses for its most recent fiscal year:
Smith Barney Adjustable
Rate Government Income Fund Class A Class B Class I
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Shareholder Transaction Expenses
Maximum sales charge imposed on purchases
(as a percentage of offering price) None None None
Maximum CDSC
(as a percentage of redemption proceeds) None* 5.00** None
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Annual Fund Operating Expenses
(as a percentage of average net assets)
Management fees 0.60% 0.60% 0.60%
12b-1 fees 0.75 0.75 0.25
Other expenses 0.22 0.28 0.22
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TOTAL FUND OPERATING EXPENSES 1.57% 1.63 1.07%
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* Class A shares acquired as part of an exchange privilege transaction,
which were originally acquired in one of the other funds of the Smith
Barney Mutual Funds at net asset value subject to a CDSC, remain subject
to the original fund's CDSC while held in the Fund.
** Existing investors in the Smith Barney 401(k) Program may continue to
purchase Class B shares of the Fund; all other investors may acquire Class
B shares through exchanges only. Upon an exchange, the new Class B shares
will be subject to the same CDSC, and will be deemed to have been
purchased on the same date as the Class B shares of the fund that have
been exchanged. Class B shares acquired by participating plans will be
subject to an eight year 3% CDSC, payable upon a participating plan's
withdrawal from the Smith Barney 401(k) Program.
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Prospectus Summary (continued)
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Class A shares of the Fund purchased through the Smith Barney AssetOne
Program will be subject to an annual asset-based fee, payable quarterly, in lieu
of the initial sales charge. The fee will vary to a maximum of 1.50%, depending
on the amount of assets held through the Program. For more information, please
call your Salomon Smith Barney Financial Consultant.
The sales charge and CDSC set forth in the above table is the maximum CDSC
imposed by any of the funds participating in the Smith Barney Mutual Funds
exchange program. Investors may pay actual charges of less than 5% depending on
the CDSC of the shares from which the exchange was made and the length of time
the shares are held and whether the shares are held through the Smith Barney
401(k) and ExecChoice(TM) Programs. See "Purchase of Shares - Smith Barney
401(k) Program and ExecChoice(TM) Program" and "Redemption of Shares -
Contingent Deferred Sales Charge, Class B shares." Management fees payable by
the Fund include investment advisory fees computed daily and payable monthly to
Strategy Advisers at the annual rate of 0.40% of the value of the Fund's average
daily net assets, and administration fees computed daily and payable monthly to
MMC in an amount equal to 0.20% of the value of the Fund's average daily net
assets. The Fund pays no direct fee to BlackRock. The nature of the services for
which the Fund pays management fees is described under "Management of the Fund."
Salomon Smith Barney also receives with respect to Class A and B shares an
annual 12b-1 distribution and shareholder servicing fee of 0.75% of the value of
average daily net assets of the respective Classes, of which 0.50% is used by
Salomon Smith Barney to cover expenses that are primarily intended to result in,
or that are primarily attributable to, the sale of shares, and of which 0.25% is
used by Salomon Smith Barney to provide compensation for ongoing servicing
and/or maintenance of shareholder accounts. For Class I shares, Salomon Smith
Barney receives a shareholder servicing fee of 0.25% and no distribution fees.
"Other expenses" in the above table include fees for shareholder services,
custodial fees, legal and accounting fees, printing costs and registration fees.
EXAMPLE
The following example is intended to assist an investor in understanding
the various costs that an investor in the Fund will bear directly or indirectly.
The example assumes payment by the Fund of operating expenses at the levels set
forth in the table above. See "Purchase of Shares," "Redemption of Shares" and
"Management of the Fund."
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Prospectus Summary (continued)
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Smith Barney Adjustable
Rate Government Income Fund 1 year 3 years 5 years 10 years*
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An investor would pay the following
expenses on a $1,000 investment,
assuming (1) 5.00% annual return and
(2) redemption at the end of each
time period:
Class A shares $16 $50 $86 $187
Class B shares $67 $81 $99 $192
Class I shares $11 $34 $59 $131
An investor would pay the following
expenses on the same investment,
assuming the same annual return and
no redemption:
Class A shares $16 $50 $86 $187
Class B shares $17 $51 $89 $192
Class I shares $11 $34 $59 $131
* Ten-year figures assume conversion of Class B shares to Class A shares at the
end of the eighth year following the date of purchase.
The example also provides a means for the investor to compare expense
levels of funds with different fee structures over varying investment periods.
To facilitate such comparison, all funds are required to utilize a 5.00% annual
return assumption. However, the Fund's actual return will vary and may be
greater or less than 5.00%. This example should not be considered a
representation of past or future expenses and actual expenses may be greater or
less than those shown.
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Financial Highlights
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The following information for the three years ended May 31, 1998 has been
audited by KPMG Peat Marwick LLP, independent auditors, whose report thereon
appears in the Fund's Annual Report dated May 31, 1998. The information for the
fiscal years ended May 31, 1993 through May 31, 1995 has been audited by other
auditors. The information set out below should be read in conjunction with the
financial statements and related notes that also appear in the Fund's Annual
Report to shareholders, which is incorporated by reference into the Statement of
Additional Information.
Smith Barney Adjustable Rate Government Income Fund
For a share of each class of beneficial interest outstanding throughout each
year.
<TABLE>
<CAPTION>
Class A Shares 1998 1997 1996 1995(1) 1994 1993(2)
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<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 9.84 $ 9.84 $ 9.88 $ 9.78 $ 9.96 $ 10.00
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Income From Operations:
Net investment income(3) 0.49 0.43 0.56 0.47 0.37 0.44
Net realized and unrealized gain (loss) 0.04 0.08 (0.04) 0.13 (0.17) (0.05)
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Total Income From Operations 0.53 0.51 0.52 0.60 0.20 0.39
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Less Distributions From:
Net investment income (0.50) (0.46) (0.56) (0.49) (0.38) (0.43)
Net realized gains -- -- -- (0.01) -- --
Capital (0.01) (0.05) -- -- -- --
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Total Distributions (0.51) (0.51) (0.56) (0.50) (0.38) (0.43)
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Net Asset Value, End of Year $ 9.86 $ 9.84 $ 9.84 $ 9.88 $ 9.78 $ 9.96
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Total Return 5.57% 5.31% 5.48% 6.39% 2.05% 3.89%++
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Net Assets, End of Year
(in millions) $ 108 $ 124 $ 156 $ 174 $ 284 $ 313
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Ratio to Average Net Assets:
Expenses(3)(4) 1.57% 1.69% 1.58% 1.60% 1.53% 1.50%+
Net investment income 4.94 4.42 5.66 4.94 3.72 4.36+
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Portfolio Turnover Rate 242% 288% 273% 524% 525% 236%
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</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 had not been 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, 1998, May 31, 1997, May 31, 1996, 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 3.34%, 3.09%, 3.10%, 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.
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Financial Highlights (continued)
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Smith Barney Adjustable Rate Government Income Fund
<TABLE>
<CAPTION>
Class B Shares 1998 1997 1996 1995(1) 1994 1993(2)
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<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 9.82 $ 9.84 $ 9.88 $ 9.78 $ 9.96 $ 9.96
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Income From Operations:
Net investment income(3) 0.49 0.39 0.56 0.47 0.37 0.25
Net realized and unrealized gain (loss) 0.04 0.10 (0.04) 0.13 (0.17) --
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Total Income From Operations 0.53 0.49 0.52 0.60 0.20 0.25
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Less Distributions From:
Net investment income (0.50 (0.46) (0.56) (0.49) (0.38) (0.25)
Net realized gains -- -- -- (0.01) -- --
Capital (0.01) (0.05) -- -- -- --
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Total Distributions (0.51) (0.51) (0.56) (0.50) (0.38) (0.25)
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Net Asset Value, End of Year $ 9.84 $ 9.82 $ 9.84 $ 9.88 $ 9.78 $ 9.96
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Total Return 5.56% 5.10% 5.48% 6.39% 2.05% 2.56%++
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Net Assets, End of Year
(in millions) $ 2 $ 3 $ 6 $ 5 $ 8 $ 4
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Ratio to Average Net Assets:
Expenses(3)(4) 1.63% 1.71% 1.60% 1.63% 1.57% 1.50%+
Net investment income 5.03% 4.32 5.64 4.92 3.68 4.36+
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Portfolio Turnover Rate 242% 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 had not been 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, 1998, May 31, 1997, May 31, 1996, 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 3.40%, 3.11%, 3.12%, 2.49%, 2.35% and 1.92%,
respectively.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
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Financial Highlights (continued)
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For a share of each class of beneficial interest outstanding throughout the
period.
Smith Barney Adjustable Rate Government Income Fund
Class I Shares 1998 1997(1)
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Net Asset Value, Beginning of Period $ 9.85 $ 9.79
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Income From Operations:
Net investment income 0.55 0.10
Net realized and unrealized gain 0.04 0.02
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Total Income From Operations 0.59 0.12
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Less Distributions:
Net investment income (0.56) (0.06)
Capital (0.01) (0.00)*
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Total Distributions (0.57) (0.06)
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Net Asset Value, End of Period $ 9.87 $ 9.85
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Total Return 6.12% 1.20%++
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Net Assets, End of Period (in millions) $ 3.0 $ 2.4
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Ratio to Average Net Assets+:
Expenses(2) 1.07% 1.10%+
Net investment income 5.45 5.60+
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Portfolio Turnover Rate 242% 288%
================================================================================
(1) For the period from April 18, 1997 (inception date) to May 31, 1997.
(2) For the year ended May 31, 1998 and the period ended May 31, 1997 the
annualized expense ratios were calculated excluding interest expense. The
ratios including interest expense were 2.84% and 2.50%, respectively.
* 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.
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Investment Objectives and Management Policies
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INVESTMENT OBJECTIVES
The investment objectives of the Fund are to seek to provide high current
income and to limit the degree of fluctuation of its net asset value resulting
from movements in interest rates. These investment objectives may not be changed
without the approval of the holders of a majority of the Fund's outstanding
shares. No assurance can be given that the Fund will be able to achieve its
investment objectives.
INVESTMENT POLICIES
In seeking to achieve its investment objectives, the Fund will invest
principally in Adjustable Rate Securities and U.S. government securities. Under
normal market conditions, the Fund will invest at least 65% of its net assets in
U.S. government securities, and will also invest at least 65% of its net assets
in Adjustable Rate Securities, many of which will also be U.S. government
securities. The Fund's assets not invested in U.S. government securities may be
invested in, among other instruments, fixed rate and adjustable rate MBSs, ABSs
and corporate debt securities rated within the two highest categories by a
nationally recognized statistical rating organization (an "NRSRO"), such as
those rated Aa by Moody's Investors Service, Inc. ("Moody's") or AA by Standard
& Poor's Ratings Group ("S&P") and money market instruments with a comparable
short-term rating. Up to 20% of the Fund's total assets may be invested in
securities that are unrated but deemed to be of comparable credit quality by
BlackRock, and up to 10% of the Fund's total assets may be invested in U.S.
dollar-denominated foreign securities, including MBSs and ABSs issued by foreign
entities that are of comparable credit quality. The foregoing policies as to
ratings of portfolio securities will be applicable at the time securities are
purchased by the Fund; if portfolio securities of the Fund are subsequently
assigned lower ratings, if they cease to be rated or if they cease to be deemed
to be comparable, BlackRock will reassess whether the Fund should continue to
hold the securities.
The Fund may invest up to 5% of its total assets in municipal obligations
and in zero coupon securities, including zero coupon U.S. Treasury securities.
In addition, the Fund may engage in various hedging strategies to increase
investment return and/or protect against interest rate changes in an effort to
maintain the stability of its net asset value.
The Fund seeks to achieve low volatility of net asset value by investing
in a diversified portfolio of securities that BlackRock believes will, in the
aggregate, be resistant to significant fluctuations in market value. In
selecting securities for the Fund, BlackRock will take into account various
factors that will affect the volatility of the Fund's assets, such as the time
to the next coupon reset date for the securities, the payment characteristics of
the securities and the dollar weighted average life of the Fund's portfolio. The
Fund expects that under normal
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Investment Objectives and Management Policies (continued)
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circumstances the dollar weighted average life (or period until the next reset
date) of its portfolio securities will be approximately two years.
ADJUSTABLE RATE SECURITIES
Adjustable Rate Securities are instruments that bear interest at rates
that adjust at periodic intervals at a fixed amount (typically referred to as a
"spread") over the market levels of interest rates as reflected in specified
indexes. The Adjustable Rate Securities in which the Fund will invest will
consist primarily of MBSs and ABSs. MBSs are securities that directly or
indirectly represent an interest in, or are backed by and are payable from,
mortgage loans secured by real property. ABSs are similar in structure to MBSs,
except that the underlying asset pools consist of credit card, automobile or
other types of receivables, or of commercial loans. MBSs and ABSs are issued in
structured financings through which a sponsor securitizes the underlying
mortgage loans or financial assets to provide the underlying assets with greater
liquidity or to achieve certain other financial goals.
The interest paid on Adjustable Rate Securities and, therefore, the
current income earned by the Fund by investing in them, will be a function
primarily of the indexes upon which adjustments are based and the applicable
spread relating to the securities. Examples of indexes that may be used are (a)
one-, three- and five-year U.S. Treasury securities adjusted to a constant
maturity index, (b) U.S. Treasury bills of three or six months, (c) the daily
Bank Prime Loan Rate made available by the Federal Reserve Board, (d) the cost
of funds for member institutions of the Federal Home Loan Bank of San Francisco
and (e) the offered quotations to leading banks in the London interbank market
for Eurodollar deposits of a specified duration ("LIBOR").
The interest rates paid on Adjustable Rate Securities are generally
readjusted periodically to an increment over the chosen interest rate index.
Such readjustments occur at intervals ranging from one to 36 months. The degree
of volatility in the market value of the Adjustable Rate Securities in the
Fund's portfolio will be a function of the frequency of the adjustment period,
the applicable index and the degree of volatility in the applicable index. It
will also be a function of the maximum increase or decrease of the interest rate
adjustment on any one adjustment date, in any one year and over the life of the
securities. These maximum increases and decreases are typically referred to as
"caps" and "floors," respectively. The Fund will not seek to maintain an overall
average cap or floor, although BlackRock will consider caps or floors in
selecting Adjustable Rate Securities for the Fund.
The adjustable interest rate feature underlying the Adjustable Rate
Securities in which the Fund invests generally will act as a buffer to reduce
sharp changes in the Fund's net asset value in response to normal interest rate
fluctuations. As the interest rates on the mortgages underlying the Fund's MBSs
are reset periodically,
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yields of portfolio securities will gradually align themselves to reflect
changes in market rates and should cause the net asset value of the Fund to
fluctuate less dramatically than it would if the Fund invested in more
traditional long-term, fixed rate debt securities. During periods of rapidly
rising interest rates, however, changes in the coupon rate may temporarily lag
behind changes in the market rate, possibly resulting in a lower net asset value
until the coupon resets to market rates. Thus, investors could suffer some
principal loss if they sell their shares of the Fund before the interest rates
on the underlying mortgages are adjusted to reflect current market rates.
Unlike fixed rate mortgages, which generally decline in value during
periods of rising interest rates, the Fund's MBSs will allow the Fund to
participate in increases in interest rates through periodic adjustments in the
coupons of the underlying mortgages, resulting in both higher current yields and
lower price fluctuations. In addition, if prepayments of principal are made on
the underlying mortgages during periods of rising interest rates, the Fund
generally will be able to reinvest those amounts in securities with a higher
current rate of return. The Fund will not benefit from increases in interest
rates to the extent that interest rates rise to the point at which they cause
the current coupon of Adjustable Rate Securities to exceed the maximum allowable
caps. The Fund's net asset value could vary to the extent that current yields on
Adjustable Rate Securities are different from market yields during interim
periods between the coupon reset dates.
MBSs. Three basic types of MBSs are currently available for investments:
(a) those issued or guaranteed by the United States Government or one of its
agencies or instrumentalities, primarily consisting of securities either
guaranteed by the Government National Mortgage Association ("GNMA") or issued by
the Federal National Mortgage Association ("FNMA") or the Federal Home Loan
Mortgage Corporation ("FHLMC"); (b) those issued by private issuers that
represent an interest in or are collateralized by MBSs issued or guaranteed by
the United States government or one of its agencies or instrumentalities; and
(c) those issued by private issuers that represent an interest in or are
collateralized by whole mortgage loans or MBSs without a United States
government guarantee but usually having some form of private credit enhancement.
GNMA, FNMA and FHLMC are agencies or instrumentalities of the United
States government, and MBSs issued or guaranteed by them are generally
considered to be of higher quality than those issued or guaranteed by
non-governmental entities. GNMA MBSs consist of pass-through interests in pools
of mortgage loans guaranteed or insured by agencies or instrumentalities of the
United States. FNMA and FHLMC MBSs most often represent pass-through interests
in pools of similarly insured or guaranteed mortgage loans or pools of
conventional mortgage loans or participations in the pools. GNMA, FNMA and FHLMC
"pass-through" MBSs are so named because they represent undivided interests in
the underlying mortgage
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pools, and a proportionate share of both regular interest and principal payments
(net of fees assessed by GNMA, FNMA and FHLMC and any applicable loan servicing
fees), as well as unscheduled early prepayments on the underlying mortgage pool,
are passed through monthly to the holders of the MBSs.
Timely payment of principal and interest on GNMA MBSs is guaranteed by
GNMA, a wholly owned corporate instrumentality of the United States government
within the Department of Housing and Urban Development, which guarantee is
backed by the full faith and credit of the United States government. FNMA, a
federally chartered and privately owned corporation organized and existing under
the Federal National Mortgage Association Charter Act, guarantees timely payment
of principal and interest on FNMA MBSs. FHLMC, a corporate instrumentality of
the United States, guarantees (a) the timely payment of interest on all FHLMC
MBSs, (b) the ultimate collection of principal with respect to some FHLMC MBSs
and (c) the timely payment of principal with respect to other FHLMC MBSs.
Neither the obligations of FNMA nor those of FHLMC are backed by the full faith
and credit of the United States. Nevertheless, because of the relationship of
each of these entities to the United States, MBSs issued by them are generally
considered to be high quality securities with minimal credit risk.
Certain of the MBSs, as well as certain of the ABSs, in which the Fund may
invest will be issued by private issuers. Such MBSs and ABSs may take a form
similar to the pass-through MBSs issued by agencies or instrumentalities of the
United States described above, or may be structured in a manner similar to the
other types of MBSs or ABSs described below. Private issuers include originators
of or investors in mortgage loans and receivables such as savings and loan
associations, savings banks, commercial banks, investment banks, finance
companies and special purpose finance subsidiaries of these types of
institutions.
Credit enhancements provided for certain MBSs and ABSs issued by
non-governmental entities typically take one of two forms: (a) liquidity
protection or (b) protection against losses resulting from ultimate default by
an obligor on the underlying assets. Liquidity protection refers to the
provision of advances, generally by the entity administering the pool of assets,
to ensure that the receipt of payments on the underlying pool occurs in a timely
fashion. Protection against losses resulting from default ensures ultimate
payment of the obligations on at least a portion of the assets in the pool. This
protection may be provided through guarantees, insurance policies or letters of
credit obtained by the issuer or sponsor from third parties, through various
means of structuring the transaction or through a combination of these
approaches. The degree of credit support provided for each issue is generally
based on historical information with respect to the level of credit risk
associated with the underlying assets. Delinquencies or losses in excess of
those anticipated could adversely affect the return on an investment in a
security. The Fund will not pay any additional fees for credit support, although
the existence
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of credit support may increase the price of a security. BlackRock will monitor,
on an ongoing basis, the creditworthiness of the providers of credit enhancement
for such MBSs and ABSs held by the Fund.
Among the specific types of MBSs in which the Fund may invest are ARMs,
which are pass-through mortgage securities collateralized by mortgages with
adjustable rather than fixed rates. ARMs eligible for inclusion in a mortgage
pool generally provide for a fixed initial mortgage interest rate for either the
first 3, 6, 12, 13, 36 or 60 scheduled monthly payments. Thereafter, the
interest rates are subject to periodic adjustment based on changes in a
designated benchmark index.
The Fund may invest in MBSs taking the form of collateralized mortgage
obligations ("CMOs"), which are debt obligations collateralized by mortgage
loans or mortgage pass-through securities. Typically, CMOs are collateralized by
GNMA, FNMA or FHLMC certificates, but also may be collateralized by whole loans
or private mortgage pass-through securities (this collateral being referred to
collectively in this Prospectus as "Mortgage Assets"). Multi-class pass-through
securities are equity interests in a trust composed of Mortgage Assets. Payments
of principal of and interest on the Mortgage Assets, and any reinvestment income
on the Mortgage Assets, provide the funds to pay debt service on the CMOs or
make scheduled distributions on the multi-class pass-through securities. CMOs
may be issued by agencies or instrumentalities of the United States government,
or by private originators of, or investors in, mortgage loans, including
depository institutions, mortgage banks, investment banks and special purpose
subsidiaries of these types of institutions.
In a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of CMOs, often referred to as a "tranche," is issued at a specific
fixed or floating coupon rate and has a stated maturity or final distribution
date. Principal prepayments on the Mortgage Assets may cause the CMOs to be
retired substantially earlier than their stated maturities or final distribution
dates. Interest is paid or accrues on all classes of the CMOs on a monthly,
quarterly or semi-annual basis. The principal of and interest on the Mortgage
Assets may be allocated among the several classes of a CMO series in a number of
different ways. Generally, the purpose of the allocation of the cash flow of a
CMO to the various classes is to obtain a more predictable cash flow to the
individual tranches than exists with the underlying collateral of the CMO. As a
general rule, the more predictable the cash flow is on a CMO tranche, the lower
the anticipated yield will be on that tranche at the time of issuance relative
to prevailing market yields on MBSs.
The Fund may invest in, among other things, parallel pay CMOs and Planned
Amortization Class CMOs ("PAC Bonds"). Parallel pay CMOs are structured to
provide payments of principal on each payment date to more than one class. These
simultaneous payments are taken into account in calculating the stated maturity
date or final distribution date of each class, which, like other CMO structures,
must be
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retired by its stated maturity date or final distribution date but may be
retired earlier. PAC Bonds are parallel pay CMOs that generally require payments
of a specified amount of principal on each payment date; the required principal
payments on PAC Bonds have the highest priority after interest has been paid to
all classes.
ABSs. The Fund will invest in various types of Adjustable Rate Securities
in the form of ABSs. The securitization techniques for ABSs are similar to those
used for MBSs; through the use of trusts and special purpose corporations,
various types of receivables (such as home equity loans and automobile and
credit card receivables) are securitized in pass-through structures similar to
the mortgage pass-through structures described above or in a pay-through
structure similar to the CMO structure. ABSs are typically bought or sold from
or to the same entities that act as primary dealers in U.S. government
securities.
Certain of the ABSs in which the Fund will invest will be guaranteed by
the Small Business Administration ("SBA"). The SBA is an independent agency of
the United States, and ABSs guaranteed by the SBA carry a guarantee of both
principal and interest backed by the full faith and credit of the United States.
These ABSs may include pass-through securities collateralized by SBA guaranteed
loans whose interest rates adjust in much the same fashion as described above
with respect to ARMs. These loans generally include commercial loans such as
working capital loans and equipment loans. The underlying loans are originally
made by private lenders and are guaranteed in part by the SBA, the guaranteed
portion of the loans constituting the underlying financial assets in these ABSs.
In general, the collateral supporting ABSs is of shorter maturity than
mortgage loans and may be less likely to experience substantial prepayments.
Like MBSs, ABSs are often backed by a pool of assets representing the
obligations of a number of different parties. Currently, pass-through securities
collateralized by SBA guaranteed loans and home equity loans are the most
prevalent ABSs that are Adjustable Rate Securities.
ABSs are relatively new and untested instruments and may be subject to
greater risk of default during periods of economic downturn than other
securities, including MBSs, satisfying the quality standards of the Fund, which
characteristics of ABSs could result in possible losses to the Fund. In
addition, the secondary market for ABSs may not be as liquid as the market for
other securities, including MBSs, which may result in the Fund experiencing
difficulty in valuing ABSs.
U.S. GOVERNMENT SECURITIES
In addition to the U.S. government securities guaranteed by GNMA and
issued by FNMA and FHLMC described above, the Fund may invest in other U.S.
government securities such as bills, certificates of indebtedness and notes and
bonds issued by the United States Treasury. These instruments are direct
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obligations of the United States government and, as such, are backed by the full
faith and credit of the United States. They differ primarily in their interest
rates, the lengths of their maturities and the dates of their issuance.
OTHER INVESTMENTS OF THE FUND
Fixed Rate MBSs. Fixed rate MBSs in which the Fund may invest consist
primarily of fixed rate pass-through securities and fixed rate CMOs. Like
Adjustable Rate Securities, these fixed rate securities may be issued either by
agencies or instrumentalities of the United States government or by the types of
private issuers described above. The basic structures of fixed rate MBSs are the
same as those described above with respect to Adjustable Rate Securities. The
principal difference between fixed rate securities and Adjustable Rate
Securities is that the interest rate on the former type of securities is set at
a predetermined amount and does not vary according to changes in any index.
Stripped MBSs. The Fund may invest in stripped MBSs ("SMBSs"), which are
derivative multi-class mortgage-backed securities typically issued by the same
types of issuers that issue MBSs. Unlike MBSs, SMBSs commonly involve two
classes of securities that receive different proportions of the interest and
principal distributions on a pool of mortgage assets. A common variety of SMBSs
contemplates one class (the principal-only or "PO" class) receiving some of the
interest and most of the principal from the underlying assets, and the other
class (the interest-only or "IO" class) receiving most of the interest and the
remainder of the principal. In the most extreme case, the IO class receives all
of the interest, while the PO class receives all of the principal. Although the
Fund may purchase securities of a PO class, it is more likely to purchase the
securities of an IO class.
Although IO class SMBSs individually have greater market volatility than
Adjustable Rate Securities, the Fund will seek to combine investments in IOs
with other investments that have offsetting price patterns. The value of IOs
varies with a direct correlation to changes in interest rates, whereas the value
of fixed rate MBSs, like that of other fixed rate debt securities, varies
inversely with interest rate fluctuations. Therefore, active management of IOs
in combination with fixed rate MBSs is intended to add incremental yield from
changes in market rates while not materially increasing the volatility of the
Fund's net asset value.
The yield to maturity of an IO class is extremely sensitive to the rate of
principal payments (including prepayments) on the related underlying assets, and
a rapid rate of principal payments in excess of that considered in pricing the
securities will have a material adverse effect on an IO security's yield to
maturity. If the underlying mortgage assets experience greater than anticipated
payments of principal, the Fund may fail to recoup fully its initial investment
in IOs. The sensitivity of an IO that represents the interest portion of a
particular class as opposed to the interest portion of an entire pool to
interest rate fluctuations may be
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Investment Objectives and Management Policies (continued)
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increased because of the characteristics of the principal portion to which they
relate.
Corporate Debt Securities. The Fund may purchase corporate debt securities
rated within the two highest categories by an NRSRO or, if unrated, deemed to be
of comparable credit quality by BlackRock. These debt securities may have
adjustable or fixed rates of interest and in certain instances may be secured by
assets of the issuer. Adjustable rate corporate debt securities may have
features similar to those of adjustable rate MBSs, but corporate debt
securities, unlike MBSs, are not subject to prepayment risk other than through
contractual call provisions that generally impose a penalty for prepayment.
Fixed rate debt securities may also be subject to call provisions.
Foreign Securities. The Fund may invest up to 10% of its total assets in
U.S. dollar-denominated foreign securities, including MBSs and ABSs issued by
foreign entities, although under current market conditions the Fund does not
expect to invest in foreign securities.
Investments in foreign securities involve certain risks not ordinarily
associated with investments in securities of domestic issuers. These risks
include fluctuations in foreign exchange rates, future political and economic
developments, and the possible imposition of exchange controls or other foreign
governmental laws or restrictions.
Municipal Obligations. The Fund may invest up to 5% of its total assets in
obligations issued by state and local governments, political subdivisions,
agencies and public authorities ("Municipal Obligations"). Any Municipal
Obligation that is backed directly or indirectly by U.S. Treasury securities or
the full faith and credit of the United States government will be considered by
BlackRock to have the highest rating.
Zero Coupon Securities. The Fund may purchase zero coupon securities when
yields on those securities are attractive, to enhance portfolio liquidity or for
a combination of both of these purposes. Zero coupon securities are debt
obligations that are issued or purchased at a significant discount from face
value, which do not require the periodic payment of interest. The discount
approximates the total amount of interest the security might accrue and compound
over the period until maturity or the particular interest payment date at a rate
reflecting the market rate of the securities at the time of issuance or
purchase. Zero coupon securities benefit the issuer by mitigating its need for
cash to meet debt service, but also require a higher rate of return to attract
investors who are willing to defer receipt of cash. These investments may
experience greater volatility in market value than fixed income securities that
make regular payments of interest. The Fund may invest in zero coupon securities
issued by the United States Treasury, or component parts of Treasury Bonds that
represent scheduled interest and principal payments on the bonds. The Fund will
accrue income on zero coupon securities it holds for tax and
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Investment Objectives and Management Policies (continued)
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accounting purposes, which income is distributable to shareholders and which,
because no cash is received at the time of accrual, may require the liquidation
of portfolio securities to satisfy the Fund's distribution obligations.
Money Market Instruments. Money market instruments in which the Fund may
invest are limited to: U.S. government securities; bank obligations (including
certificates of deposit, time deposits and bankers' acceptances of domestic or
foreign banks, domestic savings and loan associations and other banking
institutions having total assets in excess of $500 million); commercial paper
rated no lower than Prime-1 by Moody's or A-1 by S&P or the equivalent from
another NRSRO, or, if unrated, of an issuer having an outstanding, unsecured
debt issue then rated within the highest rating category; and repurchase
agreements, as more fully described below. U.S. government securities in which
the Fund may invest include obligations issued or guaranteed by U.S. agencies
and instrumentalities that are supported solely by the credit of the agency or
instrumentality. At no time will the Fund's investments in bank obligations,
including time deposits, exceed 25% of its assets.
The Fund will invest in an obligation of a foreign bank or foreign branch
of a U.S. bank only if BlackRock determines that the obligation presents minimal
credit risks. The obligations of foreign banks or foreign branches of U.S. banks
in which the Fund will invest may be traded in or outside the United States, but
will be denominated in U.S. dollars. Obligations of a foreign bank or foreign
branch of a U.S. bank entail risks that include foreign economic and political
developments, foreign governmental restrictions that may adversely affect the
payment of principal and interest on the obligations, foreign exchange controls
and foreign withholding or other taxes on income. Foreign branches of domestic
banks are not necessarily subject to the same or similar regulatory requirements
that apply to domestic banks, such as mandatory reserve requirements, loan
limitations, and accounting, auditing and financial record keeping requirements.
In addition, less information may be publicly available about a foreign branch
of a domestic bank than about a domestic bank.
Illiquid Securities. The Fund may invest up to 15% of its net assets in
securities for which no readily available market exists or other illiquid
securities, including repurchase agreements having maturities of more than seven
days, interest rate swaps and ABSs that cannot be disposed of promptly within
seven days and in the usual course of business without the Fund's receiving a
reduced price. In the absence of a change in the position of the staff of the
SEC, the Fund will treat over-the-counter ("OTC") options as illiquid
securities. The Fund will also treat POs and IOs as illiquid securities except
for POs and IOs issued by U.S. government agencies and instrumentalities, whose
liquidity is monitored by BlackRock subject to the supervision of MMC and the
Fund's Board of Trustees.
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INVESTMENT TECHNIQUES AND STRATEGIES
The Fund may use at any time any of the techniques and strategies
described below. The Fund is under no obligation to use any of the listed
practices at any given time or under any particular economic condition. In
addition, no assurance can be given that the use of any practice will have its
intended result.
Repurchase Agreements. The Fund may enter into repurchase agreement
transactions with member banks of the Federal Reserve System or with certain
dealers on the Federal Reserve Bank of New York's list of reporting dealers. A
repurchase agreement is a contract under which the buyer of a security
simultaneously commits to resell the security to the seller at an agreed-upon
price on an agreed-upon date. Under the terms of a typical repurchase agreement,
the Fund would acquire an underlying debt obligation for a relatively short
period subject to an obligation of the seller to repurchase, and the Fund to
resell, the obligation at an agreed-upon price and time, thereby determining the
yield during the Fund's holding period. This arrangement results in a fixed rate
of return that is not subject to market fluctuations during the Fund's holding
period. Under each repurchase agreement, the selling institution will be
required to maintain the value of the securities subject to the repurchase
agreement at not less than their repurchase price.
The value of the securities underlying a repurchase agreement of the Fund
will be monitored on an ongoing basis by BlackRock or MMC to ensure that the
value is at least equal at all times to the total amount of the repurchase
obligation, including interest. BlackRock or MMC will also monitor, on an
ongoing basis to evaluate potential risks, the creditworthiness of the banks and
dealers with which the Fund enters into repurchase agreements.
Reverse Repurchase Agreements. The Fund may enter into reverse repurchase
agreement transactions with member banks on the Federal Reserve Bank of New
York's list of reporting dealers. A reverse repurchase agreement, which is
considered a borrowing by the Fund, involves a sale by the Fund of securities
that it holds concurrently with an agreement by the Fund to repurchase the same
securities at an agreed-upon price and date. The Fund typically will invest the
proceeds of a reverse repurchase agreement in money market instruments or
repurchase agreements maturing not later than the expiration of the reverse
repurchase agreement. The Fund will enter into a reverse repurchase agreement
for these purposes only when the interest income to be earned from the
investment of the proceeds is greater than the interest expense of the
transaction. The Fund may also use the proceeds of reverse repurchase agreements
to provide liquidity to meet redemption requests when the sale of the Fund's
securities is considered to be disadvantageous.
The Fund will establish a segregated account with its custodian, PNC Bank,
in which the Fund will maintain cash, U.S. government securities or other liquid
high
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Investment Objectives and Management Policies (continued)
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grade debt obligations equal in value to its obligations with respect to reverse
repurchase agreements.
Dollar Roll Transactions. To take advantage of attractive financing
opportunities in the mortgage market and to enhance current income, the Fund may
enter into dollar roll transactions. A dollar roll transaction, which is
considered a borrowing by the Fund, involves a sale by the Fund of a security to
a financial institution, such as a bank or broker-dealer, concurrently with an
agreement by the Fund to repurchase a similar security from the institution at a
later date at an agreed-upon price. The securities that are repurchased will
bear the same interest rate as those sold, but generally will be collateralized
by different pools of mortgages with different prepayment histories than those
sold. During the period between the sale and repurchase, the Fund will not be
entitled to receive interest and principal payments on the securities sold.
Proceeds of the sale will be invested in additional instruments for the Fund,
and the income from these investments, together with any additional fee income
received on the sale, will generate income for the Fund exceeding the yield on
the securities sold. Dollar roll transactions involve the risk that the market
value of the securities sold by the Fund may decline below the repurchase price
of those securities. At the time that the Fund enters into a dollar roll
transaction, it will place in a segregated account maintained with its
custodian, PNC Bank, cash, U.S. government securities or other liquid high grade
debt obligations having a value equal to the repurchase price and will
subsequently monitor the account to ensure that its value is maintained.
When-Issued and Delayed Delivery Securities. The Fund may purchase or sell
securities on a when-issued or delayed delivery basis. When-issued or delayed
delivery transactions arise when securities are purchased or sold by the Fund
with payment and delivery taking place in the future in order to secure what is
considered to be an advantageous price and yield to the Fund at the time of
entering into the transaction. PNC Bank will maintain, in a segregated account
of the Fund, cash, debt securities of any grade or equity securities, having a
value equal to or greater than the Fund's purchase commitments, provided such
securities have been determined to be liquid and unencumbered, and are marked to
market daily, pursuant to guidelines established by the Board of Trustees. PNC
Bank will also segregate securities sold on a delayed basis. The payment
obligations and the interest rates that will be received are each fixed at the
time the Fund enters into the commitment and no interest accrues to the Fund
until settlement. Thus, it is possible that the market value at the time of
settlement could be higher or lower than the purchase price if the general level
of interest rates has changed.
Short Sales. The Fund may make short sales of securities. A short sale is
a transaction in which the Fund sells a security it does not own in anticipation
that the market price of that security will decline. The Fund may make short
sales both as a form of hedging to offset potential declines in securities
positions it holds in similar securities and in order to maintain portfolio
flexibility.
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The Fund may make short sales "against the box" without complying with the
limitations described above. In a short sale against the box transaction, the
Fund, at the time of the sale, owns or has the immediate and unconditional right
to acquire at no additional cost the identical security sold. This is
distinguished from a "naked short," in which the Fund does not own or have the
right to acquire the security sold.
Lending of Portfolio Securities. To generate income, the Fund may lend
portfolio securities to brokers, dealers and other financial organizations.
These loans, if and when made, may not exceed 30% of the Fund's assets taken at
value. The Fund's loans of securities will be collateralized by cash, letters of
credit or U.S. government securities. The cash or instruments collateralizing
the Fund's loans of securities will be maintained at all times in a segregated
account with PNC Bank in an amount at least equal to the current market value of
the loaned securities.
Options Transactions. The Fund is authorized to engage in transactions
involving put and call options. The Fund may purchase a put option, for example,
in an effort to protect the value of a security that it owns against a
substantial decline in market value, if BlackRock believes that a defensive
posture is warranted for a portion of the Fund's portfolio. In addition, in
seeking to protect certain portfolio securities against a decline in market
value at a time when put options on those particular securities are not
available for purchase, the Fund may purchase a put option on securities it does
not hold. Although changes in the value of the put option should generally
offset changes in the value of the securities being hedged, the correlation
between the two values may not be as close in the latter type of transaction as
in a transaction in which the Fund purchases a put option on an underlying
security it owns.
The Fund may purchase call options on securities it intends to acquire to
hedge against an anticipated market appreciation in the price of the underlying
securities. If the market price does rise as anticipated in such a situation,
the Fund will benefit from that rise only to the extent that the rise exceeds
the premiums paid. If the anticipated rise does not occur or if it does not
exceed the premium, the Fund will bear the expense of the option premiums and
transaction costs without gaining an offsetting benefit.
The Fund is authorized to engage in transactions involving
over-the-counter options ("OTC options") and options traded on a U.S. securities
exchange. Whereas exchange-traded options are in effect guaranteed by The
Options Clearing Corporation, the Fund relies on the dealer from which it
purchases an OTC option to perform if the option is exercised. BlackRock will
monitor the creditworthiness of dealers with which the Fund enters into OTC
option transactions under the general supervision of MMC and the Fund's Board of
Trustees.
Futures Contracts and Options on Futures Contracts. The Fund may enter
into interest rate futures contracts on U.S. government securities and MBSs. A
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Investment Objectives and Management Policies (continued)
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futures contract on securities, other than GNMAs which are cash settled, is an
agreement to purchase or sell an agreed amount of securities at a set price for
delivery on an agreed future date. The Fund may purchase a futures contract as a
hedge against an anticipated decline in interest rates, and resulting increase
in market price, of securities the Fund intends to acquire. The Fund may sell a
futures contract as a hedge against an anticipated increase in interest rates,
and resulting decline in market price, of securities the Fund owns.
The Fund may purchase call and put options on futures contracts on U.S.
government securities and MBSs that are traded on U.S. commodity exchanges. An
option on a futures contract gives the purchaser the right, in return for the
premium paid, to assume a position in a futures contract (a long position if the
option is a call and short position if the option is a put) at a specified
exercise price at any time during the option exercise period. The writer of the
option is required upon exercise to assume an offsetting futures position (a
short position if the option is a call and a long position if the option is a
put). Upon the exercise of the option, the assumption of offsetting futures
positions by the writer and holder of the option will be accompanied by delivery
of the accumulated cash balance in the writer's futures margin account that
represents the amount by which the market price of the futures contract at
exercise exceeds, in the case of a call, or is less than, in the case of a put,
the exercise price of the option on the futures contract.
The Fund will not purchase an option if, as a result of the purchase, more
than 20% of its total assets would be invested in premiums for options and
options on futures. In addition, the Fund may not sell futures contracts or
purchase related options if immediately after the sale the sum of the amount of
initial margin deposits on the Fund's existing futures and options on futures
and for premiums paid for the related options would exceed 5% of the market
value of the Fund's total assets, after taking into account unrealized profits
and unrealized losses on any such contracts the Fund has entered into, except
that, in the case of an option that is in-the-money at the time of purchase, the
in-the-money amount may be excluded in computing the 5% limitation. The Fund is
subject to no overall limitation on the percentage of its assets that may be
subject to a hedge position.
The Fund will purchase put options on futures contracts primarily to hedge
its portfolio of U.S. government securities and MBSs against the risk of rising
interest rates, and the consequential decline in the prices of U.S. government
securities and MBSs it owns. The Fund will purchase call options on futures
contracts to hedge the Fund's portfolio against a possible market advance at a
time when the Fund is not fully invested in U.S. government securities and MBSs
(other than U.S. Treasury Bills).
Interest Rate Transactions. The Fund may enter into interest rate swaps,
which are "derivative" transactions involving the exchange by the Fund with
another party
25
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Investment Objectives and Management Policies (continued)
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of their respective commitments to pay or receive interest, such as, for
example, an exchange of floating rate payments for fixed rate payments. The Fund
expects to enter into these transactions primarily to preserve a return or
spread on a particular investment or a portion of its portfolio or to protect
against any increase in the price of securities that the Fund anticipates
purchasing at a later date. The Fund intends to use these transactions as a
hedge and not as a speculative investment.
The Fund will enter into interest rate swap transactions on a net basis;
that is, the two payment streams are netted out, with the Fund receiving or
paying only the net amount of the two payments. The net amount of the excess, if
any, of the Fund's obligations over its entitlements with respect to each
interest rate swap will be accrued daily, and an amount of cash, U.S. government
securities or other liquid high grade debt obligations having an aggregate net
asset value at least equal to the accrued excess will be maintained by the Fund
in a segregated account with PNC Bank.
Transactions Involving Eurodollar Instruments. The Fund may from time to
time purchase Eurodollar instruments traded on the Chicago Mercantile Exchange.
These instruments are in essence U.S. dollar-denominated futures contracts or
options on futures contracts that are linked to LIBOR. Eurodollar futures
contracts enable purchasers to obtain a fixed rate for the lending of funds and
sellers to obtain a fixed rate for borrowings. The Fund intends to use
Eurodollar futures contracts and options on futures contracts to hedge against
changes in LIBOR, to which many interest rate swaps are linked. The use of these
instruments is subject to the same limitations and risks as those applicable to
the use of the interest rate futures contracts and options on futures contracts
described under "Futures Contracts and Options on Futures Contracts" above.
Borrowing. The Fund may borrow from banks for temporary or emergency (not
leveraging) purposes and enter into reverse repurchase agreements or dollar
rolls in an aggregate amount equal to up to 33 1/3% of the value of its total
assets (computed at the time the loan is made). The Fund may pledge up to 33
1/3% of its total assets to secure these borrowings. Under normal market
conditions, the Fund expects to engage in borrowing with respect to
approximately 10% of its total assets. If the Fund's asset coverage for
borrowings falls below 300%, the Fund will take prompt action to reduce its
borrowings.
Year 2000. The investment management and administration services provided
to the Fund by Strategy Advisers and MMC (collectively, the "Managers") and the
services provided to shareholders by Salomon Smith Barney depend on the smooth
functioning of their computer systems. Many computer software systems in use
today cannot recognize the year 2000, but revert to 1900 or some other date, due
to the manner in which dates were encoded and calculated. That failure could
have a negative impact on the Fund's operations, including the handling of
securities trades, pricing and account services. The Managers and Salomon Smith
Barney
26
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Investment Objectives and Management Policies (continued)
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have advised the Fund that they have been reviewing all of their computer
systems and actively working on necessary changes to their systems to prepare
for the year 2000 and expect that their systems will be compliant before that
date. In addition, the Managers have been advised by the Fund's custodian,
transfer agent and accounting service agent that they are also in the process of
modifying their systems with the same goal. There can, however, be no assurance
that the Managers, Salomon Smith Barney or any other service provider will be
successful, or that interaction with other non-complying computer systems will
not impair Fund services at that time.
In addition, the ability of issuers to make timely payments of interest
and principal or to continue their operations or services may be impaired by the
inadequate preparation of their computer systems for the year 2000. This may
adversely affect the market values of securities of specific issuers or of
securities generally if the inadequacy of preparation is perceived as widespread
or as affecting trading markets.
RISK FACTORS AND SPECIAL CONSIDERATIONS
Interest Rate Risk. The Fund's portfolio will be affected by general
changes in interest rates that will result in increases or decreases in the
market value of the obligations held by the Fund. The market value of the
obligations in the Fund's portfolio can be expected to vary inversely to changes
in prevailing interest rates. Investors should also recognize that, in periods
of declining interest rates, the Fund's yield will tend to be somewhat higher
than prevailing market rates, and in periods of rising interest rates, the
Fund's yield will tend to be somewhat lower. In addition, when interest rates
are falling, money received by the Fund from the continuous sale of its shares
will likely be invested in portfolio instruments producing lower yields than the
balance of its portfolio, thereby reducing the Fund's current yield. In periods
of rising interest rates, the opposite result can be expected to occur.
Adjustable Rate Securities. The types of securities in which the Fund will
invest have certain unique attributes that warrant special consideration or that
present risks that may not exist in other types of mutual fund investments. Some
of these risks and special considerations are peculiar to Adjustable Rate
Securities whereas others, most notably the risk of prepayments, pertain to the
characteristics of MBSs or ABSs generally.
Payments of principal of and interest on MBSs and ABSs are made more
frequently than are payments on conventional debt securities. In addition,
holders of MBSs and of certain ABSs (such as ABSs backed by home equity loans)
may receive unscheduled payments of principal at any time representing
prepayments on the underlying mortgage loans or financial assets. When the
holder of the security attempts to reinvest prepayments or even the scheduled
payments of principal and interest, it may receive a rate of interest that is
higher or lower than the rate on the
27
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Investment Objectives and Management Policies (continued)
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MBS or ABS originally held. To the extent that MBSs or ABSs are purchased by the
Fund at a premium, mortgage foreclosures and principal prepayments may result in
loss to the extent of the premium paid. If MBSs or ABSs are bought at a
discount, however, both scheduled payments of principal and unscheduled
prepayments will increase current and total returns and will accelerate the
recognition of income which, when distributed to shareholders, will be taxable
as ordinary income. BlackRock will consider remaining maturities or estimated
average lives of MBSs and ABSs in selecting them for the Fund.
ABSs may present certain risks not relevant to MBSs. Although ABSs are a
growing sector of the financial markets, they are relatively new instruments and
may be subject to a greater risk of default during periods of economic downturn
than MBSs. In addition, assets underlying ABSs such as credit card receivables
are generally unsecured, and debtors are entitled to the protection of various
state and federal consumer protection laws, some of which provide a right of
set-off that may reduce the balance owed. Finally, the market for ABS may not be
as liquid as that for MBSs.
The interest rate reset features of Adjustable Rate Securities held by the
Fund will reduce the effect on the net asset value of Fund shares caused by
changes in market interest rates. The market value of Adjustable Rate Securities
and, therefore, the Fund's net asset value, however, may vary to the extent that
the current interest rate on the securities differs from market interest rates
during periods between interest reset dates. The longer the adjustment intervals
on Adjustable Rate Securities held by the Fund, the greater the potential for
fluctuations in the Fund's net asset value.
Investors in the Fund will receive increased income as a result of upward
adjustments of the interest rates on Adjustable Rate Securities held by the Fund
in response to market interest rates. The Fund and its shareholders will not
benefit, however, from increases in market interest rates once those rates rise
to the point at which they cause the rates on the Adjustable Rate Securities to
reach their maximum adjustment rate, annual or lifetime caps. Because of their
interest rate adjustment feature, Adjustable Rate Securities are not an
effective means of "locking-in" attractive rates for periods in excess of the
adjustment period. In addition, mortgagors on loans underlying MBSs with respect
to which the underlying mortgage assets carry no agency or instrumentality
guarantee are often qualified for the loans on the basis of the original payment
amounts; the mortgagor's income may not be sufficient to enable it to continue
making its loan payments as the payments increase, resulting in a greater
likelihood of default.
Any benefits to the Fund and its shareholders from an increase in the
Fund's net asset value caused by declining market interest rates is reduced by
the potential for increased prepayments and a decline in the interest rates paid
on Adjustable Rate Securities held by the Fund. When market rates decline
significantly, the
28
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Investment Objectives and Management Policies (continued)
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prepayment rate on Adjustable Rate Securities is likely to increase as borrowers
refinance with fixed rate mortgage loans, thereby decreasing the capital
appreciation potential of Adjustable Rate Securities. As a result, the Fund
should not be viewed as consistent with an objective of seeking capital
appreciation.
Options and Futures Markets. Participation in the options or futures
markets involves investment risks and transaction costs to which the Fund would
not be subject absent the use of these strategies. If BlackRock's predictions of
movements in the direction of the securities and interest rate markets are not
accurate, the adverse consequences to the Fund may leave the Fund in a worse
position than if options or futures strategies were not used. Risks inherent in
the use of options, futures contracts and options on futures contracts include:
(a) dependence on BlackRock's ability to predict correctly movements in the
direction of interest rates and securities prices; (b) imperfect correlation
between the price of options and futures contracts and options on futures
contracts and movements in the prices of the securities being hedged; and (c)
the skills needed to use these strategies being different from those needed to
select portfolio securities. In addition, positions in futures contracts and
options on futures contracts may be closed out only on the exchange or board of
trade on which they were entered into, and no assurance can be given that an
active market will exist for a particular contract or option at a particular
time.
Lending Portfolio Securities. In lending securities to brokers, dealers
and other financial organizations, the Fund will be subject to risks, which,
like those associated with other extensions of credit, include the possible
delays in realizing on, or loss of, collateral should the borrower fail
financially.
Repurchase and Reverse Repurchase Agreements. In entering into a
repurchase agreement, the Fund bears a risk of loss in the event that the other
party to the transaction defaults on its obligations and the Fund is delayed or
prevented from exercising its rights to dispose of the underlying securities,
including the risk of a possible decline in the value of the underlying
securities during the period in which the Fund seeks to assert its rights to
them, the risk of incurring expenses associated with asserting those rights and
the risk of losing all or a part of the income from the agreement.
A reverse repurchase agreement involves the risk that the market value of
the securities retained by the Fund may decline below the price of the
securities the Fund has sold but is obligated to repurchase under the agreement.
In the event the buyer of securities under a reverse repurchase agreement files
for bankruptcy or becomes insolvent, the Fund's use of the proceeds of the
agreement may be restricted pending a determination by the party, or its trustee
or receiver, whether to enforce the Fund's obligation to repurchase the
securities.
When-Issued and Delayed Delivery Transactions. Securities purchased on
29
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Investment Objectives and Management Policies (continued)
- --------------------------------------------------------------------------------
a when-issued or delayed delivery basis may expose the Fund to risk because the
securities may experience fluctuations in value prior to their delivery.
Purchasing when-issued or delayed delivery securities can involve the additional
risk that the yield available in the market when the delivery takes place may be
higher than that obtained in the transaction itself.
Short Sales. If the price of the security sold short increases between the
time of the short sale and the time the Fund replaces the borrowed security, the
Fund will incur a loss; conversely, if the price declines, the Fund will realize
a capital gain. Although the Fund's gain is limited to the price at which it
sold the security short, its potential loss is theoretically unlimited in
respect to a "naked" short.
Borrowing. If the Fund borrows to invest in securities, any investment
gains made on the securities in excess of interest paid on the borrowing will
cause the net asset value of the Fund's shares to rise faster than would
otherwise be the case. On the other hand, if the investment performance of the
additional securities purchased fails to cover their costs (including any
interest paid on the money borrowed) to the Fund, the net asset value of the
Fund's shares will decrease faster than would otherwise be the case. This is the
speculative characteristic known as "leverage."
PORTFOLIO TRANSACTIONS AND TURNOVER
Newly issued securities ordinarily are purchased directly from the issuer
or from an underwriter; other purchases and sales usually are placed with those
dealers from which it appears that the best price or execution will be obtained.
Usually no brokerage commissions, as such, are paid by the Fund for purchases
and sales undertaken through principal transactions, although the price paid
usually includes an undisclosed compensation to the dealer acting as agent. The
prices paid to underwriters of newly issued securities usually include a
concession paid by the issuer to the underwriter, and purchases of after-market
securities from dealers ordinarily are executed at a price between the bid and
asked price.
Transactions on behalf of the Fund are allocated to various dealers by
BlackRock in its best judgment. The primary consideration is prompt and
effective execution of orders at the most favorable price. Subject to that
primary consideration, dealers may be selected for research, statistical or
other services to enable BlackRock to supplement its own research and analysis
with the views and information of other securities firms.
Although investment decisions for the Fund will be made independently from
those of the other accounts managed by BlackRock, investments of the type the
Fund may make may also be made by those other accounts. When the Fund and one or
more other accounts managed by BlackRock are prepared to invest in, or desire to
dispose of, the same security or other investment instrument, available
investments or opportunities for sales will be allocated in a manner believed by
BlackRock
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Investment Objectives and Management Policies (continued)
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to be equitable to each. In some cases, this procedure may adversely affect the
price paid or received by the Fund or the size of the position obtained or
disposed of by the Fund.
The Fund has no fixed policy with respect to portfolio turnover, but does
not expect to trade in securities for short-term gain. The Fund's annual
portfolio turnover rate will not be a factor preventing a sale or purchase when
BlackRock believes investment considerations warrant such sale or purchase.
Since the Fund's inception, the Fund's annual portfolio turnover rate has
exceeded 200% in each fiscal year. Annual turnover at this rate means that the
Fund's portfolio securities are replaced more than twice during a period of one
year. Portfolio turnover rate is calculated by dividing the lesser of sales or
purchases of portfolio securities by the average monthly value of the Fund's
portfolio securities, excluding securities having a maturity at the date of
purchase of one year or less. High portfolio turnover may involve corresponding
greater transaction costs that will be borne directly by the Fund. See
"Financial Highlights" for the Fund's annual Portfolio Turnover Rate.
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Valuation of Shares
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The Fund's net asset value per share is determined as of the close of
regular trading on the NYSE on each day that the NYSE is open, by dividing the
net asset value attributable to each Class by the total number of shares of the
Class outstanding.
Generally, the Fund's investments are valued at market value or, in the
absence of a market value with respect to any security, at fair value as
determined by or under the direction of the Fund's Board of Trustees. Short-term
investments that have a maturity of more than 60 days are valued at prices based
on market quotations for securities of similar type, yield and maturity.
Short-term investments with a remaining maturity of 60 days or less are valued
at amortized cost when the Board has determined that amortized cost approximates
fair value. Corporate debt securities, MBSs and ABSs held by the Fund are valued
on the basis of valuations provided by dealers in those instruments or by an
independent pricing service approved by the Board of Trustees; any such pricing
service, in determining value, will use information with respect to transactions
in the securities being valued, quotations from dealers, market transactions in
comparable securities, analysis and evaluations of various relationships between
securities and yield to maturity information.
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Dividends, Distributions and Taxes
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DIVIDENDS AND DISTRIBUTIONS
The Fund's policy is to declare and pay monthly dividends from its net
investment income. Dividends from net realized capital gains, if any, will be
distributed annually. The Fund may also pay additional dividends shortly before
December 31 from certain amounts of undistributed ordinary income and capital
gains realized, in order to avoid a Federal excise tax liability. If a
shareholder does not otherwise instruct, dividends and capital gain
distributions will be automatically reinvested in additional same Class shares
at the appropriate net asset value, with no additional sales charge or CDSC.
The per share amounts of dividends from net investment income on Class A
shares may be lower than that of Classes B and I, mainly as a result of the
distribution and service fees applicable to the Class A shares. Capital gain
distributions, if any, will be the same across all Classes of Fund shares (A, B
and I).
TAXES
The following is a summary of the material federal tax considerations
affecting the Fund and Fund shareholders; please refer to the SAl for further
discussion. In addition to the considerations described below and in the SAI,
there may be other federal, state, local, and/or foreign tax implications to
consider. Because taxes are a complex matter, prospective shareholders are urged
to consult their tax advisors for more detailed information with respect to the
tax consequences of an investment.
The Fund intends to qualify, as it has in prior years, under Subchapter M
of the Internal Revenue Code (the "Code") for tax treatment as a regulated
investment company. In each taxable year that the Fund qualifies, so long as
such qualification is in the best interests of its shareholders, the Fund will
pay no federal income tax on its net investment company taxable income and
long-term capital gain that is distributed to shareholders.
Dividends paid from net investment income and net realized short-term
securities gain, are subject to federal income tax as ordinary income.
Distributions, if any, from net realized long-term securities gains derived from
the sale of securities held by the Fund for more than one year, are taxable as
long-term capital gains, regardless of the length of time a shareholder has
owned Fund shares.
Shareholders are required to pay tax on all taxable distributions, even if
those distributions are automatically reinvested in additional Fund shares. None
of the dividends paid by the Fund will qualify for the corporate dividends
received deduction. Dividends consisting of interest from U.S. government
securities may be exempt from state and local income taxes. The Fund will inform
shareholders of the source and tax status of all distributions promptly after
the close of each calendar year.
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Dividends, Distributions and Taxes (continued)
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A shareholder's gain or loss on the disposition of Fund shares (whether by
redemption, sale or exchange), generally will be a long-term or short-term gain
or loss depending on the length of time the shares had been owned at
disposition. Losses realized by a shareholder on the disposition of Fund shares
owned for six months or less will be treated as a long-term capital loss to the
extent a capital gain dividend had been distributed on such shares.
The Fund is required to withhold ("backup withholding") 31 % of all
taxable dividends, capital gain distributions, and the proceeds of any
redemption, regardless of whether gain or loss is realized upon the redemption,
for shareholders who do not provide the Fund with a correct taxpayer
identification number (social security or employer identification number).
Withholding from taxable dividends and capital gain distributions also is
required for shareholders who otherwise are subject to backup withholding. Any
tax withheld as a result of backup withholding does not constitute an additional
tax, and may be claimed as a credit on the shareholders' federal income tax
return.
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Purchase of Shares
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GENERAL
The Fund offers three classes of shares. Class A shares are sold to
investors with no initial sales charge and are subject to ongoing distribution
and service fees. Class B shares are available through exchange purchases and/or
the Smith Barney 401(k) and ExecChoice(TM) Programs and are subject to a CDSC
payable upon certain redemptions. Class I shares are sold without an initial
sales charge or CDSC and are available only to investors investing a minimum of
$100,000. See "Prospectus Summary -- Alternative Purchase Arrangements" for a
discussion of factors to consider in selecting which class of shares to
purchase.
Purchases of Fund shares must be made through a brokerage account
maintained with Salomon Smith Barney, with an Introducing Broker or with an
investment dealer in the selling group. In addition, certain investors may
purchase shares directly from the Fund through the Transfer Agent. When
purchasing shares of the Fund, investors must specify whether the purchase is
for Class A, Class B or Class I shares. Smith Barney and other broker/dealers
may charge their customers an annual account maintenance fee in connection with
a brokerage account through which an investor purchases or holds shares.
Accounts held directly at the Transfer Agent are not subject to a maintenance
fee.
Investors in Class A and Class B (through Exchange Purchases) shares may
open an account in the Fund by making an initial investment of at least $1,000
for each account, or $250 for an IRA or a Self-employed Retirement Plan, in the
Fund. Investors in Class I shares may open an account by making an initial
investment
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Purchase of Shares (continued)
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of $100,000. Subsequent investments of at least $50 may be made for all Classes.
For participants in retirement plans qualified under Section 403(b)(7) or
Section 401(a) of the Code, the minimum initial investment requirement for Class
A and Class B shares and the subsequent investment requirement for all Classes
in the Fund is $25. For shareholders purchasing shares of the Fund through the
Systematic Investment Plan, the minimum initial investment requirement is $25
for monthly purchases and $50 for quarterly purchases. There are no minimum
investment requirements for Class A shares for employees of Travelers and its
subsidiaries, including Salomon Smith Barney, and Directors or Trustees of any
Travelers-affiliated funds, including the Smith Barney Mutual Funds, and their
spouses and children. The Fund reserves the right to waive or change minimums,
to decline any order to purchase its shares and to suspend the offering of
shares from time to time. Shares purchased will be held in the shareholder's
account by the Transfer Agent. Share certificates are issued only upon a
shareholder's written request to the Transfer Agent.
The minimum initial and subsequent investment requirements in the Fund for
an account established under the Uniform Gift to Minors Act is $250 and the
subsequent investment requirement is $50.
The minimum initial and subsequent investment requirements in the Fund for
an account established under the Simple IRA and the Easy Simple IRA Programs is
$1. Exchange investments will have a $1 minimum.
Purchase orders received by the Fund or Salomon Smith Barney prior to the
close of regular trading on the NYSE, on any day the Fund calculates its net
asset value, are priced according to the net asset value determined on that day
(the "trade date"). Orders received by dealers or Introducing Brokers prior to
the close of regular trading on the NYSE on any day the Fund calculates its net
asset value, are priced according to the net asset value determined on that day
provided the order is received by the Fund or Salomon Smith Barney prior to
Salomon Smith Barney's close of business (the "trade date"). For shares
purchased through Salomon Smith Barney or Introducing Brokers purchasing through
Salomon Smith Barney, payment for Fund shares is due on the third business day
after the trade date (the "settlement date"). In all other cases, payment must
be made with the purchase order.
SYSTEMATIC INVESTMENT PLAN
Class A and Class I shareholders may make additions to their accounts at
any time by purchasing shares through a service known as the Systematic
Investment Plan. Under the Systematic Investment Plan, Salomon Smith Barney or
the Transfer Agent is authorized through preauthorized transfers of at least $25
on a monthly basis or at least $50 on a quarterly basis to charge an account
with a bank or other financial institution on a monthly or quarterly basis as
indicated by the shareholder to provide for systematic additions to the
shareholder's Fund account. For shareholders purchasing Class A and Class I
shares of the Fund through the Systematic Investment
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Purchase of Shares (continued)
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Plan on a monthly basis, the minimum initial investment requirement and the
minimum subsequent investment requirement is $25. For shareholders purchasing
Class A and Class I shares of the Fund through the Systematic Investment Plan on
a quarterly basis, the minimum initial investment requirement and the minimum
subsequent investment requirement is $50. A shareholder who has insufficient
funds to complete the transfer will be charged a fee of up to $25 by Salomon
Smith Barney or the Transfer Agent. The Systematic Investment Plan also
authorizes Salomon Smith Barney to apply cash held in the shareholder's Salomon
Smith Barney brokerage account or redeem the shareholder's shares of a Salomon
Smith Barney money market fund to make additions to the account. Additional
information is available from the Fund or a Salomon Smith Barney Financial
Consultant.
CLASS B CONVERSION FEATURE
Class B shares will convert automatically to Class A shares eight years
after the date on which they were originally purchased. There will also be
converted at that time such proportion of Class B Dividend Shares owned by the
shareholder as the total number of his or her Class B shares converting at the
time bears to the total number of Class B shares (other than Class B Dividend
Shares) owned by the shareholder. See "Prospectus Summary -- Alternative
Purchase Arrangements -- Class B Shares Conversion Feature."
The length of time that CDSC Shares acquired through an exchange have been
held will be calculated from the date that the shares exchanged were initially
acquired in one of the other Smith Barney Mutual Funds, and Fund shares being
redeemed will be considered to represent, as applicable, capital appreciation or
dividend and capital gain distribution reinvestments in such other funds. For
Federal income tax purposes, the amount of any CDSC will reduce the gain or
increase the loss, as the case may be, on the amount realized on redemption. The
amount of any CDSC will be paid to Salomon Smith Barney.
WAIVERS OF CDSC
The CDSC will be waived on: (a) exchanges (see "Exchange Privilege"); (b)
automatic cash withdrawals in amounts equal to or less than 1.00% per month of
the value of the shareholder's shares at the time the withdrawal plan commences
(see "Automatic Cash Withdrawal Plan") (provided, however, that automatic cash
withdrawals in amounts equal to or less than 2.00% per month of the value of the
shareholder's shares will be permitted for withdrawal plans that were
established prior to November 7, 1994); (c) redemptions of shares within 12
months following the death or disability of the shareholder; (d) redemption of
shares made in connection with qualified distributions from retirement plans or
IRAs upon the attainment of age 591/2; (e) involuntary redemptions; and (f)
redemptions of shares to effect a combination of the Fund with any investment
company by merger, acquisition of assets or otherwise. In addition, a
shareholder who has redeemed shares from other Smith Barney Mutual Funds may,
35
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Purchase of Shares (continued)
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under certain circumstances, reinvest all or part of the redemption proceeds
within 60 days and receive pro rata credit for any CDSC imposed on the prior
redemption.
CDSC waivers will be granted subject to confirmation (by Salomon Smith
Barney in the case of shareholders who are also Salomon Smith Barney clients or
by the Transfer Agent in the case of all other shareholders) of the
shareholder's status or holdings, as the case may be.
SMITH BARNEY 401(K) AND EXECCHOICE(TM) PROGRAMS
Investors may be eligible to participate in the Smith Barney 401(k)
Program or the Smith Barney ExecChoice(TM) Program. To the extent applicable,
the following terms and conditions, which are outlined below, are offered to all
plans participating ("Participating Plans") in these programs.
The Fund offers to Participating Plans Class A shares as an investment
choice under the Smith Barney 401(k) and ExecChoice(TM) Programs, provided the
Participating Plan makes an initial investment of $1,000,000 or more of Class A
shares of one or more funds of the Smith Barney Mutual Funds. Class A shares
acquired through the Participating Plans are subject to the same service and/or
distribution fees as the Class A shares acquired by other investors.
Participating Plans wishing to acquire shares of the Fund through the
Smith Barney 401(k) Program or the Smith Barney ExecChoice(TM) Program must
purchase such shares directly from First Data. For further information regarding
these Programs, investors should contact a Smith Barney Financial Consultant.
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Exchange Privilege
- --------------------------------------------------------------------------------
Except as otherwise noted below, shares of Class A or Class B may be
exchanged at the net asset value next determined for shares of the same Class in
the following funds of the Smith Barney Mutual Funds, to the extent shares are
offered for sale in the shareholder's state of residence. Exchanges of Class A
and Class B shares are subject to minimum investment requirements and all shares
are subject to the other requirements of the fund into which exchanges are made.
Class I shares do not have exchange privileges.
Fund Name
- --------------------------------------------------------------------------------
Growth Funds
Concert Peachtree Growth Fund
Concert Social Awareness Fund
Smith Barney Aggressive Growth Fund Inc.
Smith Barney Appreciation Fund Inc.
Smith Barney Balanced Fund
Smith Barney Contrarian Fund
36
<PAGE>
- --------------------------------------------------------------------------------
Exchange Privilege (continued)
- --------------------------------------------------------------------------------
Smith Barney Convertible Fund
Smith Barney Fundamental Value Fund Inc.
Smith Barney Funds, Inc. -- Large Cap Value Fund
Smith Barney Large Cap Blend Fund
Smith Barney Large Capitalization Growth Fund
Smith Barney Natural Resources Fund Inc.
Smith Barney Premium Total Return Fund
Smith Barney Small Cap Blend Fund, Inc.
Smith Barney Special Equities Fund
Taxable Fixed Income Funds
Smith Barney Diversified Strategic Income Fund
* Smith Barney Funds, Inc. -- Short-Term High Grade Bond Fund
Smith Barney Funds, Inc. -- U.S. Government Securities Fund
Smith Barney Government Securities Fund
Smith Barney High Income Fund
Smith Barney Investment Grade Bond Fund
Smith Barney Managed Governments Fund Inc.
Smith Barney Total Return Bond Fund
Tax-Exempt Funds
Smith Barney Arizona Municipals Fund Inc.
Smith Barney California Municipals Fund Inc.
* Smith Barney Intermediate Maturity California Municipals Fund
* Smith Barney Intermediate Maturity New York Municipals Fund
Smith Barney Managed Municipals Fund Inc.
Smith Barney Massachusetts Municipals Fund
Smith Barney Muni Funds -- Florida Portfolio
Smith Barney Muni Funds -- Georgia Portfolio
* Smith Barney Muni Funds -- Limited Term Portfolio
Smith Barney Muni Funds -- National Portfolio
Smith Barney Muni Funds -- New York Portfolio
Smith Barney Muni Funds -- Pennsylvania Portfolio
Smith Barney New Jersey Municipals Fund Inc.
Smith Barney Oregon Municipals Fund
Global-International Funds
Smith Barney Hansberger Global Small Cap Value Fund
Smith Barney Hansberger Global Value Fund
Smith Barney World Funds, Inc. -- Emerging Markets Portfolio
Smith Barney World Funds, Inc. -- European Portfolio
Smith Barney World Funds, Inc. -- Global Government Bond Portfolio
37
<PAGE>
- --------------------------------------------------------------------------------
Exchange Privilege (continued)
- --------------------------------------------------------------------------------
Smith Barney World Funds, Inc. -- International Balanced Portfolio
Smith Barney World Funds, Inc. -- International Equity Portfolio
Smith Barney World Funds, Inc. -- Pacific Portfolio
Smith Barney Concert Allocation Series Inc.
Smith Barney Concert Allocation Series Inc. -- Balanced Portfolio
Smith Barney Concert Allocation Series Inc. -- Conservative Portfolio
Smith Barney Concert Allocation Series Inc. -- Global Portfolio
Smith Barney Concert Allocation Series Inc. -- Growth Portfolio
Smith Barney Concert Allocation Series Inc. -- High Growth Portfolio
Smith Barney Concert Allocation Series Inc. -- Income Portfolio
Money Market Funds
+ Smith Barney Exchange Reserve Fund
* Smith Barney Money Funds, Inc. -- Cash Portfolio
* Smith Barney Money Funds, Inc. -- Government Portfolio
* Smith Barney Money Funds, Inc. -- Retirement Portfolio
* Smith Barney Municipal Money Market Fund, Inc.
* Smith Barney Muni Funds -- California Money Market Portfolio
* Smith Barney Muni Funds -- New York Money Market Portfolio
- ----------
* Available for exchange with Class A shares of the Fund.
+ Available for exchange with Class B shares of the Fund.
Class A Exchanges. Class A shares of the Fund are subject to the
appropriate initial sales charge upon the exchange of such shares for Class A
shares of a fund sold with a sales charge, including such an exchange of shares
obtained through automatic reinvestment. This does not apply to the Smith Barney
401(k) Program and ExecChoice(TM) Programs.
Class B Exchanges. In the event a Class B shareholder (unless such
shareholder was a Class B shareholder of the Short-Term World Income Fund on
July 15, 1994) wishes to exchange all or a portion of his or her shares in any
of the funds imposing a CDSC, the exchanged Class B shares will be subject to
that CDSC. Upon the exchange, the newly acquired Class B shares will be deemed
to have been purchased on the date the Class B shares of the fund that have been
exchanged were acquired.
Additional Information Regarding the Exchange Privilege. Excessive
exchange transactions can be detrimental to the Fund's performance and its
shareholders. MMC may determine that a pattern of frequent exchanges is
excessive and contrary to the best interests of the Fund's other shareholders.
In this event, MMC may, at its discretion, decide to limit additional purchases
and/or exchanges by the shareholder. Upon such a determination, the Fund will
provide notice in writing or by telephone to the shareholder at least 15 days
prior to suspending the exchange privilege and during the 15 day period the
shareholder will be required to (a) redeem his or her
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<PAGE>
- --------------------------------------------------------------------------------
Exchange Privilege (continued)
- --------------------------------------------------------------------------------
shares in the Fund or (b) remain invested in the Fund or exchange into any of
the other Smith Barney Mutual Funds then available, which position the
shareholder would be expected to maintain for a significant period of time. All
relevant factors will be considered in determining what constitutes an abusive
pattern of exchanges.
Certain shareholders may be able to exchange shares by telephone. See
"Redemption of Shares -- Telephone Redemption Exchange Program". Exchanges will
be processed at the net asset value next determined. Redemption procedures
discussed below are also applicable for exchanging shares, and exchanges will be
made upon receipt of all supporting documents in proper form. If the account
registration of the shares of the fund being acquired is identical to the
registration of the shares of the fund exchanged, no signature guarantee is
required. A capital gain or loss for tax purposes will be realized upon the
exchange, depending upon the cost or other basis of shares redeemed. Before
exchanging shares, investors should read the current prospectus describing the
shares to be acquired. The Fund reserves the right to modify or discontinue
exchange privileges upon 60 days' prior notice to shareholders.
- --------------------------------------------------------------------------------
Redemption of Shares
- --------------------------------------------------------------------------------
The Fund is required to redeem the shares of the Fund tendered to it, as
described below, at a redemption price equal to the net asset value per share
next determined after receipt of a written request in proper form at no charge
other than any applicable CDSC. Redemption requests received after the close of
regular trading on the NYSE are priced at the net asset value next determined.
If a shareholder holds shares in more than one Class, any request for
redemption must specify the Class being redeemed. In the event of a failure to
specify which Class, or if the investor owns fewer shares of the Class than
specified, the redemption request will be delayed until the Transfer Agent
receives further instructions from Salomon Smith Barney, or if the shareholder's
account is not with Salomon Smith Barney, from the shareholder directly. The
redemption proceeds will be remitted on or before the third business day
following receipt of proper tender, except on any days on which the NYSE is
closed or as permitted under the 1940 Act in extraordinary circumstances.
Generally, if the redemption proceeds are remitted to a Salomon Smith Barney
brokerage account, these funds will not be invested for the shareholder's
benefit without specific instruction and Salomon Smith Barney will benefit from
the use of temporarily uninvested funds. Redemption proceeds for shares
purchased by check, other than a certified or official bank check, will be
remitted upon clearance of the check, which may take up to ten days or more.
Shares held by Salomon Smith Barney as custodian must be redeemed by
submitting a written request to a Salomon Smith Barney Financial Consultant.
Shares other than those held by Salomon Smith Barney as custodian may be
39
<PAGE>
- --------------------------------------------------------------------------------
Redemption of Shares (continued)
- --------------------------------------------------------------------------------
redeemed through an investor's Financial Consultant, Introducing Broker or
dealer in the selling group or by submitting a written request for redemption
to:
Smith Barney Adjustable Rate Government Income Fund
Class A, B or I (please specify)
c/o First Data Investor Services Group
P.O. Box 5128
Boston, Massachusetts 01581-5128
A written redemption request must (a) state the Class and number or dollar
amount of shares to be redeemed, (b) identify the shareholder's account number
and (c) be signed by each registered owner exactly as the shares are registered.
If the shares to be redeemed were issued in certificate form, the certificates
must be endorsed for transfer (or be accompanied by an endorsed stock power) and
must be submitted by First Data together with the redemption request. Any
signature appearing on a share certificate, stock power or written redemption
request in excess of $10,000 must be guaranteed by an eligible guarantor
institution such as a domestic bank, savings and loan institution, domestic
credit union, member bank of the Federal Reserve System or member firm of a
national securities exchange. Written redemption requests of $10,000 or less do
not require a signature guarantee unless more than one such redemption request
is made in any 10-day period. Redemption proceeds will be mailed to an
investor's address of record. The Transfer Agent may require additional
supporting documents for redemptions made by corporations, executors,
administrators, trustees or guardians. A redemption request will not be deemed
properly received until the Transfer Agent receives all required documents in
proper form.
TELEPHONE REDEMPTION AND EXCHANGE PROGRAM
Shareholders who do not have a Salomon Smith Barney brokerage account may
be eligible to redeem and exchange Fund shares by telephone. To determine if a
shareholder is entitled to participate in this program, he or she should contact
the Transfer Agent at 1-800-451-2010. Once eligibility is confirmed, the
shareholder must complete and return a Telephone/Wire Authorization Form, along
with a signature guarantee that will be provided by the Transfer Agent upon
request. (Alternatively, an investor may authorize telephone redemptions on the
new account application with the applicant's signature guarantee when making
his/her initial investment to the Fund.)
Redemptions. Redemption requests of up to $10,000 of any class or classes
of the Fund's shares may be made by eligible shareholders by calling First Data
at 1-800-451-2010. Such requests may be made between 9:00 a.m. and 4:00 p.m.
(New York City time) on any day the NYSE is open. Redemption requests received
after the close of regular trading on the NYSE are priced at the net asset value
next determined. Redemption of shares (i) by retirement plans or (ii) for which
certificates have been issued are not permitted under this program.
40
<PAGE>
- --------------------------------------------------------------------------------
Redemption of Shares (continued)
- --------------------------------------------------------------------------------
A shareholder will have the option of having the redemption proceeds
mailed to his/her address of record or wired to a bank account predesignated by
the shareholder. Generally, redemption proceeds will be mailed or wired, as the
case may be, on the next business day following the redemption request. In order
to use the wire procedures, the bank receiving the proceeds must be a member of
the Federal Reserve System or have a correspondent relationship with a member
bank. The Fund reserves the right to charge shareholders a nominal fee for each
wire redemption. Such charges, if any, will be assessed against the
shareholder's account from which shares were redeemed. In order to change the
bank account designated to receive redemption proceeds, a shareholder must
complete a new Telephone/ Wire Authorization Form and, for the protection of the
shareholder's assets, will be required to provide a signature guarantee and
certain other documentation.
Exchanges. Eligible shareholders may make exchanges by telephone if the
account registration from the Fund being acquired is identical to the
registration of the shares of the Fund exchanged. Such exchange request may be
made by calling the Transfer Agent at 1-800-451-2010 between 9:00 a.m. and 4:00
p.m. (New York time) on any day on which the NYSE is open. Exchange requests
received after the close of regular trading on the NYSE are processed at the net
asset value next determined.
Additional Information regarding Telephone Redemption and Exchange
Program. Neither the Fund nor its agents will be liable for following
instructions communicated by telephone that are reasonably believed to be
genuine. The Fund and its agents will employ procedures designed to verify the
identity of the caller and legitimacy of instructions (for example, a
shareholder's name and account number will be required and phone calls may be
recorded). The Fund reserves the right to suspend, modify or discontinue the
telephone redemption and exchange program or impose a charge for this service at
any time following at least seven (7) days' prior notice to shareholders.
AUTOMATIC CASH WITHDRAWAL PLAN
The Fund offers shareholders an automatic cash withdrawal plan, under
which shareholders who own shares with a value of at least $10,000 may elect to
receive periodic cash payments of at least $50 monthly or quarterly. The
withdrawal plan will be carried over on exchanges between funds or classes of
the Fund. Any applicable CDSC will be waived on amounts withdrawn by a
shareholder that do not exceed 1% per month of the value of the shareholder's
shares subject to the CDSC at the time the withdrawal plan commences. With
respect to withdrawal plans in effect prior to November 7, 1994, any applicable
CDSC will be waived on amounts withdrawn that do not exceed 2.00% per month of
the shareholder shares subject to the CDSC. For further information regarding
the automatic cash withdrawal plan, shareholders should contact their Salomon
Smith Barney Financial Consultant.
41
<PAGE>
- --------------------------------------------------------------------------------
Redemption of Shares (continued)
- --------------------------------------------------------------------------------
CONTINGENT DEFERRED SALES CHARGE, CLASS B SHARES
Class B shares, which may be acquired only upon an exchange with another
fund in the Smith Barney Group of Funds, are subject upon redemption to the
highest CDSC (if any) of the shares from which the exchange or any preceding
exchange was made. A CDSC payable to Salomon Smith Barney is imposed on any
redemption of Class B shares that causes the value of a shareholder's account to
fall below the dollar amount of all payments by the shareholder for the Class B
shares (or any predessor of those shares) that were exchanged for Class B shares
of the Fund ("purchase payments") during the preceding five years. No charge is
imposed to the extent that the net asset value of the Class B shares redeemed
does not exceed (a) the current net asset value of Class B shares purchased
through reinvestment of dividends or capital gains distributions, plus (b) the
current net asset value of Class B shares acquired in an exchange that were
originally purchased more than five years prior to the redemption, plus (c)
increases in the net asset value of the shareholder's Class B shares above the
purchase payments made during the preceding five years.
In circumstances in which the CDSC is imposed, the amount of the charge
will depend on (a) the CDSC schedule applicable to shares of the fund that were
exchanged for the shares being redeemed; and (b) the number of years since the
shareholder made the purchase payment from which the amount is being redeemed. A
redemption of shares acquired in exchange for shares that had been the subject
of two or more exchanges among funds with differing CDSC schedules will be
subject to the highest applicable CDSC schedule. See "Exchange Privilege."
Solely for purposes of determining the number of years since a purchase payment,
all purchase payments during a month will be aggregated and deemed to have been
made on the last day of the preceding Salomon Smith Barney statement month. The
purchase payment from which a redemption is made is assumed to be the earliest
purchase payment from which a full redemption has not already been effected.
Class B shares will automatically convert to Class A shares eight years
after the date they were purchased. For this purpose, the date of purchase of
Class B shares of the Fund refers to the purchase date of the shares given in
exchange for the Class B shares of the Fund.
- --------------------------------------------------------------------------------
Minimum Account Size
- --------------------------------------------------------------------------------
The Fund reserves the right to involuntarily liquidate any shareholder's
account if the aggregate net asset value of the shares held in the Fund is less
than $500. (If a shareholder has more than one account in the Fund, each account
must satisfy the minimum account size.) The Fund, however, will not redeem
shares based solely upon market reductions in net asset value. Before the Fund
exercises such right, shareholders will receive written notice and will be
permitted 60 days to bring accounts up to minimum to avoid involuntary
liquidation.
42
<PAGE>
- --------------------------------------------------------------------------------
Performance
- --------------------------------------------------------------------------------
From time to time the Fund may advertise its total return, average annual
total return and yield in advertisements. In addition, in other types of sales
literature the Fund may include its current dividend return. These figures are
computed separately for the respective Classes of shares of the Fund. These
figures are based on historical earnings and are not intended to indicate future
performance. Total return is computed for a specified period of time assuming
reinvestment of all income dividends and capital gain distributions on the
reinvestment dates at prices calculated as stated in this Prospectus, then
dividing the value of the investment at the end of the period so calculated by
the initial amount invested and subtracting 100%. The standard average annual
total return, as prescribed by the SEC, is derived from this total return, which
provides the ending redeemable value. Such standard total return information may
also be accompanied with nonstandard total return information for differing
periods computed in the same manner but without annualizing the total return.
The yield of the Fund refers to the net investment income earned by investments
in the Fund over a thirty-day period. This net investment income is then
annualized, i.e., the amount of income earned by the investment during that
thirty-day period is assumed to be earned each 30-day period for twelve periods
and is expressed as a percentage of the investments. The yield quotation is
calculated according to a formula prescribed by the SEC to facilitate comparison
with yields quoted by other investment companies. The Fund calculates current
dividend return for each Class by annualizing the most recent distribution and
dividing by the net asset value on the last day of the period for which current
dividend return is presented. The current dividend return for each Class may
vary from time to time depending on market conditions, the composition of its
investment portfolio and operating expenses. These factors and possible
differences in the methods used in calculating current dividend return should be
considered when comparing a Class's current return to yields published for other
investment companies and other investment vehicles. The Fund may also include
comparative performance information in advertising or marketing its shares. Such
performance information may include data from Lipper Analytical Services, Inc.
and other financial publications.
- --------------------------------------------------------------------------------
Management of the Fund
- --------------------------------------------------------------------------------
BOARD OF TRUSTEES
Overall responsibility for management and supervision of the Fund rests
with the Fund's Board of Trustees. The Board of Trustees approves all
significant agreements between the Fund and the companies that furnish services
to the Fund, including agreements with the Fund's distributor, investment
adviser, sub-investment adviser, administrator, custodian and transfer agent.
The day-to-day
43
<PAGE>
- --------------------------------------------------------------------------------
Management of the Fund (continued)
- --------------------------------------------------------------------------------
investment activities of the Fund have been delegated to Strategy Advisers and
BlackRock. The SAI contains background information regarding each Trustee and
executive officer of the Fund.
INVESTMENT ADVISER
Strategy Advisers, located at 388 Greenwich Street, New York, New York
10013, serves as the Fund's investment adviser. In this capacity, Strategy
Advisers, subject to the supervision and direction of the Fund's Board of
Trustees, is generally responsible for furnishing, or causing to be furnished to
the Fund, investment management services. Included among the specific services
provided by Strategy Advisers as investment adviser are: the selection and
compensation of a sub-investment adviser to the Fund; the review of all
purchases and sales of portfolio instruments made by the Fund to assess
compliance with its stated investment objectives and policies; the monitoring of
the selection of brokers and dealers effecting investment transactions on behalf
of the Fund, and the payment of reasonable salaries and expenses of those of the
Fund's officers and employees, and the fees and expenses of those members of the
Fund's Board of Trustees who are directors, officers or employees of Salomon
Smith Barney, MMC or Strategy Advisers. Strategy Advisers provides investment
management, investment advisory and/or administrative services to individual,
institutional and investment company clients that had aggregate assets under
management, as of August 31, 1998, in excess of $4.1 billion. For the fiscal
year ended May 31, 1998, Strategy Advisers received fees in an amount equal to
0.40% of the Fund's average daily net assets.
SUB-INVESTMENT ADVISER -- BLACKROCK
Under the terms of the sub-investment advisory agreement among Strategy
Advisers, the Fund and BlackRock, Strategy Advisers employs BlackRock as the
Fund's sub-investment adviser. BlackRock is an indirect subsidiary of PNC Bank
Corp. In December 1997, PNC Bank announced the strategic consolidation of its
various asset management firms under BlackRock, Inc., which maintains its
principal offices at 345 Park Avenue, New York, New York 10154. BlackRock has
served as investment adviser to fixed income investors in the United States and
overseas, and had assets under management in excess of $119 billion as of June
30, 1998. Some of the other asset management firms, which historically have
provided liquidity management and domestic and international equity management
services, merged with and into BlackRock in March, 1998 as part of the firm's
expansion from a fixed income investment manager to a multi-product investment
adviser.
As the Fund's sub-investment adviser, BlackRock, subject to the
supervision and direction of the Fund's Board of Trustees, and subject to review
by Strategy Advisers, manages the Fund's portfolio in accordance with the
investment objectives and stated policies of the Fund, makes investment
decisions for the Fund, selects the brokers and dealers through which the Fund's
investment transactions are effected and places
44
<PAGE>
- --------------------------------------------------------------------------------
Management of the Fund (continued)
- --------------------------------------------------------------------------------
purchase and sale orders for the Fund's portfolio transactions. BlackRock also
pays the salaries of all officers and employees of the Fund who are employed by
both it and the Fund, provides the Fund with investment officers who are
authorized by the Board of Trustees to execute purchases and sales of securities
and other financial instruments on behalf of the Fund and employs a professional
staff of portfolio managers who draw upon a variety of sources for research
information for the Fund. Strategy Advisers pays BlackRock a fee for services
provided by BlackRock to the Fund that is accrued daily and paid monthly at the
annual rate of 0.20% of the value of the Fund's average daily net assets. The
Fund pays no direct fee to BlackRock.
PORTFOLIO MANAGEMENT
Since the Fund's commencement of operations, June 22, 1992, Keith T.
Anderson, Scott M. Amero and Robert S. Kapito, each a senior officer at
BlackRock, have been responsible for managing the day-to-day investment
activities of the Fund.
Management's discussion and analysis, and additional performance
information regarding the Fund during the fiscal year ended May 31, 1998, is
included in the Annual Report for that period. A copy of the Annual Report may
be obtained upon request and without charge from a Salomon Smith Barney
Financial Consultant or by writing or calling the Fund at the address or phone
number listed on page one of this Prospectus.
ADMINISTRATOR -- MMC
MMC, located at 388 Greenwich Street, New York, New York 10013 serves as
the Fund's administrator. As the Fund's administrator, MMC calculates the net
asset value of the Fund's shares and generally assists in all aspects of the
Fund's administration and operation. MMC provides investment management,
investment advisory and/or administrative services to investment companies that
had aggregate assets under management of approximately $106 billion as of August
31, 1998. MMC receives a fee for services provided to the Fund that is accrued
daily and paid monthly at the annual rate of 0.20% of the value of the Fund's
average daily net assets.
On April 6, 1998, Travelers announced that it had entered into a Merger
Agreement with Citicorp. The transaction was approved by the stockholders of
both Travelers and Citicorp on June 22, 1998 and by the Federal Reserve Board on
September 23, 1998. The companies expect the merger to close on or about October
8, 1998, creating a new entity to be called Citigroup. By approving the merger,
the Federal Reserve Board approved Travelers, as the surviving entity, becoming
a bank holding company subject to regulation under Bank Holding Company Act of
1956 (the "BHCA"), the requirements of the Glass-Seagall Act and certain other
laws and regulations.
The Managers do not believe that compliance with applicable law following
45
<PAGE>
- --------------------------------------------------------------------------------
Management of the Fund (continued)
- --------------------------------------------------------------------------------
the merger of Travelers and Citicorp will have a material adverse effect on
their ability to continue to provide the Fund with the same level of investment
advisory and administration services that it currently receives.Salomon Smith
Barney and the Managers believe that the Managers' services and the shareholder
service activities performed by Salomon Smith Barney are not underwriting and
would be consistent with the Glass-Steagall Act and other relevant federal and
state laws. However, there is little controlling precedent regarding the
performance of the combination of investment advisory, shareholder servicing and
administrative activities by subsidiaries of bank holding companies. If Salomon
Smith Barney and the Managers, or their affiliates, were to be prevented from
acting as the manager, administrator or a shareholder service agent, the Fund
would seek alternative means for obtaining these services. The Fund does not
expect that shareholders would suffer any adverse financial consequences as a
result of any such occurrence.
- --------------------------------------------------------------------------------
Distributor
- --------------------------------------------------------------------------------
Salomon Smith Barney is located at 388 Greenwich Street, New York, New
York 10013. Salomon Smith Barney distributes shares of the Fund as principal
underwriter and as such conducts a continuous offering pursuant to a "best
efforts" arrangement requiring it to take and pay for only such securities as
may be sold to the public. Pursuant to a plan of distribution adopted by the
Fund under Rule 12b-1 under the 1940 Act (the "Plan"), Salomon Smith Barney is
paid a service fee with respect to Class A, Class B and Class I shares of the
Fund at the annual rate of 0.25% of the average daily net asset value of the
respective Class. Salomon Smith Barney is also paid a distribution fee with
respect to Class A and Class B shares at the rate of 0.50% of the average daily
net assets attributable to those Classes. The service fees are used by Salomon
Smith Barney primarily to pay its Financial Consultants for servicing
shareholder accounts, and the distribution fees are used to cover expenses
primarily intended to result in the sale of shares. These expenses include:
advertising expenses; the cost of printing and mailing prospectuses to potential
investors; payments to and expenses of Salomon Smith Barney Financial
Consultants and other persons who provide support services in connection with
the distribution of shares; interest and/or carrying charges; and indirect and
overhead costs of Salomon Smith Barney in connection with the sale of Fund
shares, including lease, utility, communications and sales promotion expenses.
Salomon Smith Barney Financial Consultants may receive different levels of
compensation for selling different Classes of shares.
Payments under the Plan are not tied exclusively to the distribution and
shareholder service expenses actually incurred by Salomon Smith Barney and the
payments may exceed distribution expenses actually incurred. The Fund's Board of
Trustees will evaluate the appropriateness of the Plan and its payment terms on
a
46
<PAGE>
- --------------------------------------------------------------------------------
Distributor (continued)
- --------------------------------------------------------------------------------
continuing basis and in so doing will consider all relevant factors, including
expenses borne by Salomon Smith Barney, amounts received under the Plan and
proceeds of the CDSC.
The Glass-Steagall Act currently prohibits certain financial institutions
from underwriting securities of open-end investment companies, such as the Fund.
Therefore, in connection with the anticipated merger of Travelers and Citicorp
and as a consequence of the anticipated applicability of the BHCA and the
Glass-Steagall Act, the Fund plans to retain the services of a new entity (which
is not otherwise affiliated with Travelers) to act as distributor of the Fund's
shares.
- --------------------------------------------------------------------------------
Additional Information
- --------------------------------------------------------------------------------
The Fund was organized as an unincorporated business trust under the laws
of the Commonwealth of Massachusetts pursuant to a Master Trust Agreement dated
May 7, 1992. On November 5, 1992 the Fund filed an Amended and Restated Master
Trust Agreement (as amended from time to time, the "Trust Agreement"). The Fund
commenced operations on June 22, 1992, and on July 30, 1993 the Fund changed its
name to Smith Barney Shearson Adjustable Rate Government Income Fund. On
November 7, 1994 the Fund changed its name to Smith Barney Adjustable Rate
Government Income Fund.
Each Class of shares represents an identical interest in the Fund's
investment portfolio. As a result, the Classes have the same rights, privileges
and preferences, except with respect to: (a) the designation of each Class; (b)
the effect of the respective sales charges, if any, for each Class; (c) the
expenses allocable exclusively to each Class; (d) voting rights on matters
exclusively affecting a single Class; (e) the exchange privileges of each Class;
and (f) the conversion feature of the Class B shares. The Fund's Board of
Trustees does not anticipate that there will be any conflicts among the
interests of the holders of the different Classes of shares of the Fund. The
Board of Trustees, on an ongoing basis, will consider whether any such conflict
exists and, if so, take appropriate action.
When matters are submitted for shareholder vote, shareholders of each
Class will have one vote for each full share owned and a proportionate,
fractional vote for any fractional share held of that Class. Generally, shares
of the Fund will be voted on a Fund-wide basis except for matters affecting only
the interests of one Class. The Fund does not hold annual shareholder meetings.
There normally will be no meeting of shareholders for the purpose of electing
Trustees unless and until such time as less than a majority of the Trustees
holding office have been elected by shareholders. The Board of Trustees will
call a meeting for any purpose upon written request of shareholders holding at
least 10% of the Fund's outstanding shares. Shareholders of record owning no
less than two-thirds of the outstanding
47
<PAGE>
- --------------------------------------------------------------------------------
Additional Information (continued)
- --------------------------------------------------------------------------------
shares of the Fund may remove a Trustee through a declaration in writing or by
vote cast in person or by proxy at a meeting called for that purpose.
Shareholders who satisfy certain criteria will be assisted by the Fund in
communicating with other shareholders in seeking the holding of the meeting.
PNC Bank, located at 17th and Chestnut Streets, Philadelphia,
Pennsylvania, 19103, serves as custodian of the Fund's investments.
First Data Investor Services Group, Inc., located at Exchange Place,
Boston, Massachusetts 02109, serves as the Fund's transfer agent.
The Fund sends to each of its shareholders a semi-annual report and an
audited annual report, each of which includes a list of the investment
securities held by the Fund at the end of the period covered. In an effort to
reduce the Fund's printing and mailing costs, the Fund plans to consolidate the
mailing of its semi-annual and annual reports by household. This consolidation
means that a household having multiple accounts with the identical address of
record will receive a single copy of each report. In addition, the Fund also
plans to consolidate the mailing of its Prospectus so that a shareholder having
multiple accounts (that is, individual, IRA and/or Self-Employed Retirement Plan
accounts) will receive a single Prospectus annually. When the Fund's annual
report is combined with the Prospectus into a single document, the Fund will
mail the combined document to each shareholder to comply with legal
requirements. Any shareholder who does not want this consolidation to apply to
his or her account should contact his or her Salomon Smith Barney Financial
Consultant or the Transfer Agent.
48
<PAGE>
SMITH BARNEY
A Member of TravelersGroup[LOGO]
Smith Barney
Adjustable Rate
Government
Income Fund
388 Greenwich Street
New York, New York 10013
(212) 723-9218
FD0249 9/98
