<PAGE> 1
ANNUAL REPORT TO
SHAREHOLDERS FOR THE YEAR
ENDED OCTOBER 31, 1999
LONG-TERM INVESTING IN A SHORT-TERM WORLD(SM)
[MORNINGSTAR RATINGS LOGO]
KEMPER STRATEGIC
INCOME FUND
"... Our decision to move from Treasuries and
mortgages into high yield bonds and
emerging market securities was definitely
the right one. ..."
[KEMPER FUNDS LOGO]
<PAGE> 2
CONTENTS
3
ECONOMIC OVERVIEW
5
MANAGEMENT TEAM
6
PERFORMANCE UPDATE
7
TERMS TO KNOW
9
PORTFOLIO STATISTICS
10
PORTFOLIO OF INVESTMENTS
21
FINANCIAL STATEMENTS
23
NOTES TO
FINANCIAL STATEMENTS
28
FINANCIAL HIGHLIGHTS
30
REPORT OF INDEPENDENT AUDITORS
At A GLANCE
KEMPER STRATEGIC INCOME FUND
TOTAL RETURNS
FOR THE YEAR ENDED OCTOBER 31, 1999 (UNADJUSTED FOR ANY SALES CHARGE)
[BAR GRAPH]
<TABLE>
<CAPTION>
KEMPER STRATEGIC INCOME KEMPER STRATEGIC INCOME LIPPER GENERAL BOND
KEMPER STRATEGIC INCOME FUND CLASS A FUND CLASS B FUND CLASS C FUNDS CATEGORY AVERAGE*
- ------------------------------------ ----------------------- ----------------------- -----------------------
<S> <C> <C> <C>
2.43% 1.57% 1.78% 3.54%
</TABLE>
RETURNS AND RANKINGS ARE HISTORICAL AND DO NOT GUARANTEE FUTURE RESULTS.
INVESTMENT RETURNS AND PRINCIPAL VALUE WILL FLUCTUATE SO THAT SHARES, WHEN
REDEEMED, MAY BE WORTH MORE OR LESS THAN ORIGINAL COST.
*LIPPER ANALYTICAL SERVICES, INC. RETURNS AND RANKINGS ARE BASED UPON CHANGES IN
NET ASSET VALUE WITH ALL DIVIDENDS REINVESTED AND DO NOT INCLUDE THE EFFECT OF
SALES CHARGES; IF SALES CHARGES HAD BEEN INCLUDED, RESULTS MAY HAVE BEEN LESS
FAVORABLE.
NET ASSET VALUE
<TABLE>
<CAPTION>
AS OF AS OF
10/31/99 10/31/98
- ---------------------------------------------------------
<S> <C> <C>
KEMPER STRATEGIC INCOME FUND
CLASS A $5.26 $5.60
- ---------------------------------------------------------
KEMPER STRATEGIC INCOME FUND
CLASS B $5.26 $5.59
- ---------------------------------------------------------
KEMPER STRATEGIC INCOME FUND
CLASS C $5.29 $5.62
- ---------------------------------------------------------
</TABLE>
KEMPER STRATEGIC INCOME FUND RANKINGS*
COMPARED WITH ALL OTHER FUNDS IN THE LIPPER GENERAL BOND FUNDS CATEGORY
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C
- ---------------------------------------------------------
<S> <C> <C> <C>
1-YEAR #67 of #82 of #79 of
104 funds 104 funds 104 funds
- ---------------------------------------------------------
5-YEAR #24 of #37 of #32 of
44 funds 44 funds 44 funds
- ---------------------------------------------------------
10-YEAR #1 of 7 funds N/A N/A
- ---------------------------------------------------------
15-YEAR #10 of 26 funds N/A N/A
- ---------------------------------------------------------
20-YEAR #11 of 20 funds N/A N/A
- ---------------------------------------------------------
</TABLE>
DIVIDEND AND YIELD REVIEW
THE FOLLOWING TABLE SHOWS PER SHARE DIVIDEND AND YIELD INFORMATION FOR THE FUND
AS OF OCTOBER 31, 1999.
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C
- ---------------------------------------------------------
<S> <C> <C> <C>
ONE-YEAR INCOME: $0.4815 $0.4241 $0.4365
- ---------------------------------------------------------
OCTOBER DIVIDEND: $0.0365 $0.0317 $0.0331
- ---------------------------------------------------------
ANNUALIZED
DISTRIBUTION RATE+: 8.32% 7.23% 7.51%
- ---------------------------------------------------------
SEC YIELD+: 9.28% 10.02% 9.30%
- ---------------------------------------------------------
</TABLE>
+CURRENT ANNUALIZED DISTRIBUTION RATE IS THE LATEST MONTHLY DIVIDEND SHOWN AS AN
ANNUALIZED PERCENTAGE OF NET ASSET VALUE WHICH DOES NOT INCLUDE SALES CHARGE
ADJUSTMENT ON OCTOBER 31, 1999. DISTRIBUTION RATE SIMPLY MEASURES THE LEVEL OF
DIVIDENDS AND IS NOT A COMPLETE MEASURE OF PERFORMANCE. THE SEC YIELD IS NET
INVESTMENT INCOME PER SHARE EARNED OVER THE MONTH ENDED OCTOBER 31, 1999, SHOWN
AS AN ANNUALIZED PERCENTAGE OF THE MAXIMUM OFFERING PRICE ON THAT DATE. THE SEC
YIELD IS COMPUTED IN ACCORDANCE WITH THE STANDARDIZED METHOD PRESCRIBED BY THE
SECURITIES AND EXCHANGE COMMISSION. YIELDS AND DISTRIBUTION RATES ARE
HISTORICAL AND WILL FLUCTUATE.
THE FUND MAY INVEST IN LOWER-RATED AND NON-RATED SECURITIES WHICH PRESENT
GREATER RISK OF LOSS TO PRINCIPAL AND INTEREST THAN HIGHER-RATED SECURITIES. THE
FUND MAY ALSO INVEST A SIGNIFICANT PORTION OF ITS ASSETS IN FOREIGN SECURITIES
WHICH PRESENT SPECIAL RISKS INCLUDING FLUCTUATING EXCHANGE RATES, GOVERNMENT
REGULATION AND DIFFERENCES IN LIQUIDITY THAT MAY AFFECT THE VOLATILITY OF YOUR
INVESTMENT.
YOUR FUND'S STYLE
[YOUR FUND'S STYLE FIXED STYLE BOX]
MORNINGSTAR INCOME STYLE BOX Source: Data provided by Morningstar, Inc.,
Chicago, IL (312) 696-6000.
The Income Style Box placement is based on a
fund's average effective maturity or
duration and the average credit rating of
the bond portfolio.
PLEASE NOTE THAT STYLE BOXES DO NOT
REPRESENT AN EXACT ASSESSMENT OF RISK AND
DO NOT REPRESENT FUTURE PERFORMANCE. THE
FUND'S PORTFOLIO CHANGES FROM DAY-TO-DAY.
A LONGER-TERM VIEW IS REPRESENTED BY THE
FUND'S MORNINGSTAR CATEGORY, WHICH IS
BASED ON ITS ACTUAL INVESTMENT STYLE AS
MEASURED BY ITS UNDERLYING PORTFOLIO
HOLDINGS OVER THE PAST THREE-YEARS.
MORNINGSTAR HAS PLACED KEMPER STRATEGIC
INCOME FUND IN THE MULTISECTOR BOND
CATEGORY. PLEASE CONSULT THE PROSPECTUS
FOR A DESCRIPTION OF INVESTMENT POLICIES.
<PAGE> 3
SCUDDER KEMPER INVESTMENTS, THE INVESTMENT MANAGER FOR KEMPER FUNDS, IS ONE OF
THE LARGEST AND MOST EXPERIENCED INVESTMENT MANAGEMENT ORGANIZATIONS IN THE
WORLD, MANAGING MORE THAN $290 BILLION IN ASSETS FOR INSTITUTIONAL AND CORPORATE
CLIENTS, RETIREMENT AND PENSION PLANS, INSURANCE COMPANIES, MUTUAL FUND
INVESTORS AND INDIVIDUALS. SCUDDER KEMPER INVESTMENTS OFFERS A FULL RANGE OF
INVESTMENT COUNSEL AND ASSET MANAGEMENT CAPABILITIES BASED ON A COMBINATION OF
PROPRIETARY RESEARCH AND DISCIPLINED, LONG-TERM INVESTMENT STRATEGIES.
ECONOMIC Overview
DEAR KEMPER FUNDS SHAREHOLDER:
Markets have been aquiver about inflation risks. Growth in the United States
continues to exceed most expectations. Labor markets are visibly tight. These
are the precursors to inflation -- everybody knows it.
Everybody except us, that is. We don't buy it in principle, and reality is
proving our theory correct.
First, let's look at growth. The traditional economic view is that growth
causes inflation. Today, we're seeing exactly the opposite: Low inflation is
causing growth. Low inflation keeps interest rates down, and low interest rates
spur investment by making borrowing money cheap. Investment allows companies to
add capacity, keeping competition fierce. As a result, companies aren't raising
prices; they're competing for business by keeping goods attractive and prices
low. That's true for the old economy, in which consumers were buying t-shirts,
and the new economy, in which consumers are buying Internet services. Everywhere
they look, consumers see bargains -- in the malls, in the auto showrooms, at the
mortgage companies.
As for tight labor markets, the traditional economic view is that tight
labor -- i.e., many "help-wanted" signs -- forces companies to pay a premium for
talent. That, in turn, forces companies to raise their prices in order to
protect their profits. And raising prices results in inflation. In contrast, we
believe that tight labor markets won't cause wages to surge. Why?
To start with, temporary agencies have proliferated, accounting for 2.2
percent of jobs, up from 0.5 percent in the early 1980s. They get just the right
amount and type of labor to the right spot at the right time to get the job
done.
Immigration also keeps a lid on wage rates, since it replenishes the work
force much faster than births. Immigration is at its highest level ever; an
amazing 10 percent of the population is foreign-born. Nearly 1 million people
enter the United States legally each year, and another 300,000 just show up.
When they get here, they look for jobs. And often, they're willing to accept
lower-paying jobs than the average citizen.
Finally, and perhaps most importantly, wage rates are kept in check by
executives' intense profit focus. Payroll is a company's biggest expense. When
payroll skyrockets, profits decline -- and that would be bad for a CEO who
promised Wall Street double-digit earnings growth from now to the end of time.
If investors are disappointed in earnings growth, they sell their stock. And
when they sell their stock, the stock options that are an essential part of many
executives' compensation are as valuable as scrap paper.
Supporting our theory are two distinct and important sets of data released in
late October: The Bureau of Economic Analysis released its third-quarter
estimate of gross domestic product (GDP), the value of all goods and services
produced in the United States, and the Bureau of Labor Statistics released its
employment cost index (ECI), which measures what employers pay for their
workers' wages, salaries and benefits.
GDP grew at a 4.8 percent rate in the third quarter, up sharply from the
revised 1.9 percent second-quarter pace and just slightly above the consensus
estimate of 4.7 percent.
At the same time, however, the ECI rose by 0.8 percent in the July-September
period, down from a 1.1 percent increase in the second quarter. The
third-quarter gain also was lower than the 0.9 percent increase forecast by
economists in a Reuters poll. (The report, by the way, is said to be one of the
favorites of Federal Reserve Chairman Alan Greenspan, who uses it as a key
indicator of inflation pressures in the world's largest economy.)
In essence, then, the U.S. economy posted its strongest growth so far this
year in the third quarter, while wage costs remained tame. The combination of
strong consumer demand and the lowest unemployment in a generation just isn't
igniting wage-driven inflation.
Nevertheless, the Federal Reserve Board raised the federal funds rate and the
discount rate by one quarter of a point (0.25%) each at its Nov. 16 meeting. Do
we think the Fed made a bad decision? Actually, no.
First, the Fed has to guard against the possibility that the old relationship
between growth and inflation will soon reassert itself. Even if the Fed shared
our belief that
3
<PAGE> 4
ECONOMIC GUIDEPOSTS
ECONOMIC ACTIVITY IS A KEY INFLUENCE ON INVESTMENT PERFORMANCE AND
SHAREHOLDER DECISION-MAKING. PERIODS OF RECESSION OR BOOM, INFLATION OR
DEFLATION, CREDIT EXPANSION OR CREDIT CRUNCH HAVE A SIGNIFICANT IMPACT ON
MUTUAL FUND PERFORMANCE.
THE FOLLOWING ARE SOME SIGNIFICANT ECONOMIC GUIDEPOSTS AND THEIR
INVESTMENT RATIONALE THAT MAY HELP YOUR INVESTMENT DECISION-MAKING. THE
10-YEAR TREASURY RATE AND THE PRIME RATE ARE PREVAILING INTEREST RATES.
THE OTHER DATA REPORT YEAR-TO-YEAR PERCENTAGE CHANGES.
[BAR GRAPH]
<TABLE>
<CAPTION>
NOW (11/30/99) 6 MONTHS AGO 1 YEAR AGO 2 YEARS AGO
-------------- ------------ ---------- -----------
<S> <C> <C> <C> <C>
10-year Treasury rate (1) 6.00 5.50 4.80 5.90
Prime rate (2) 8.50 7.75 8.00 8.50
Inflation rate (3)* 2.60 2.30 1.50 2.00
The U.S. dollar (4) -0.7 -0.9 1.20 9.40
Capital goods orders (5)* 12.60 2.50 -0.6 6.40
Industrial production (5)* 3.30 2.90 3.50 6.90
Employment growth (6)* 2.10 2.10 2.30 2.70
</TABLE>
(1) FALLING INTEREST RATES IN RECENT YEARS HAVE BEEN A BIG PLUS FOR FINANCIAL
ASSETS.
(2) THE INTEREST RATE THAT COMMERCIAL LENDERS CHARGE THEIR BEST BORROWERS.
(3) INFLATION REDUCES AN INVESTOR'S REAL RETURN. IN THE LAST FIVE YEARS,
INFLATION HAS BEEN AS HIGH AS 6 PERCENT. THE LOW, MODERATE INFLATION OF THE
LAST FEW YEARS HAS MEANT HIGH REAL RETURNS.
(4) CHANGES IN THE EXCHANGE VALUE OF THE DOLLAR IMPACT U.S. EXPORTERS AND THE
VALUE OF U.S. FIRMS' FOREIGN PROFITS.
(5) THESE INFLUENCE CORPORATE PROFITS AND EQUITY PERFORMANCE.
(6) AN INFLUENCE ON FAMILY INCOME AND RETAIL SALES.
*DATA AS OF 10/30/99.
SOURCE: ECONOMICS DEPARTMENT, SCUDDER KEMPER INVESTMENTS, INC.
Economic OVERVIEW
strong consumer demand and low unemployment isn't igniting wage-driven
inflation, the organization wouldn't be doing its job if it didn't act in the
face of any possibility that inflation might reassert itself.
More important, the Fed has to be concerned about the explosion in credit
we've seen during the last year. Almost everyone but Uncle Sam has been loading
up on debt. Companies have borrowed heavily to fund mergers, share buybacks and
new investments. Homeowners have taken out bigger mortgages on their houses and
new home equity loans. Equity shareholders have ramped up their margin debt.
Financial institutions have issued record amounts of new paper to fund their
aggressive growth. The Fed's decision to raise interest rates, thereby making
borrowing costlier, should take the frenzy out of this borrowing binge. That is
a good thing for future financial stability.
Indeed, the early positive market reaction to the Fed's move suggests that the
markets share our views that the Fed made the right decision.
Thank you for your continued support. We appreciate the opportunity to serve
your investment needs.
Sincerely,
Scudder Kemper Investments Economics Group
THE INFORMATION CONTAINED IN THIS PIECE HAS BEEN TAKEN FROM SOURCES BELIEVED TO
BE RELIABLE, BUT THE ACCURACY OF THE INFORMATION IS NOT GUARANTEED. THE OPINIONS
AND FORECASTS EXPRESSED ARE THOSE OF THE ECONOMIC ADVISORS OF SCUDDER KEMPER
INVESTMENTS, INC. AS OF NOVEMBER 18, 1999, AND MAY NOT ACTUALLY COME TO PASS.
THIS INFORMATION IS SUBJECT TO CHANGE. NO PART OF THIS MATERIAL IS INTENDED AS
AN INVESTMENT RECOMMENDATION.
TO OBTAIN A KEMPER FUNDS PROSPECTUS, DOWNLOAD ONE FROM WWW.KEMPER.COM, TALK TO
YOUR FINANCIAL REPRESENTATIVE OR CALL SHAREHOLDER SERVICES AT (800) 621-1048.
THE PROSPECTUS CONTAINS MORE COMPLETE INFORMATION, INCLUDING MANAGEMENT FEES AND
EXPENSES. PLEASE READ IT CAREFULLY BEFORE YOU INVEST OR SEND MONEY.
4
<PAGE> 5
MANAGEMENT TEAM
KEMPER STRATEGIC INCOME FUND
PORTFOLIO MANAGEMENT TEAM
[J. PATRICK BEIMFORD, JR. PHOTO]
J. PATRICK BEIMFORD, JR., JOINED SCUDDER KEMPER INVESTMENTS, INC. IN 1976 AND IS
A MANAGING DIRECTOR AND LEAD PORTFOLIO MANAGER OF KEMPER STRATEGIC INCOME FUND.
BEIMFORD RECEIVED A BACHELOR OF SCIENCE DEGREE IN INDUSTRIAL MANAGEMENT FROM
PURDUE UNIVERSITY AND EARNED AN M.B.A. FROM THE UNIVERSITY OF CHICAGO.
[ROBERT CESSINE PHOTO]
ROBERT CESSINE IS A MANAGING DIRECTOR OF SCUDDER KEMPER INVESTMENTS AND
PORTFOLIO MANAGER OF KEMPER STRATEGIC INCOME FUND. HE JOINED THE COMPANY IN
1993. CESSINE RECEIVED A B.S. AND M.S. FROM THE UNIVERSITY OF WISCONSIN.
[DAN DOYLE PHOTO]
DAN DOYLE IS A SENIOR VICE PRESIDENT OF SCUDDER KEMPER INVESTMENTS AND A
PORTFOLIO MANAGER ON KEMPER'S HIGH-YIELD BOND FUNDS. HE HAS BEEN INVOLVED WITH
THE FUNDS IN BOTH RESEARCH AND TRADING SINCE 1986.
[RICHARD VANDENBERG PHOTO]
RICHARD VANDENBERG, WITH MORE THAN 25 YEARS OF INVESTMENT MANAGEMENT EXPERIENCE,
IS A MANAGING DIRECTOR OF SCUDDER KEMPER INVESTMENTS, INC. AND IS LEAD PORTFOLIO
MANAGER OF SCUDDER KEMPER'S FIXED-INCOME GOVERNMENT AND MORTGAGE FUNDS.
[ISABEL SALTZMAN PHOTO]
M. ISABEL SALTZMAN, A MANAGING DIRECTOR OF SCUDDER KEMPER INVESTMENTS, INC., IS
THE SENIOR PORTFOLIO MANAGER FOR THE FIRM'S EMERGING MARKETS BOND GROUP.
SALTZMAN JOINED THE ORGANIZATION IN 1990. SHE RECEIVED A BACHELOR'S DEGREE IN
POLITICAL SCIENCE AND ECONOMICS FROM TUFTS UNIVERSITY AND AN M.I.A. DEGREE FROM
THE SCHOOL OF INTERNATIONAL AFFAIRS, COLUMBIA UNIVERSITY.
THE VIEWS EXPRESSED IN THIS REPORT REFLECT THOSE OF THE PORTFOLIO MANAGERS ONLY
THROUGH THE END OF THE PERIOD OF THE REPORT, AS STATED ON THE COVER. THE
MANAGERS' VIEWS ARE SUBJECT TO CHANGE AT ANY TIME, BASED ON MARKET AND OTHER
CONDITIONS.
5
<PAGE> 6
PERFORMANCE UPDATE
DURING THE 12-MONTH PERIOD ENDED OCTOBER 31, 1999, INVESTORS WITNESSED A NEARLY
UNABATED RISE IN INTEREST RATES. IN THIS SECTION, PAT BEIMFORD, LEAD PORTFOLIO
MANAGER OF KEMPER STRATEGIC INCOME FUND, DISCUSSES THE FORCES BEHIND THE RISE IN
RATES, THE EFFECT IT HAD ON BOND MARKETS, AND HOW THE FUND WAS POSITIONED TO
RESPOND.
Q PAT, COULD YOU PROVIDE SHAREHOLDERS WITH SOME BACKGROUND REGARDING THE
FIXED-INCOME INVESTMENT ENVIRONMENT OVER THE LAST YEAR?
A The actions of the Federal Reserve Board provide a clear framework for how
the year progressed from a fixed-income standpoint.
As the fiscal year began, the Fed cut interest rates three times. As you may
recall, the market last October was in the grip of a "flight to quality" (See
Terms To Know on page 7) brought on by turbulence in international markets.
Russia had defaulted on part of its debt, Asian economies and currency markets
were battered by uncertainty, and the stability of Latin American markets was
coming into question. In addition, European bonds were not as stable an option
as usual, because much of Europe was converting to the euro at year-end. For
nervous investors, about the only safe bet in town was U.S. Treasury bonds (See
Terms To Know on page 7). As a result, money poured into the U.S. Treasury
market, and the demand pushed yields down to historically low levels. In fact,
for much of October 1998, the yield on 30-year U.S. Treasury bonds was actually
below 5 percent for the first time in recent memory.
To help combat the uncertainty and ward off a worsening of the situation, the
Federal Reserve instituted three rate cuts in the last quarter of 1998. The
Fed's plan, in part, was to inject liquidity into the global financial system by
stimulating the U.S. economy - and thereby other economies - and make the yields
on foreign bonds look more attractive in comparison with U.S. securities.
Q DID THE FED'S PLAN WORK?
A Yes, it did. In fact, it worked almost too well. Investors gained
confidence that foreign economies could bring their problems under control, and
assets shifted from the United States to other markets. At the same time, some
investors feared that the Fed's stimulus, which was uncharacteristically applied
during a time of strong U.S. economic growth, would ignite inflation. Both these
factors acted to push 30-year T-bond yields up from 5.08 percent at the end of
October 1998 to 6.25 percent at the end of October 1999.
As the fiscal year came to a close, the Federal Reserve was compelled to put
the brakes on the U.S. economy. In essence, the Fed began rescinding its rate
cuts of last October by raising rates on August 24 and again on September 30. In
October 1999, the Fed changed its bias to tighten, and the market anticipated
that the Fed would raise rates again on November 15.
Q WHAT WAS THE EFFECT OF RISING RATES ON THE BOND MARKETS?
A Because bond prices fall when interest rates rise, these last 12 months
have been a challenging period for bond investors. It's been tough to try to
create positive returns for shareholders when fighting the constant headwind of
rising rates. This difficulty is reflected in the returns of bond indices. Bond
returns varied widely by asset class. Treasuries and high-quality corporate
bonds, which offer relatively low income, couldn't offset falling prices and
thereby fared the worst. For example, the Lehman Long Government Bond index's*
total return for the 12-month period ended October 31, 1999, was -6.10 percent.
High-yield bonds (See Terms To Know on page 7) and emerging-market bonds, which
offer relatively high income and were best able to offset falling prices,
performed best. The Lehman High Yield Bond index* gained 4.34 percent for the
period. Emerging market debt at the beginning of the fiscal year was recovering
from a terrible beating in 1998 and responded spectacularly to the turnaround in
sentiment. The Lipper Emerging Market Debt index* returned 22.55 percent for the
year.
As you can see, bond investors had their work cut out for them this year.
Unless you were willing to risk going 100 percent into risky emerging-market
debt, you struggled to break even.
* THE LEHMAN LONG GOVERNMENT BOND INDEX IS A TOTAL RETURN INDEX CONSIDERED
GENERALLY REPRESENTATIVE OF THE MARKET FOR GOVERNMENT BOND WITH MATURITIES OF
10 YEARS OR MORE. THE LEHMAN HIGH YIELD BOND INDEX IS A TOTAL RETURN INDEX
CONSIDERED GENERALLY REPRESENTATIVE OF THE MARKET FOR BONDS RATED BELOW
INVESTMENT GRADE. THE LIPPER EMERGING MARKET DEBT INDEX IS AN EQUALLY-WEIGHTED
TOTAL RETURN INDEX OF THE LARGEST FUNDS IN LIPPER ANALYTICAL SERVICES'
EMERGING MARKET DEBT FUNDS CATEGORY.
SOURCE IS LIPPER ANALYTICAL SERVICES, INC. INVESTORS CANNOT ACTUALLY INVEST IN
THE INDICES.
Q HOW DID YOU POSITION KEMPER STRATEGIC INCOME FUND GIVEN THESE DIFFICULT
CONDITIONS?
A Despite the uncertainty in the markets as the fiscal year began, we were
reasonably sure of one thing: interest rates weren't going to go much lower.
So, we positioned the fund for a flat-to-rising interest-rate environment.
Generally, that means you look for income. We reduced our exposure to Treasuries
and mortgages, and put those assets to work in higher-income producing segments
of the market: high-yield bonds, foreign-market bonds and emerging markets.
That's basically how the fund has been positioned throughout the fiscal year.
Q HOW DID THAT STRATEGY WORK?
A The results were somewhat mixed. Our decision to move from Treasuries and
mortgages into high-yield bonds and emerging-market securities was definitely
the right one. As you can see from
6
<PAGE> 7
PERFORMANCE UPDATE
the index figures cited, high-yield and emerging-market debt substantially
outperformed Treasuries. Our high-yield picks were fairly successful as well.
Even though the market was choppy, our high-yield issues held their value for
the year overall. Our foreign-market position didn't perform as well as we would
have liked. We weren't comfortable investing heavily in more speculative
emerging-market debt, so we chose to position the fund heavily in euros, the
currency of the new European Economic Union. Our thinking was that Europe was
poised for recovery and that euros would benefit should European economies
rebound. In retrospect, we were a bit early in this move, since economic growth
in Europe just now seems to be gaining strength, and the euro has yet to retrace
its level to where it started the year. That fact has been disappointing, but
we're confident that the euro will soon begin to reflect the growth in Europe.
The bottom line is that the fund's total return finished below the middle of
the pack with its peer group weight. The fund gained 2.43 percent (A shares
unadjusted for sales charge) versus the Lipper Multi-Sector Income Fund Category
Average of 3.54 percent.
Q WHAT'S YOUR OUTLOOK FOR 2000?
A We believe Kemper Strategic Income Fund is very well positioned for the
new year. We are maintaining our present configuration with assets deployed in
three major areas: high-yield bonds, emerging-market bonds and European bonds.
The high-yield market has struggled recently because of a malaise created by
rising rates and an up tick in default rates. However, there are reasons for
optimism. The market's default rate in the third quarter was the lowest this
year. We believe that defaults will drop off significantly in the future, since
most subpar deals have already fallen by the wayside and because the deals done
this year are of substantively higher quality. In addition, if economic growth
in the United States continues at a good pace, it should enable high-yield
issuers to comfortably meet their debt-payment obligations. If interest rates
continue to be steady or to rise, the income offered by these bonds -- and the
good value they represent after a year of flat returns -- should make them very
attractive to investors.
We also continue to have faith in the fund's euro position. The European
region is showing signs of solid growth, and in fact, the EU raised interest
rates at the end of the fiscal year. Inflation has been non existent, and on the
whole, the European bond markets look decidedly more attractive than the United
States.
We expect that emerging markets will continue their recovery. Asia has led the
rebound, and Latin American markets appear ready to follow, so barring a major
negative event, we plan to maintain our emerging-market position.
Longer term, it's also important to keep in mind that the Federal Reserve has
shown its desire to proactively curb inflation at the earliest opportunity. The
rate hikes may be painful near-term, but longer-term they should serve to slow
the economy, stabilize rates, and create a good environment for the domestic
bond market.
In short, while 1999 has been a difficult year for bond investors, we believe
it has laid the foundation for sharply better performance in the year ahead.
TERMS TO KNOW
EASE Occurs when the Federal Reserve Board of Governors changes monetary policy
by decreasing the federal funds rate.
FEDERAL FUNDS (FED FUNDS) The funds that commercial banks are required to keep
on deposit at the Federal Reserve Bank in their district. In order to meet these
reserve requirements, occasionally banks need to borrow funds. These funds are
borrowed from banks that have an excess of the required amount on hand, in what
is called the "Fed funds market." The interest rate on these loans is called the
"Fed funds rate" and is the key money market rate that influences all other
short-term rates.
FEDERAL FUNDS RATE The interest rate that banks charge each other for overnight
loans that are needed to meet reserve requirements. Often considered the most
sensitive indicator of the direction of interest rates.
FLIGHT-TO-QUALITY BUYING A general increase by investors in their allocation to
U.S. Treasuries and other high-quality securities from riskier securities in
time of global economic uncertainty.
HIGH-YIELD BONDS A bond issued by a company, often without a long track record
of sales and earnings or with questionable credit strength and that pays a
higher yield to investors to help compensate for their greater risk of loss to
principal and interest than higher quality bonds. High-yield bonds carry a
credit rating of BB or lower from either Moody's or Standard & Poor's
bond-rating services and are considered to be "below investment grade" by these
rating agencies. Such bonds may also be unrated.
U.S. TREASURY A debt security issued by the U.S. Treasury, such as a Treasury
bill, Treasury bond or Treasury note. Treasuries are considered the safest of
all securities. Their safety rests in the power of the U.S. government to obtain
tax revenues to repay its obligations, and in its historical record of always
having done so.
7
<PAGE> 8
PERFORMANCE UPDATE
AVERAGE ANNUAL TOTAL RETURNS*
FOR PERIODS ENDED OCTOBER 31, 1999 (ADJUSTED FOR THE MAXIMUM SALES CHARGE)
<TABLE>
<CAPTION>
1-YEAR 5-YEAR 10-YEAR LIFE OF CLASS
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
KEMPER STRATEGIC INCOME FUND CLASS A -2.12% 5.94% 9.49% 9.60% (since 6/23/77)
.....................................................................................................
KEMPER STRATEGIC INCOME FUND CLASS B -1.25 5.75 N/A 5.36 (since 5/31/94)
.....................................................................................................
KEMPER STRATEGIC INCOME FUND CLASS C 1.78 6.05 N/A 5.68 (since 5/31/94)
.....................................................................................................
</TABLE>
[LINE GRAPH]
KEMPER STRATEGIC INCOME FUND CLASS A
Growth of an assumed $10,000 investment in Class A
shares from 6/30/77 to 10/31/99
<TABLE>
<CAPTION>
LEHMAN BROTHERS
KEMPER STRATEGIC INCOME GOVERNMENT/CORPORATE
FUND CLASS A1 INDEX+ CONSUMER PRICE INDEX++
----------------------- -------------------- ----------------------
<S> <C> <C> <C>
6/30/77 9550.00 10000.00 10000.00
9564.00 10077.00 10237.00
10092.00 10196.00 11161.00
11833.00 10431.00 12646.00
14806.00 10751.00 14214.00
15208.00 11531.00 15484.00
17570.00 15116.00 16084.00
12/31/83 20471.00 16325.00 16694.00
21646.00 18776.00 17354.00
24960.00 22776.00 18009.00
25640.00 26334.00 18212.00
23588.00 26938.00 19016.00
27755.00 28980.00 19850.00
29954.00 33106.00 20773.00
12/31/90 26166.00 35848.00 22041.00
39676.00 41629.00 22717.00
46792.00 44785.00 23369.00
56568.00 49725.00 24018.00
54369.00 47980.00 24661.00
65068.00 57213.00 25269.00
70649.00 58874.00 26127.00
76504.00 64619.00 26572.00
79402.00 70750.00 27000.00
10/31/99 77628.00 69683.00 27791.00
</TABLE>
[LINE GRAPH]
KEMPER STRATEGIC INCOME FUND CLASS B
Growth of an assumed $10,000 investment in Class B
shares from 5/31/94 to 10/31/99
<TABLE>
<CAPTION>
LEHMAN BROTHERS
KEMPER STRATEGIC INCOME GOVERNMENT/CORPORATE
FUND CLASS B1 INDEX+ CONSUMER PRICE INDEX++
----------------------- -------------------- ----------------------
<S> <C> <C> <C>
5/31/94 10000.00 10000.00 10000.00
9794.00 10063.00 10149.00
12/31/95 11613.00 11999.00 10400.00
12493.00 12347.00 10753.00
12/31/97 13389.00 13552.00 10936.00
13763.00 14838.00 11112.00
10/31/99 13274.00 14615.00 11438.00
</TABLE>
[LINE GRAPH]
KEMPER STRATEGIC INCOME FUND CLASS C
Growth of an assumed $10,000 investment in Class C
shares from 5/31/94 to 10/31/99
<TABLE>
<CAPTION>
LEHMAN BROTHERS
KEMPER STRATEGIC INCOME GOVERNMENT/CORPORATE
FUND CLASS C1 INDEX+ CONSUMER PRICE INDEX++
----------------------- -------------------- ----------------------
<S> <C> <C> <C>
5/31/94 10000.00 10000.00 10000.00
9815.00 10063.00 10149.00
12/31/95 11649.00 11999.00 10400.00
12560.00 12347.00 10753.00
12/31/97 13492.00 13552.00 10936.00
13865.00 14838.00 11112.00
10/31/99 13489.00 14615.00 11438.00
</TABLE>
PAST PERFORMANCE IS NOT A GUARANTEE OF
FUTURE RESULTS. INVESTMENT RETURNS AND
PRINCIPAL VALUES WILL FLUCTUATE SO THAT
SHARES, WHEN REDEEMED, MAY BE WORTH MORE
OR LESS THAN ORIGINAL COST.
*AVERAGE ANNUAL TOTAL RETURN AND TOTAL
RETURN MEASURE NET INVESTMENT INCOME
AND CAPITAL GAIN OR LOSS FROM
PORTFOLIO INVESTMENTS OVER THE PERIODS
SPECIFIED, ASSUMING REINVESTMENT OF
DIVIDENDS AND, WHERE INDICATED,
ADJUSTMENT FOR THE MAXIMUM SALES
CHARGE. THE MAXIMUM SALES CHARGE FOR
CLASS A SHARES IS 4.5%. FOR CLASS B
SHARES ADJUSTMENT FOR THE APPLICABLE
CONTINGENT DEFERRED SALES CHARGE
(CDSC) AS FOLLOWS: 1-YEAR, 3%; 5-YEAR,
1%; SINCE INCEPTION, 0 PERCENT AND FOR
CLASS C SHARES NO ADJUSTMENT FOR SALES
CHARGE. THE MAXIMUM CDSC FOR CLASS B
SHARES IS 4%. FOR CLASS C SHARES,
THERE IS A 1% CDSC ON CERTAIN
REDEMPTIONS WITHIN THE FIRST YEAR OF
PURCHASE. SHARE CLASSES INVEST IN THE
SAME UNDERLYING PORTFOLIO. AVERAGE
ANNUAL TOTAL RETURNS REFLECT
ANNUALIZED CHANGE WHILE TOTAL RETURN
REFLECTS AGGREGATE CHANGE. DURING THE
PERIODS NOTED, SECURITIES PRICES
FLUCTUATED. FOR ADDITIONAL
INFORMATION, SEE THE PROSPECTUS AND
STATEMENT OF ADDITIONAL INFORMATION
AND THE FINANCIAL HIGHLIGHTS AT THE
END OF THIS REPORT.
(1)PERFORMANCE INCLUDES REINVESTMENT OF
DIVIDENDS AND ADJUSTMENT FOR THE
MAXIMUM SALES CHARGE FOR CLASS A
SHARES AND THE CONTINGENT DEFERRED
SALES CHARGE IN EFFECT AT THE END OF
THE PERIOD FOR CLASS B SHARES. IN
COMPARING THE PERFORMANCE OF KEMPER
STRATEGIC INCOME FUND CLASS A SHARES
TO THAT OF THE LEHMAN BROTHERS
GOVERNMENT/CORPORATE BOND INDEX AND
THE CONSUMER PRICE INDEX, YOU SHOULD
ALSO NOTE THAT THE FUND'S
PERFORMANCE REFLECTS THE MAXIMUM
SALES CHARGE, WHILE NO SUCH CHARGES
ARE REFLECTED IN THE PERFORMANCE OF
THE INDICES.
THE FUND MAY INVEST IN LOWER-RATED AND
NON-RATED SECURITIES, WHICH PRESENT
GREATER RISK OF LOSS TO PRINCIPAL AND
INTEREST THAN HIGHER-RATED SECURITIES.
THE FUND MAY ALSO INVEST A SIGNIFICANT
PORTION OF ASSETS IN FOREIGN SECURITIES,
WHICH PRESENT SPECIAL RISKS INCLUDING
FLUCTUATING EXCHANGE RATES, GOVERNMENT
REGULATION AND DIFFERENCES IN LIQUIDITY
THAT MAY AFFECT YOUR INVESTMENT.
+THE LEHMAN BROTHERS GOVERNMENT/
CORPORATE BOND INDEX IS AN UNMANAGED
INDEX COMPRISED OF INTERMEDIATE AND
LONG-TERM GOVERNMENT AND INVESTMENT
GRADE CORPORATE DEBT SECURITIES.
SOURCE IS WIESENBERGER.
++THE CONSUMER PRICE INDEX IS A
STATISTICAL MEASURE OF CHANGE, OVER
TIME, IN THE PRICES OF GOODS AND
SERVICES IN MAJOR EXPENDITURE GROUPS
FOR ALL URBAN CONSUMERS. SOURCE IS
WIESENBERGER.
8
<PAGE> 9
PORTFOLIO STATISTICS
PORTFOLIO COMPOSITION*
<TABLE>
<CAPTION>
ON 10/31/99 ON 10/31/98
<S> <C> <C>
HIGH YIELD CORPORATES 52.0% 50.0%
................................................................................
EMERGING MARKETS -- 4.0
................................................................................
FOREIGN CURRENCY BONDS 43.0 30.0
................................................................................
OTHER 4.5 --
................................................................................
CASH EQUIVALENTS 0.5 16.0
- --------------------------------------------------------------------------------
100% 100%
</TABLE>
[PIE CHART] [PIE CHART]
YEARS TO MATURITY
<TABLE>
<CAPTION>
ON 10/31/99 ON 10/31/98
<S> <C> <C>
1-10 YEARS 83% 71%
................................................................................
11-20 YEARS 11 5
................................................................................
21+ YEARS 6 8
................................................................................
CASH AND EQUIVALENTS -- 16
- --------------------------------------------------------------------------------
100% 100%
</TABLE>
[PIE CHART] [PIE CHART]
AVERAGE MATURITY
<TABLE>
<CAPTION>
ON 10/31/99 ON 10/31/98
<S> <C> <C>
AVERAGE MATURITY 8.6 years 8.7 years
- ---------------------------------------------------------------------------------------------------
</TABLE>
*PORTFOLIO COMPOSITION AND HOLDINGS ARE SUBJECT TO CHANGE.
9
<PAGE> 10
PORTFOLIO OF INVESTMENTS
KEMPER STRATEGIC INCOME FUND
Portfolio of Investments at October 31, 1999
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
MARKET
REPURCHASE AGREEMENTS--0.1% PRINCIPAL AMOUNT(C) VALUE
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(a) Repurchase Agreement with State Street Bank
and Trust Company dated 10/29/1999,
5.200%, due 11/01/1999
(Cost $693) $ 693 $ 693
-----------------------------------------------------------------------------
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
COMMERCIAL PAPER--0.4%
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Federal Home Loan Mortgage Corp.
5.16%, 11/01/1999
(Cost $2,500) 2,500 2,500
-----------------------------------------------------------------------------
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
FOREIGN BONDS--41.9%
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
U.S.$ DENOMINATED--17.7%
Federative Republic of Brazil, Eligible
Interest, Floating Rate Bond, LIBOR plus
.8125%, 6.125%, 04/15/2006 45 37
Federative Republic of Brazil, 9.375%,
04/07/2008 6,250 5,125
Kingdom of Morocco, Restructuring and
Consolidation Agreement, Tranche A,
Floating Rate Bond, LIBOR plus .8125%,
6.063%, 01/01/2009 21,248 18,619
Republic of Brazil, 11.625%, 04/15/2004 2,875 2,760
Republic of Bulgaria, Interest Arrears Bond,
LIBOR plus .8125%, 6.688%, 07/28/2011 36,500 27,831
Republic of Columbia, 8.625%, 04/1/2008 2,150 1,833
Republic of Panama, Past Due Interest Bond,
6.50%, 07/17/2016 4,034 3,025
Republic of Panama, 8.875%, 09/30/2027 13,750 11,103
Republic of Turkey, 12.00%, 12/15/2008 840 851
Republic of Turkey, 12.375%, 06/15/2009 14,700 14,847
Republic of Venezuela, Debt Conversion Bond,
Floating Rate Bond, Series DL, LIBOR plus
.875%, 5.938%, 12/18/2007 6,476 5,202
United Mexican States, 9.875%, 01/15/2007 7,950 7,975
United Mexican States, 10.375%, 02/17/2009 3,550 3,606
United Mexican States, 11.375%, 09/15/2016 10,000 10,665
United Mexican States, 11.500%, 05/15/2026 10,000 11,168
------------------------------------------------------------------------------
124,647
------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------
NON U.S.$--24.2%
Buoni Poliennali Del Tesoro, 6.75%,
02/01/2007 EUR 25,000 28,648
Deutschland Republic, 6.00%, 01/04/2007 DEM 30,166 33,569
Federal Republic of Germany, 5.625%,
01/04/2028 EUR 7,283 7,500
Federal Republic of Germany, 6.00%,
07/04/2007 EUR 64,999 72,394
Kingdom of Spain, 6.00%, 01/31/2008 EUR 26,000 28,585
------------------------------------------------------------------------------
170,696
------------------------------------------------------------------------------
TOTAL FOREIGN BONDS
(Cost $333,042) 295,343
------------------------------------------------------------------------------
</TABLE>
10
<PAGE> 11
PORTFOLIO OF INVESTMENTS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
MARKET
CORPORATE BONDS--56.3% PRINCIPAL AMOUNT(C) VALUE
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CONSUMER DISCRETIONARY--7.4%
AFC Enterprises, 10.25%, 05/15/2007 $ 3,240 $ 3,208
AMF Bowling Worldwide, Inc., Step-up Coupon,
0% to 03/15/2001, 12.25% to 03/15/2006 995 507
AMF Bowling Worldwide, Inc, 10.875%,
03/15/2006 3,950 2,410
Advantica Restaurant Co., 11.25%, 01/15/2008 2,695 2,102
Avis Rent A Car, 11.00%, 05/01/2009 2,210 2,279
Avondale Mills, 10.25%, 05/01/2006 170 138
Boca Resorts Inc., 9.88%, 04/15/2009 2,830 2,660
Carrols Corp., 9.50%, 12/01/2008 270 223
Cinemark USA, Inc., Series D, 9.625%,
08/01/2008 2,000 1,770
Circus Circus Enterprises, Inc., 9.25%,
12/01/2005 1,010 1,013
Cole National Group Inc., 9.875%, 12/31/2006 1,300 1,014
Eldorado Resorts, 10.50%, 08/15/2006 1,120 1,142
Finlay Enterprises, Inc., 9.00%, 05/01/2008 2,050 1,804
Galey & Lord, Inc., 9.125%, 03/01/2008 1,080 238
Guitar Center Management, 11.00%, 07/01/2006 3,057 2,996
Harvey's Casino Resorts, 10.625%, 06/01/2006 2,630 2,696
Hedstrom Corp., 10.00%, 06/01/2007 2,170 1,758
Herff Jones, Inc., 11.00%, 08/15/2005 1,050 1,114
Hines Horticulture, Inc., 11.75%, 10/15/2005 1,748 1,783
Hollywood Entertainment Corp., 10.625%,
08/15/2004 1,030 876
Imperial Home Decor Group, Inc., 11.00%,
03/15/2008 720 122
Iron Age Holdings Corp., Step-up Coupon, 0%
to 05/01/2003, 12.125% to 05/01/2009 570 171
Iron Age Holdings Corp., 9.875%, 05/01/2008 720 554
J. Crew Group, Step-up Coupon, 0% to
10/15/2002, 13.125% to 10/15/2008 5,120 2,355
J. Crew Group, 10.375%, 10/15/2007 2,350 1,974
Krystal Inc., 10.25%, 10/01/2007 2,620 2,581
Mohegan Tribal Gaming Authority, 8.13%,
01/01/2006 20 19
Mohegan Tribal Gaming Authority, 8.75%,
01/01/2009 180 175
National Vision Association, Ltd., 12.75%,
10/15/2005 5,450 1,635
Perkins Finance, L.P., 10.125%, 12/15/2007 1,280 1,274
Phillips-Van Heusen Corp., 9.50%, 05/01/2008 630 573
Pillowtex Corp., 9.00%, 12/15/2007 650 182
Pillowtex Corp., 10.00%, 11/15/2006 80 22
Players International, 10.875%, 04/15/2005 1,585 1,668
Regal Cinemas, Inc., 9.50%, 06/01/2008 860 636
Regal Cinemas, Inc., 8.875%, 12/15/2010 2,140 1,487
Restaurant Co., Step-up Coupon, 0% to
05/15/2003, 11.25% to 05/15/2008 1,480 844
Sealy Mattress Co., Step-up Coupon, 0% to
12/15/2002, 10.875% to 12/15/2007 1,595 1,069
Specialty Retailers, Inc., 8.50%, 07/15/2005 360 259
Specialty Retailers, Inc., 9.00%, 07/15/2007 1,760 1,056
Station Casinos, Inc., 9.75%, 04/15/2007 630 643
Station Casinos, Inc., 10.125%, 03/15/2006 790 815
------------------------------------------------------------------------------
51,845
</TABLE>
11
<PAGE> 12
PORTFOLIO OF INVESTMENTS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
MARKET
PRINCIPAL AMOUNT(C) VALUE
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CONSUMER STAPLES--0.2%
Jafra Cosmetics International, Inc., 11.75%,
05/01/2008 $ 1,435 $ 1,263
------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
HEALTH--1.6%
ALARIS Medical Systems, Inc., Step-up
Coupon, 0% to 08/01/2003, 11.125% to
08/01/2008 4,910 2,087
Abbey Healthcare Group, Inc., 9.50%,
11/01/2002 2,200 2,101
Dade International, Inc., 11.125%,
05/01/2006 1,000 1,035
MEDIQ Inc., 11.00%, 06/01/2008 2,390 765
Magellan Health Services, Inc., 9.00%,
02/15/2008 2,400 2,004
Mariner Post-Acute Network, Inc., Step-up
Coupon, 0% to 11/07/2002, 10.50% to
11/01/2007 5,020 126
Mariner Post-Acute Network, Inc., 10.50%,
08/01/2006 3,520 3,238
Vencor, Inc., 9.875%, 05/01/2005 970 174
------------------------------------------------------------------------------
11,530
- -------------------------------------------------------------------------------------------------------------------------
COMMUNICATIONS--14.0%
21st Century Telecom Group, Inc., Step-up
Coupon, 0% to 02/15/2003, 12.25% to
02/15/2008 3,630 1,615
Allegiance Telecom, Inc., Step-up Coupon, 0%
to 02/15/2003, 11.75% to 02/15/2008 1,520 1,011
Allegiance Telecom, Inc., 12.875%,
05/15/2008 1,750 1,921
American Cellular Corp., 10.50%, 05/15/2008 3,060 3,297
Bresnan Communications Co., Step-up Coupon,
0% to 02/01/2004, 9.25% to 02/01/2009 690 459
Call-Net Enterprises, Inc., Step-up Coupon,
0% to 08/15/2002, 9.27% to 08/15/2007 1,080 691
Call-Net Enterprises, Inc., Step-up Coupon,
0% to 05/15/2004, 10.80% to 05/15/2009 710 394
Call-Net Enterprises, Inc., Step-up Coupon,
0% to 8/15/2003, 8.94% to 08/15/2008 1,080 610
Call-Net Enterprises, Inc., 9.375%,
05/15/2009 600 552
Comunicacion Cellular, S.A., Step-up Coupon,
0% to 09/29/2000, 14.125% to 03/01/2005 160 88
Crown Castle International Corp., Step-up
Coupon, 0% to 11/15/2002, 10.625% to
11/15/2007 3,850 2,772
Dobson Communication Corp., 11.75%,
04/15/2007 1,680 1,781
Econophone Inc., Step-up Coupon, 0% to
02/01/2003, 11.000% to 02/15/2008 530 292
Esprit Telecom Group, PLC, 10.875%,
06/15/2008 800 768
Esprit Telecom Group, PLC, 11.50%,
12/15/2007 2,345 2,298
Global Telesystems Group, 9.875%, 02/15/2005 820 734
ICG Holdings, Inc., Step-up Coupon, 0% to
09/15/2000, 13.50% to 09/15/2005 6,545 5,727
IPC Communications Inc., Step-up Coupon, 0%
to 11/01/2001, 10.875% to 05/01/2008 2,910 2,124
Impsat Corp., 12.375%, 06/15/2008 1,765 1,341
Intermedia Communications of Florida, Inc.,
Step-up Coupon, 0% to 05/15/2001, 12.50%
to 05/15/2006 1,800 1,485
</TABLE>
12
<PAGE> 13
PORTFOLIO OF INVESTMENTS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
MARKET
PRINCIPAL AMOUNT(C) VALUE
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Intermedia Communications of Florida, Inc.,
Step-up Coupon, 0% to 07/15/2002, 11.25%
to 07/15/2007 $ 1,980 $ 1,376
KMC Telecom Holdings, Inc., Step-up Coupon,
0% to 02/15/2003, 12.50% to 02/15/2008 3,480 1,810
KMC Telecom Holdings, Inc., 13.50%,
05/15/2009 320 315
Level 3 Communications, Inc., Step-up
Coupon, 0% to 12/01/2003, 10.50% to
12/01/2008 1,400 819
Level 3 Communications, Inc., 9.125%,
05/01/2008 3,170 2,925
Long Distance Direct Holdings, Inc., 12.25%,
04/15/2008 1,300 676
MGC Communications, 13.00%, 10/01/2004 2,250 2,025
McLeod USA, Inc., Step-up Coupon, 0% to
03/01/2002, 10.50% to 03/01/2007 3,640 2,857
McLeodUSA Inc., 9.25%, 07/15/2007 550 547
McLeodUSA Inc., 9.50%, 11/01/2008 370 374
MetroNet Communications Corp., Step-up
Coupon, 0% to 06/15/2003, 9.95% to
06/15/2008 2,035 1,582
MetroNet Communications Corp., Step-up
Coupon, 0% to 11/01/2002, 10.75% to
11/01/2007 850 697
MetroNet Communications Corp., 10.625%,
11/01/2008 1,150 1,305
MetroNet Communications Corp., 12.00%,
08/15/2007 560 652
Millicom International Cellular, S.A.,
Step-up Coupon, 0% to 06/01/2001, 13.50%
to 06/01/2006 3,850 2,791
Netia Holdings, Step-up Coupon, 0% to
11/01/2001, 11.25% to 11/01/2007 875 543
Netia Holdings, 10.25%, Step-up Coupon, 0%
to 9/1/2002, 10.65% to 11/01/2007 560 476
Nextel Communications Inc., Step-up Coupon,
0% to 02/15/2003, 9.75% 02/15/2008 1,600 1,128
Nextel Communications, Inc., Step-up Coupon,
0% to 9/15/2002, 10.65% to 09/15/2007 1,825 1,369
Nextel Communications, Inc., Step-up Coupon,
0% to 10/31/2002, 9.75% to 10/31/2007 955 683
Nextel Communications, Inc., Step-up Coupon,
0% to 2/15/99, 9.75% to 08/15/2004 2,930 2,981
Nextlink Communications, Inc., Step-up
Coupon, 0% to 04/15/2003, 9.45% to
04/15/2008 930 567
Nextlink Communications, Inc., Step-up
Coupon, 0% to 06/01/2004, 12.25% to
06/01/2009 1,720 1,015
Nextlink Communications, Inc., 10.75%,
11/15/2008 1,550 1,573
Nextlink Communications, Inc., 12.50%,
04/15/2006 2,545 2,710
PTC International Finance, Step-up Coupon,
0% to 07/01/2002, 10.75% to 07/01/2007 8,390 5,789
Pinnacle Holdings, Inc., Step-up Coupon, 0%
to 03/15/2003, 10.00% to 03/15/2008 1,470 882
Price Communications Wireless, 9.125%,
12/15/2006 630 639
</TABLE>
13
<PAGE> 14
PORTFOLIO OF INVESTMENTS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
MARKET
PRINCIPAL AMOUNT(C) VALUE
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Primus Telecommunications Group, 11.25%,
01/15/2009 $ 480 $ 446
Primus Telecommunications Group, 11.75%,
08/01/2004 2,630 2,577
Primus Telecommunications Group, 12.75%,
10/15/2009 1,380 1,366
RCN Corp., Step-up Coupon, 0% to 07/01/2003,
11.00% to 07/01/2008 880 554
RCN Corp., 10.00%, 10/15/2007 100 100
Rogers Cantel, 9.75%, 06/01/2016 460 515
SBA Communications Corp., Step-up Coupon,
0% to 03/01/2003, 12.00% to 03/01/2008 1,610 877
Telecorp PCS, Inc., Step-up Coupon, 0% to
04/01/2004, 11.625% to 4/15/2009 1,700 1,041
Teligent, Inc., Step-up Coupon, 0% to
03/01/2003, 11.50% to 03/01/2008 1,100 578
Teligent, Inc., 11.50%, 12/01/2007 2,100 1,922
TriTel Pcs, Inc., Step-up Coupon, 0% to
05/15/2004, 12.75% to 05/15/2009 930 561
Triton Communications, L.L.C., Step-up
Coupon, 0% to 05/01/2003, 11.00% to
05/01/2008 8,850 6,084
U.S. Xchange, L.L.C., 15.00%, 07/01/2008 1,090 1,090
USA Mobile Communications Holdings, Inc.,
14.00%, 11/01/2004 2,510 1,958
United Pan-Europe Communications, 13.375%,
11/01/2009 1,290 684
Versatel Telecom, 11.875%, 07/15/2009 390 369
Versatel Telecom, 13.25%, 05/15/2008 930 930
Versatel Telecom, 13.25%, 05/15/2008 490 490
Viatel, Inc., Step-up Coupon, 0% to
04/15/2003, 12.50% to 04/15/2008 1,740 970
Viatel, Inc., 11.25%, 04/15/2008 2,980 2,809
Winstar Equipment II, 12.50%, 03/15/2004 1,560 1,607
------------------------------------------------------------------------------
98,594
- ---------------------------------------------------------------------------------------------------------------------------
FINANCIAL--5.4%
Banco Nacional de Desenvolvimiento
Economico e Social, 13.64%, 06/16/2008 12,025 10,401
Banco Nacional de Desenvolvimiento Economico
e Social, 15.22%, 6/16/2008 17,500 15,138
Intertek Finance, PLC, 10.25%, 11/01/2006 2,650 2,491
Kappa Beheer BV, 10.625%, 07/15/2009 7,630 8,199
Spectrasite Holdings, Inc., Step-up Coupon,
0% to 04/01/2004, 11.25% to 04/15/2009 1,070 556
Spectrasite Holdings, Inc., Step-up Coupon,
0% to 07/15/2003, 12.00% to 07/15/2008 2,280 1,300
------------------------------------------------------------------------------
38,085
- ---------------------------------------------------------------------------------------------------------------------------
MEDIA--6.7%
Capstar Broadcasting, Step-up Coupon, 0% to
02/01/2002, 12.75% to 02/01/2009 3,330 2,914
Chancellor Media Co., 9.00%, 10/01/2008 440 450
American Lawyer Media, Inc., Step-up Coupon,
0% to 12/15/2002, 12.25% to 12/15/2008 360 216
Avalon Cable Holdings LLC, Step-up Coupon,
0% to 12/01/2003, 11.875% to 12/01/2008 1,760 1,118
Avalon Cable of Michigan, 9.375%, 12/1/2008 270 271
CSC Holdings, Inc., 8.125%, 08/15/2009 1,370 1,353
CSC Holdings, Inc., 9.25%, 11/01/2005 130 132
CSC Holdings, Inc., 9.875%, 04/01/2023 1,000 1,043
</TABLE>
14
<PAGE> 15
PORTFOLIO OF INVESTMENTS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
MARKET
PRINCIPAL AMOUNT(C) VALUE
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CSC Holdings, Inc., 10.50%, 05/15/2016 $ 1,200 $ 1,299
Charter Communication Holdings LLC, Step-up
Coupon, 0% to 04/01/2004, 9.92% to
04/01/2011 2,230 1,316
Charter Communication Holdings LLC, 8.25%,
04/01/2007 1,340 1,260
Comcast UK Cable Partners, Ltd., Step-up
Coupon 0% to 11/15/2000, 11.20% to
11/15/2007 4,200 3,843
Diamond Cable Communications, PLC, 13.25%,
09/30/2004 2,025 2,182
Diva Systems Corp., Step-up Coupon, 0% to
03/01/2003, 12.625% to 03/01/2008 1,700 455
Echostar DBS Corp., 9.25%, 02/01/2006 940 931
Echostar DBS Corp., 9.38%, 02/01/2009 610 604
Falcon Holding Group, Step-up Coupon, 0% to
04/15/2003, 9.285% to 04/15/2010 1,740 1,246
Frontiervision Holdings, 11.00%, 10/15/2006 1,200 1,278
Frontiervision Holdings, LP, Step-up Coupon,
0% to 09/15/2001, 11.875% to 09/15/2007 2,560 2,189
Interep National Radio Sales, Inc., 10.00%,
07/01/2008 1,070 1,065
Metromedia Fiber Network, Inc., 10.00%,
11/15/2008 1,530 1,507
NTL Communications Corp., Step-up Coupon,
0% to 10/01/2003, 12.375% to 10/01/2008 740 505
NTL, Inc., Step-up Coupon, 0% to 02/01/2001,
10.500% to 02/01/2006 430 375
NTL, Inc., 11.50%, 10/01/2008 2,905 3,152
Outdoor Systems, Inc., 9.375%, 10/15/2006 2,410 2,494
Radio Unica Corp., Step-up Coupon, 0% to
08/01/2002, 11.75% to 08/01/2006 1,180 764
Renaissance Media Group, Step-up Coupon,
0% to 04/15/2003, 10.00% to 04/15/2008 1,000 700
SFX Entertainment, Inc., 9.125%, 02/01/2008 1,565 1,444
SFX Entertainment, Inc., 9.125%, 12/01/2008 1,570 1,448
Sinclair Broadcasting Group, Inc., 8.75%,
12/15/2007 730 668
Star Choice Communications, Inc., 13.00%,
12/15/2005 875 866
TeleWest Communications, PLC, Step-up
Coupon, 0% to 04/15/2004, 9.25% to
04/15/2009 180 110
TeleWest Communications, PLC, Step-up
Coupon, 0% to 10/01/2000, 11.00% to
10/01/2007 2,395 2,167
TeleWest Communications, PLC, 11.25%,
11/01/2008 1,250 1,350
Transwestern Publishing, Step-up Coupon,
0% to 11/15/2002, 11.875% to 11/15/2008 3,100 2,170
Transwestern Publishing, 9.625%, 11/15/2007 1,340 1,296
United International Holdings, Step-up
Coupon, 0% to 02/15/2003, 10.75% to
02/15/2008 1,710 974
------------------------------------------------------------------------------
47,155
</TABLE>
15
<PAGE> 16
PORTFOLIO OF INVESTMENTS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
MARKET
PRINCIPAL AMOUNT(C) VALUE
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
SERVICE INDUSTRIES--2.2%
Buhrmann US Inc., 12.25%, 11/01/2009 $ 1,220 $ 1,208
Coinmach Corp., 11.75%, 11/15/2005 4,370 4,501
ImPac Group, Inc., 10.125%, 03/15/2008 2,370 2,133
Integrated Electrical Services, Inc.,
9.375%, 02/01/2009 1,120 1,081
Kindercare Learning Centers Inc., 9.50%,
02/15/2009 3,260 3,056
La Petite Academy, Inc., 10.00%, 05/15/2008 2,800 2,205
Spincycle, Inc., Step-up Coupon, 0% to
05/01/2001, 12.75% to 05/01/2005 4,010 602
Verio, Inc., 11.25%, 12/01/2008 690 717
------------------------------------------------------------------------------
15,503
- ---------------------------------------------------------------------------------------------------------------------------
DURABLES--1.5%
Accuride Corp., 9.25%, 02/01/2008 760 688
Airxcel, 11.000%, 11/15/2007 3,430 3,396
BE Aerospace, Inc., 9.50%, 11/01/2008 640 608
DeCrane Aircraft Holdings, Inc., 12.000%,
09/30/2008 2,740 2,630
Fairchild Corp., 10.75%, 04/15/2009 1,240 1,066
Transdigm, Inc., 10.375%, 12/01/2008 930 865
United Rentals, Inc., 9.25%, 01/15/2009 1,420 1,296
------------------------------------------------------------------------------
10,549
- ---------------------------------------------------------------------------------------------------------------------------
MANUFACTURING--6.7%
Atlantis Group, Inc., 11.00%, 02/15/2003 1,328 1,328
BPC Holdings Corp., 12.50%, 06/15/2006 2,810 2,585
Berry Plastics Corp., 12.25%, 04/15/2004 505 513
Consolidated Container Capital, Inc.,
10.125%, 07/15/2009 470 474
Consumers International, 10.25%, 04/01/2005 1,220 1,153
Day International Group, Inc., 11.125%,
06/01/2005 2,660 2,710
Doman Industries, Ltd., 8.75%, 03/15/2004 800 624
Eagle-Picher Holdings, Inc., 9.375%,
03/01/2008 2,510 2,146
Foamex, L.P., 13.50%, 08/15/2005 810 770
Fonda Group, 9.50%, 03/01/2007 3,270 2,796
GS Technologies, 12.00%, 09/01/2004 940 498
GS Technologies, 12.25%, 10/01/2005 1,260 643
Gaylord Container Corp., 9.75%, 06/15/2007 1,870 1,739
Gaylord Container Corp., 9.875%, 02/15/2008 2,890 2,514
Golden Northwest Aluminum, Inc., 12.00%,
12/15/2006 620 634
Graham Packaging Co., Step-up Coupon, 0% to
01/15/2003, 10.75% to 01/15/2009 610 392
Grove Holdings LLC, Step-up Coupon, 0% to
05/01/2003, 11.625% to 05/01/2009 260 31
Grove Investors, PIK, 14.50%, 05/01/2010 777 78
Huntsman Package, 11.75%, 12/01/2004 2,100 2,184
Knoll Inc., 10.875%, 03/15/2006 1,638 1,818
Millar Western Forest Products, Ltd.,
9.875%, 05/15/2008 1,070 1,054
Motors and Gears, Inc., 10.75%, 11/15/2006 860 808
Neenah Corp., 11.125%, 05/01/2007 840 775
Plainwell, Inc., 11.00%, 03/01/2008 2,200 1,584
Printpack, Inc., 10.625%, 08/15/2006 1,700 1,551
Riverwood International Corp., 10.25%,
04/01/2006 620 620
Riverwood International Corp., 10.625%,
08/01/2007 615 624
</TABLE>
16
<PAGE> 17
PORTFOLIO OF INVESTMENTS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
MARKET
PRINCIPAL AMOUNT(C) VALUE
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Riverwood International Corp., 10.875%,
04/01/2008 $ 6,125 $ 5,941
SF Holdings Group, Inc., Step-up Coupon, 0%
to 03/15/2003, 12.75% to 03/15/2008 1,380 580
Spinnaker Industries, 10.75%, 10/15/2006 5,290 4,126
Stone Container Corp., 11.50%, 08/15/2006 670 704
Stone Container Corp., 12.25%, 04/01/2002 190 191
Terra Industries, 10.75%, 09/30/2003 1,240 707
Texas Petrochemicals, 11.125%, 07/01/2006 1,370 1,109
U.S. Can Corp., 10.125%, 10/15/2006 1,030 1,040
Venture Holdings, 11.00%, 06/01/2007 160 155
------------------------------------------------------------------------------
47,199
- -------------------------------------------------------------------------------------------------------------------------
TECHNOLOGY--0.9%
Cherokee International Corp., 10.50%,
05/01/2009 600 534
PSINet, Inc., 10.00%, 02/15/2005 430 426
PSINet, Inc., 11.00%, 08/01/2009 2,310 2,356
PSINet, Inc., 11.50%, 11/01/2008 1,290 1,329
Viasystems, Inc., 9.75%, 06/01/2007 2,180 1,744
------------------------------------------------------------------------------
6,389
- -------------------------------------------------------------------------------------------------------------------------
ENERGY--1.4%
Benton Oil & Gas Co., 11.625%, 05/01/2003 2,510 1,807
Chesapeake Energy Corp., 9.625%, 05/01/2005 1,000 945
Continental Resources, Inc., 10.25%,
08/01/2008 3,020 2,522
Key Energy Services, Inc., 14.00%,
01/15/2009 590 634
Ocean Energy, Inc., 9.75%, 10/01/2006 550 567
Ocean Energy, Inc., 10.375%, 10/15/2005 620 651
Pen Holdings, Inc., 9.875%, 06/15/2008 755 713
Pride International, Inc., 10.00%,
06/01/2009 630 627
R&B Falcon Corp., 9.50%, 12/15/2008 790 766
R&B Falcon Corp., 11.00%, 03/15/2006 30 32
RAM Energy, 11.50%, 02/15/2008 600 270
------------------------------------------------------------------------------
9,534
- -------------------------------------------------------------------------------------------------------------------------
METALS & MINERALS--1.8%
Euramax International, PLC, 11.25%,
10/01/2006 3,405 3,405
MMI Products, Inc., 11.25%, 04/15/2007 1,800 1,827
Metal Management, Inc., 10.00%, 05/15/2008 1,570 1,052
Metals USA Inc., 8.625%, 02/15/2008 500 454
Renco Steel Holdings Co., Series B, 10.875%,
02/01/2005 2,180 1,788
Republic Tech International, 13.75%,
07/15/2009 2,780 2,571
Wells Aluminum Corp., 10.125%, 06/01/2005 1,870 1,832
------------------------------------------------------------------------------
12,929
- -------------------------------------------------------------------------------------------------------------------------
CONSTRUCTION--1.6%
Congoleum Corp., 8.625%, 08/01/2008 2,000 1,730
Dimac Corp., 12.50%, 10/01/2008 1,980 970
Forecast Group, L.P., 11.375%, 12/15/2000 1,125 1,117
Fortress Group, 13.75%, 05/15/2003 2,560 1,613
Hovnanian Enterprises, Inc., 9.125%,
05/01/2009 920 842
Hovnanian Enterprises, Inc., 9.75%,
06/01/2005 490 448
Kevco, Inc., 10.375%, 12/01/2007 1,740 696
Nortek Inc., Series A, 8.875%, 08/01/2008 420 395
Nortek, Inc., 9.125%, 09/01/2007 2,390 2,294
Nortek, Inc., 9.875%, 03/01/2004 130 127
</TABLE>
17
<PAGE> 18
PORTFOLIO OF INVESTMENTS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
MARKET
PRINCIPAL AMOUNT(C) VALUE
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Toll Corp., 7.75%, 09/15/2007 $ 180 $ 163
Toll Corp., 8.75%, 11/15/2006 150 146
US Home Corp., 8.875%, 02/15/2009 910 802
------------------------------------------------------------------------------
11,343
- -------------------------------------------------------------------------------------------------------------------------
TRANSPORTATION--0.9%
Petro Stopping Centers, 10.50%, 02/01/2007 2,200 2,112
TFM, S.A. de C.V., 10.25%, 06/15/2007 1,320 1,148
Trans World Airlines, Inc., 11.375%,
03/01/2006 960 403
Transtar Holdings, Inc., Step-up Coupon, 0%
to 12/15/99, 13.375% to 12/15/2003 670 657
Travelcenters America, 10.25%, 04/01/2007 2,180 2,148
------------------------------------------------------------------------------
6,468
- -------------------------------------------------------------------------------------------------------------------------
OTHER--4.0%
Riverside Group, 7.437%, 07/16/2008 30,000 28,099
------------------------------------------------------------------------------
TOTAL CORPORATE BONDS
(Cost $427,443) 396,485
------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
CONVERTIBLE BONDS--0.4%
- -------------------------------------------------------------------------------------------------------------------------
CONSUMER DISCRETIONARY--0.4%
MISCELLANEOUS--0.4%
Corporate Express, Inc., 4.50%, 07/01/2000 2,980 2,935
(Cost $2,826)
------------------------------------------------------------------------------
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
PREFERRED STOCKS--0.8% NUMBER OF SHARES
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
COMMUNICATIONS--0.3%
CELLULAR TELEPHONE--0.2%
Dobson Communications, PIK 975 956
------------------------------------------------------------------------------
TELEPHONE/ COMMUNICATIONS--0.1%
21st Century Telecom Group, Inc. 267 133
Nextel Communications, Inc., PIK 743 758
------------------------------------------------------------------------------
891
- -------------------------------------------------------------------------------------------------------------------------
FINANCIAL--0.2%
REAL ESTATE--0.2%
Crown American Realty Trust 24,970 999
------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
MEDIA--0.2%
BROADCASTING & ENTERTAINMENT--0.2%
Sinclair Capital 13,500 1,350
------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
MANUFACTURING--0.1%
CONTAINERS & PAPER--0%
SF Holdings Group, Inc., PIK 6 18
SF Holdings Group, Inc., PIK 30 90
------------------------------------------------------------------------------
108
MACHINERY/ COMPONENTS--0.1%
Eagle-Picher Holdings, Inc. 180 873
------------------------------------------------------------------------------
</TABLE>
18
<PAGE> 19
PORTFOLIO OF INVESTMENTS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
MARKET
NUMBER OF SHARES VALUE
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
ENERGY--0.0%
OIL & GAS PRODUCTION--0.0%
Clark USA, PIK $ 4,371 $ 240
------------------------------------------------------------------------------
TOTAL PREFERRED STOCKS
(Cost $6,286) 5,417
------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
OTHER--0.1%
- -------------------------------------------------------------------------------------------------------------------------
COMMUNICATIONS--0.1%
TELEPHONE/ COMMUNICATIONS--0.1%
(b) 21st Century Telecom Group, Inc., Warrants
(expire 02/15/2010) 220 33
(b) Econophone, Inc., Warrants (expire
07/15/2007) 1,425 110
(b) Intelcom Group, Inc., Warrants (expire
10/15/2005) 4,026 64
(b) Intermedia Communications of Florida, Inc.,
Warrants (expire 04/15/2008) 1,060 96
(b) KMC Telecom Holdings, Inc., Warrants (expire
04/15/2008) 2,100 8
(b) Long Distance Direct Holdings, Inc.,
Warrants (expire 04/13/2008) 1,300 3
(b) MGC Communications 8,086 222
(b) MetroNet Communications Corp., Warrants
(expire 08/15/2007) 560 48
(b) Primus Telecommunications Group, Warrants
(expire 08/01/2004) 1,000 20
(b) Versatel Telecom, Warrants (expire
05/15/2008) 1,420 206
(b) Viatel, Inc. 4,194 140
------------------------------------------------------------------------------
950
- -------------------------------------------------------------------------------------------------------------------------
FINANCIAL--0%
OTHER FINANCIAL COMPANIES--0%
(b) Ono Finance PLC, Warrants, (expire
05/31/2009) 550 33
------------------------------------------------------------------------------
MEDIA--0%
CABLE TELEVISION--0.0%
(b) Diva Systems Corp., Warrants (expire
03/01/2008) 5,100 41
(b) Star Choice Communications, Inc., Warrants
(expire 12/15/2005) 20,265 50
------------------------------------------------------------------------------
91
- -------------------------------------------------------------------------------------------------------------------------
SERVICE INDUSTRIES--0%
MISCELLANEOUS CONSUMER--0%
(b) Spincycle, Inc., Warrants (expire
05/01/2005) 4,010 0
------------------------------------------------------------------------------
PRINTING/PUBLISHING--0%
(b) American Banknote Corp., Warrants (expire
12/01/2002) 1,300 0
------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
DURABLES--0%
AEROSPACE--0%
(b) Decrane Holdings Co., Warrants (expire
09/30/2008) 2,740 0
------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
MANUFACTURING--0%
CONTAINERS & PAPER--0%
(b) SF Holdings Group, Inc. 3,870 0
------------------------------------------------------------------------------
</TABLE>
19
<PAGE> 20
PORTFOLIO OF INVESTMENTS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
MARKET
NUMBER OF SHARES VALUE
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
ENERGY--0%
OIL/GAS TRANSMISSION--0%
(b) Empire Gas Corp., Warrants (expire
01/01/2001) $ 2,208 $ 0
------------------------------------------------------------------------------
OILFIELD SERVICES--0%
(b) Key Energy Services, Inc., Warrants (expire
01/15/2009) 590 12
------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
CONSTRUCTION--0%
BUILDING MATERIALS--0%
(b) Waxman Industries, Inc., Warrants (expire
06/01/2004) 222,607 7
------------------------------------------------------------------------------
HOMEBUILDING--0%
(b) Capital Pacific Holdings, Warrants (expire
12/31/2049) 4,345 2
------------------------------------------------------------------------------
TOTAL OTHER
(Cost $773) 1,095
------------------------------------------------------------------------------
TOTAL INVESTMENT PORTFOLIO--100%
(Cost $773,563) 704,468
------------------------------------------------------------------------------
</TABLE>
- -------------------------------------------------------------------------------
NOTES TO PORTFOLIO OF INVESTMENTS
- -------------------------------------------------------------------------------
(a) Repurchase agreements are fully collateralized by U.S. Treasury or U.S.
Government agency securities.
(b) Non-income producing security
(c) Principal amount stated in U.S. dollars unless otherwise noted.
CURRENCY ABBREVIATION
DEM Deutschemark
EUR Euro
PIK denotes that interest or dividend is paid in kind.
Based on the cost of investments of $773,730,000 for federal income tax purposes
at October 31, 1999, the aggregate gross unrealized appreciation was $15,172,000
the aggregate gross unrealized depreciation was $84,434,000 and the net
unrealized depreciation on investments was $69,262,000.
The accompanying Notes are an integral part of the Financial Statements.
20
<PAGE> 21
FINANCIAL STATEMENTS
STATEMENT OF ASSETS AND LIABILITIES
October 31, 1999
(IN THOUSANDS)
<TABLE>
<S> <C>
- ------------------------------------------------------------------------
ASSETS
- ------------------------------------------------------------------------
Investments, at value
(Cost: $773,563) $704,468
- ------------------------------------------------------------------------
Cash 864
- ------------------------------------------------------------------------
Foreign currency, at value (Cost: $113) 111
- ------------------------------------------------------------------------
Receivable for:
Investments sold 1,257
- ------------------------------------------------------------------------
Interest 18,147
- ------------------------------------------------------------------------
Fund shares sold 461
- ------------------------------------------------------------------------
TOTAL ASSETS 725,308
- ------------------------------------------------------------------------
- ------------------------------------------------------------------------
LIABILITIES AND NET ASSETS
- ------------------------------------------------------------------------
Payable for:
Investments purchased 2,341
- ------------------------------------------------------------------------
Fund shares redeemed 1,535
- ------------------------------------------------------------------------
Management fee 357
- ------------------------------------------------------------------------
Other accrued expenses 995
- ------------------------------------------------------------------------
Unrealized depreciation on forward currency exchange
contracts 15
- ------------------------------------------------------------------------
Total liabilities 5,243
- ------------------------------------------------------------------------
NET ASSETS $720,065
- ------------------------------------------------------------------------
- ------------------------------------------------------------------------
ANALYSIS OF NET ASSETS
- ------------------------------------------------------------------------
Paid-in capital $861,523
- ------------------------------------------------------------------------
Accumulated net realized gain (loss) on investments and
foreign currency transactions (74,093)
- ------------------------------------------------------------------------
Net unrealized appreciation (depreciation) on
Investments (69,095)
- ------------------------------------------------------------------------
Foreign currency related transactions (53)
- ------------------------------------------------------------------------
Undistributed net investment income 1,783
- ------------------------------------------------------------------------
NET ASSETS APPLICABLE TO SHARES OUTSTANDING $720,065
- ------------------------------------------------------------------------
- ------------------------------------------------------------------------
THE PRICING OF SHARES
- ------------------------------------------------------------------------
CLASS A SHARES
Net asset value and redemption price per share ($492,423 /
93,641 shares outstanding) $5.26
- ------------------------------------------------------------------------
Maximum offering price per share (net asset value, plus
4.71% of net asset value or 4.50% of offering price) $5.51
- ------------------------------------------------------------------------
CLASS B SHARES
Net asset value and redemption price (subject to
contingent deferred sales charge) per share ($198,097 /
37,694 shares outstanding) $5.26
- ------------------------------------------------------------------------
CLASS C SHARES
Net asset value and redemption price (subject to
contingent deferred sales charge) per share ($29,545 /
5,590 shares outstanding) $5.29
- ------------------------------------------------------------------------
</TABLE>
The accompanying Notes are an integral part of the Financial Statements.
21
<PAGE> 22
FINANCIAL STATEMENTS
STATEMENT OF OPERATIONS
Year ended October 31, 1999
(IN THOUSANDS)
<TABLE>
<S> <C>
- ------------------------------------------------------------------------
NET INVESTMENT INCOME
- ------------------------------------------------------------------------
Interest $ 80,756
- ------------------------------------------------------------------------
Dividends 598
- ------------------------------------------------------------------------
81,354
- ------------------------------------------------------------------------
Expenses:
Management fee 4,628
- ------------------------------------------------------------------------
Administrative services fees 1,998
- ------------------------------------------------------------------------
Trustees fees 98
- ------------------------------------------------------------------------
Custodian and transfer agent fees and related expenses 2,414
- ------------------------------------------------------------------------
Auditing 79
- ------------------------------------------------------------------------
Legal 30
- ------------------------------------------------------------------------
Reports to shareholders 280
- ------------------------------------------------------------------------
Distribution services fees 2,104
- ------------------------------------------------------------------------
Other 75
- ------------------------------------------------------------------------
Expenses, before expense reductions 11,706
- ------------------------------------------------------------------------
Expense reductions (105)
- ------------------------------------------------------------------------
Expenses, net 11,601
- ------------------------------------------------------------------------
NET INVESTMENT INCOME 69,753
- ------------------------------------------------------------------------
- ------------------------------------------------------------------------
NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS
- ------------------------------------------------------------------------
Net realized gain (loss) on
Investments (22,745)
- ------------------------------------------------------------------------
Foreign currency related transactions (707)
- ------------------------------------------------------------------------
(23,452)
- ------------------------------------------------------------------------
Change in net unrealized appreciation (depreciation) on
Investments (26,431)
- ------------------------------------------------------------------------
Foreign currency related transactions (53)
- ------------------------------------------------------------------------
(26,484)
- ------------------------------------------------------------------------
Net gain (loss) on investments (49,936)
- ------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 19,817
- ------------------------------------------------------------------------
</TABLE>
STATEMENTS OF CHANGES IN NET ASSETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED OCTOBER 31,
----------------------------
1999 1998
<S> <C> <C>
- --------------------------------------------------------------------------------------------
OPERATIONS, DIVIDENDS AND CAPITAL SHARE ACTIVITY
- --------------------------------------------------------------------------------------------
Net investment income $ 69,753 62,686
- --------------------------------------------------------------------------------------------
Net realized gain (loss) (23,452) 646
- --------------------------------------------------------------------------------------------
Change in net unrealized appreciation (depreciation) (26,484) (55,916)
- --------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations 19,817 7,416
- --------------------------------------------------------------------------------------------
Dividends to shareholders from net investment income (68,638) (63,792)
- --------------------------------------------------------------------------------------------
Net increase (decrease) from capital share transactions (81,642) 45,361
- --------------------------------------------------------------------------------------------
TOTAL INCREASE (DECREASE) IN NET ASSETS (130,463) (11,015)
- --------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------
NET ASSETS
- --------------------------------------------------------------------------------------------
Beginning of year 850,528 861,543
- --------------------------------------------------------------------------------------------
END OF YEAR (including undistributed net investment income
of $1,783 and $1,794, respectively) $ 720,065 850,528
- --------------------------------------------------------------------------------------------
</TABLE>
The accompanying Notes are an integral part of the Financial Statements.
22
<PAGE> 23
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1 DESCRIPTION OF Kemper Strategic Income Fund (the "fund") (formerly
THE FUND known as Kemper Diversified Income Fund) is
registered under the Investment Company Act of
1940, as amended (the "1940 Act"), as an open-end,
diversified management investment company organized
as a Massachusetts business trust.
The fund offers multiple classes of shares. Class A
shares are offered to investors subject to an
initial sales charge. Class B shares are offered
without an initial sales charge but are subject to
higher ongoing expenses than Class A shares and a
contingent deferred sales charge payable upon
certain redemptions. Class B shares automatically
convert to Class A shares six years after issuance.
Class C shares are offered without an initial sales
charge but are subject to higher ongoing expenses
than Class A shares and a contingent deferred sales
charge payable upon certain redemptions within one
year of purchase. Class C shares do not convert
into another class. Class I shares (none sold
through October 31, 1999) are offered to a limited
group of investors, are not subject to initial or
contingent deferred sales charges and generally
have lower ongoing expenses than other classes.
Investment income, realized and unrealized gains
and losses, and certain fund-level expenses and
expense reductions, if any, are borne pro rata on
the basis of relative net assets by the holders of
all classes of shares except that each class bears
certain expenses unique to that class such as
distribution services, shareholder services,
administrative services and certain other class
specific expenses. Differences in class expenses
may result in payment of different per share
dividends by class. All shares of the fund have
equal rights with respect to voting subject to
class specific arrangements.
The fund's financial statements are prepared in
accordance with generally accepted accounting
principles which require the use of management
estimates. The policies described below are
followed consistently by the fund in the
preparation of its financial statements.
- --------------------------------------------------------------------------------
2 SIGNIFICANT
ACCOUNTING POLICIES SECURITY VALUATION. Investments are stated at value
determined as of the close of regular trading on
the New York Stock Exchange. Portfolio debt
securities purchased with an original maturity
greater than sixty days are valued by pricing
agents approved by the officers of the trust, whose
quotations reflect broker/dealer-supplied
valuations and electronic data processing
techniques. If the pricing agents are unable to
provide such quotations, the most recent bid
quotation supplied by a bona fide market maker
shall be used. Money market instruments purchased
with an original maturity of sixty days or less are
valued at amortized cost.
All other securities are valued at their fair value
as determined in good faith by the Valuation
Committee of the Board of Trustees.
FOREIGN CURRENCY TRANSLATIONS. The books and
records of the fund are maintained in U.S. dollars.
Investment securities and other assets and
liabilities denominated in a foreign currency are
translated into U.S. dollars at the prevailing
exchange rates at period end. Purchases and sales
of investment securities, income and expenses are
translated into U.S. dollars at the prevailing
exchange rates on the respective dates of the
transactions.
23
<PAGE> 24
NOTES TO FINANCIAL STATEMENTS
Net realized and unrealized gains and losses on
foreign currency transactions represent net gains
and losses between trade and settlement dates on
securities transactions, the disposition of forward
foreign currency exchange contracts and foreign
currencies, and the difference between the amount
of net investment income accrued and the U.S.
dollar amount actually received. That portion of
both realized and unrealized gains and losses on
investments that results from fluctuations in
foreign currency exchange rates is not separately
disclosed but is included with net realized and
unrealized gains and losses on investment
securities.
REPURCHASE AGREEMENTS. The fund may enter into
repurchase agreements with certain banks and
broker/dealers whereby the fund, through its
custodian or sub-custodian bank, receives delivery
of the underlying securities, the amount of which
at the time of purchase and each subsequent
business day is required to be maintained at such a
level that the market value is equal to at least
the principal amount of the repurchase price plus
accrued interest.
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS. A
forward foreign currency exchange contract (forward
contract) is a commitment to purchase or sell a
foreign currency at the settlement date at a
negotiated rate. During the period, the fund
utilized forward contracts as a hedge against
changes in the exchange rates relating to foreign
currency denominated assets.
Forward contracts are valued at the prevailing
forward exchange rate of the underlying currencies
and unrealized gain/loss is recorded daily. Sales
and purchases of forward contracts having the same
settlement date and broker are offset and any gain
(loss) is realized on the date of offset;
otherwise, gain (loss) is realized on settlement
date. Realized and unrealized gains and losses
which represent the difference between the value of
a forward contract to buy and a forward contract to
sell are included in net realized and unrealized
gain (loss) from foreign currency related
transactions.
Certain risks may arise upon entering into forward
contracts from the potential inability of
counterparties to meet the terms of their
contracts. Additionally, when utilizing forward
contracts to hedge, the fund gives up the
opportunity to profit from favorable exchange rate
movements during the term of the contract.
TAXES. The fund's policy is to comply with the
requirements of the Internal Revenue Code, as
amended, which are applicable to regulated
investment companies and to distribute all of its
taxable income to its shareholders. Accordingly,
the fund paid no federal income taxes and no
federal income tax provision was required. At
October 31, 1999 the fund had a tax basis net loss
carryforward of approximately $73,810,000, which
may be applied against any realized net taxable
gains of each succeeding year until fully utilized
or until October 31, 2002 ($46,845,000), October
31, 2003 ($5,576,000), October 31, 2006
($2,523,000), and October 31, 2007 ($18,866,000),
the respective expiration dates, whichever occurs
first.
DISTRIBUTION OF INCOME AND GAINS. Distributions of
net investment income, if any, are made monthly.
Net realized gains from investment transactions, in
excess of available capital loss carryforwards,
would be taxable to the fund if not distributed,
and, therefore, will be distributed to shareholders
at least annually.
The timing and characterization of certain income
and capital gains distributions are determined
annually in accordance with federal tax regulations
which
24
<PAGE> 25
NOTES TO FINANCIAL STATEMENTS
may differ from generally accepted accounting
principles. As a result, net investment income
(loss) and net realized gain (loss) on investment
transactions for a reporting period may differ
significantly from distributions during such
period. Accordingly, the fund may periodically make
reclassifications among certain of its capital
accounts without impacting the net asset value of
the fund.
INVESTMENT TRANSACTIONS AND INVESTMENT
INCOME. Investment transactions are accounted for
on the trade date. Interest income is recorded on
the accrual basis. Dividend income is recorded on
the ex-dividend date. Realized gains and losses
from investment transactions are recorded on an
identified cost basis.
All discounts are accreted for both tax and
financial reporting purposes.
- --------------------------------------------------------------------------------
3
TRANSACTIONS
WITH AFFILIATES MANAGEMENT AGREEMENT. The fund has a management
agreement with Scudder Kemper Investments, Inc.
(Scudder Kemper) and pays a monthly investment
management fee of 1/12 of the annual rate of .58%
of the first $250 million of average daily net
assets declining to .42% of average daily net
assets in excess of $12.5 billion. The fund
incurred a management fee of $4,628,000 for the
year ended October 31, 1999.
UNDERWRITING AND DISTRIBUTION SERVICES
AGREEMENT. The fund has an underwriting and
distribution services agreement with Kemper
Distributors, Inc. (KDI). Underwriting commissions
paid in connection with the distribution of Class A
shares for the year ended October 31, 1999 are
$175,000.
For services under the distribution services
agreement, the fund pays KDI a fee of .75% of
average daily net assets of the Class B and Class C
shares pursuant to separate Rule 12b-1 plans for
Class B and Class C shares. Pursuant to the
agreement, KDI enters into related selling group
agreements with various firms at various rates for
sales of Class B and Class C shares. In addition,
KDI receives any contingent deferred sales charges
(CDSC) from redemptions of Class B and Class C
shares. Distribution fees and CDSC received by KDI
for the year ended October 31, 1999 are $2,843,000,
of which $158,000 is unpaid at October 31, 1999.
ADMINISTRATIVE SERVICES AGREEMENT. The fund has an
administrative services agreement with KDI. For
providing information and administrative services
to shareholders, the fund pays KDI a fee at an
annual rate of up to .25% of average daily net
assets of each class. KDI in turn has various
agreements with financial services firms that
provide these services and pays these firms based
on assets of fund accounts the firms service.
Administrative services fees (ASF) paid by the fund
to KDI for the year ended October 31, 1999 are
$1,998,000, of which $237,000 is unpaid at October
31, 1999. In addition, $4,000 was paid by KDI to
affiliates.
SHAREHOLDER SERVICES AGREEMENT. Pursuant to a
services agreement with the fund's transfer agent,
Kemper Service Company (KSvC) is the shareholder
service agent of the fund. Under the agreement,
KSvC received shareholder services fees of
$1,741,000 for the year ended October 31, 1999, of
which $502,000 is unpaid at October 31, 1999.
OFFICERS AND TRUSTEES. Certain officers or trustees
of the fund are also officers or directors of
Scudder Kemper. For the year ended October 31,
1999, the fund made no payments to its officers and
incurred trustees' fees of $98,000 to independent
trustees.
25
<PAGE> 26
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
4
INVESTMENT
TRANSACTIONS For the year ended October 31, 1999, investment
transactions (excluding short-term instruments) are
as follows (in thousands):
Purchases $746,877
Proceeds from sales 722,182
- --------------------------------------------------------------------------------
5
CAPITAL SHARE
TRANSACTIONS The following table summarizes the activity in
capital shares of the fund (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED OCTOBER 31,
1999 1998
----------------------- -----------------------
SHARES AMOUNT SHARES AMOUNT
<S> <C> <C> <C> <C>
--------------------------------------------------------------------------------
SHARES SOLD
--------------------------------------------------------------------------------
Class A 13,013 $ 73,179 18,405 $ 111,129
--------------------------------------------------------------------------------
Class B 9,253 51,822 16,699 99,712
--------------------------------------------------------------------------------
Class C 2,857 16,100 3,606 21,649
--------------------------------------------------------------------------------
Class I -- -- 1 2
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SHARES ISSUED IN REINVESTMENT OF DIVIDENDS
--------------------------------------------------------------------------------
Class A 5,305 29,406 4,474 26,626
--------------------------------------------------------------------------------
Class B 2,324 12,890 2,192 13,033
--------------------------------------------------------------------------------
Class C 312 1,739 188 1,122
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SHARES REDEEMED
--------------------------------------------------------------------------------
Class A (29,531) (164,313) (24,547) (147,027)
--------------------------------------------------------------------------------
Class B (15,690) (86,699) (12,394) (74,303)
--------------------------------------------------------------------------------
Class C (2,825) (15,766) (1,105) (6,571)
--------------------------------------------------------------------------------
Class I -- -- (2) (11)
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
CONVERSION OF SHARES
--------------------------------------------------------------------------------
Class A 6,671 37,275 7,838 47,017
--------------------------------------------------------------------------------
Class B (6,683) (37,275) (7,849) (47,017)
--------------------------------------------------------------------------------
NET INCREASE FROM
CAPITAL SHARE TRANSACTIONS $ (81,642) $ 45,361
--------------------------------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
6
LINE OF CREDIT The fund and several Kemper funds (the
"Participants") share in a $750 million revolving
credit facility for temporary or emergency
purposes, including the meeting of redemption
requests that otherwise might require the untimely
disposition of securities. The Participants are
charged an annual commitment fee which is allocated
pro rata among each of the Participants. Interest
is calculated based on the market rates at the time
of the borrowing. The fund may borrow up to a
maximum of 33 percent of its net assets under the
agreement.
- --------------------------------------------------------------------------------
7
EXPENSE OFF-SET
ARRANGEMENTS The fund has entered into an arrangement with its
custodian whereby credits realized as a result of
uninvested cash balances were used to reduce a
portion of the fund's expenses. During the period,
the fund's custodian fees were reduced by $105,000,
under this arrangement.
26
<PAGE> 27
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
8
COMMITMENTS As of October 31, 1999, the fund had entered into
the following forward currency exchange contracts
resulting in net unrealized depreciation of
$15,000.
<TABLE>
<CAPTION>
CONTRACTS TO IN EXCHANGE SETTLEMENT NET UNREALIZED
DELIVER FOR DATE DEPRECIATION
-----------------------------------------------------------------------------
<S> <C> <C> <C>
EUR $7,500,000 USD $7,991,000 7/24/2000 $15,000
</TABLE>
27
<PAGE> 28
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
----------------------------------------
CLASS A
----------------------------------------
YEAR ENDED OCTOBER 31,
----------------------------------------
1999(A) 1998(A) 1997 1996 1995
- -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
- -----------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE
- -----------------------------------------------------------------------------------
Net asset value, beginning of year $5.60 5.96 5.99 5.98 5.77
- -----------------------------------------------------------------------------------
Income from investment operations:
Net investment income .49 .44 .46 .46 .55
- -----------------------------------------------------------------------------------
Net realized and unrealized gain (loss)
on investments and foreign currency (.35) (.35) .01 .12 .16
- -----------------------------------------------------------------------------------
Total from investment operations .14 .09 .47 .58 .71
- -----------------------------------------------------------------------------------
Less distribution from net investment
income .48 .45 .50 .57 .50
- -----------------------------------------------------------------------------------
Net asset value, end of year $5.26 5.60 5.96 5.99 5.98
- -----------------------------------------------------------------------------------
TOTAL RETURN 2.43% 1.28 8.13 10.27 12.90
- -----------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS
- -----------------------------------------------------------------------------------
Expenses, before expense reductions 1.11% 1.04 1.03 1.03 1.09
- -----------------------------------------------------------------------------------
Expenses, net 1.10% 1.04 1.03 1.03 1.09
- -----------------------------------------------------------------------------------
Net investment income 8.80% 7.36 7.68 7.72 9.43
- -----------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
----------------------------------------
CLASS B
----------------------------------------
YEAR ENDED OCTOBER 31,
----------------------------------------
1999(A) 1998(A) 1997 1996 1995
- -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
- -----------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE
- -----------------------------------------------------------------------------------
Net asset value, beginning of year $5.59 5.96 5.99 5.98 5.77
- -----------------------------------------------------------------------------------
Income from investment operations:
Net investment income .43 .38 .40 .41 .49
- -----------------------------------------------------------------------------------
Net realized and unrealized gain (loss) (.34) (.36) .01 .12 .16
- -----------------------------------------------------------------------------------
Total from investment operations .09 .02 .41 .53 .65
- -----------------------------------------------------------------------------------
Less distribution from net investment
income .42 .39 .44 .52 .44
- -----------------------------------------------------------------------------------
Net asset value, end of year $5.26 5.59 5.96 5.99 5.98
- -----------------------------------------------------------------------------------
TOTAL RETURN 1.57% .12 7.13 9.23 11.87
- -----------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS
- -----------------------------------------------------------------------------------
Expenses, before expense reductions 2.06% 2.01 1.98 1.96 2.04
- -----------------------------------------------------------------------------------
Expenses, net 2.05% 2.01 1.98 1.96 2.04
- -----------------------------------------------------------------------------------
Net investment income 7.85% 6.39 6.73 6.79 8.48
- -----------------------------------------------------------------------------------
</TABLE>
28
<PAGE> 29
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
------------------------------------------------
CLASS C
------------------------------------------------
YEAR ENDED OCTOBER 31,
------------------------------------------------
1999(A) 1998(A) 1997 1996 1995
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
- -------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE
- -------------------------------------------------------------------------------------------
Net asset value, beginning of year $5.62 5.99 6.01 6.00 5.79
- -------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income .45 .39 .42 .41 .50
- -------------------------------------------------------------------------------------------
Net realized and unrealized gain (loss) (.34) (.36) .01 .12 .16
- -------------------------------------------------------------------------------------------
Total from investment operations .11 .03 .43 .53 .66
- -------------------------------------------------------------------------------------------
Less distribution from net investment
income .44 .40 .45 .52 .45
- -------------------------------------------------------------------------------------------
Net asset value, end of year $5.29 5.62 5.99 6.01 6.00
- -------------------------------------------------------------------------------------------
TOTAL RETURN 1.78% .28 7.37 9.33 11.95
- -------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS
- -------------------------------------------------------------------------------------------
Expenses, before expense reductions 1.87% 1.84 1.85 1.86 1.86
- -------------------------------------------------------------------------------------------
Expenses, net 1.85% 1.84 1.85 1.86 1.86
- -------------------------------------------------------------------------------------------
Net investment income 8.05% 6.56 6.86 6.89 8.68
- -------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA FOR ALL CLASSES
- -------------------------------------------------------------------------------------------
YEAR ENDED OCTOBER 31,
------------------------------------------------
1999 1998 1997 1996 1995
<S> <C> <C> <C> <C> <C>
Net assets at end of year (in thousands) $720,065 850,528 861,543 778,752 754,222
- -------------------------------------------------------------------------------------------
Portfolio turnover rate 92% 751 347 310 286
- -------------------------------------------------------------------------------------------
</TABLE>
NOTE: Total return does not reflect the effect of any sales charges.
(a) Per share data was determined based on monthly average shares outstanding
during the period.
- --------------------------------------------------------------------------------
TAX INFORMATION
- --------------------------------------------------------------------------------
Please consult a tax adviser if you have questions about federal or state income
tax laws, or on how to prepare your tax returns. If you have specific questions
about your Kemper Fund account, please call 1-800-621-1048.
29
<PAGE> 30
REPORT OF INDEPENDENT AUDITORS
THE BOARD OF TRUSTEES AND SHAREHOLDERS
KEMPER STRATEGIC INCOME FUND
We have audited the accompanying statement of assets and liabilities,
including the portfolio of investments, of Kemper Strategic Income Fund
(formerly known as "Kemper Diversified Income Fund") as of October 31, 1999, the
related statements of operations for the year then ended and changes in net
assets for each of the two years in the period then ended, and the financial
highlights for each of the fiscal periods since 1995. These financial statements
and financial highlights are the responsibility of the fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of investments owned as of
October 31, 1999, by correspondence with the custodian. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of Kemper
Strategic Income Fund at October 31, 1999, the results of its operations for the
year then ended, the changes in its net assets for each of the two years in the
period then ended, and the financial highlights for each of the fiscal periods
since 1995, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Chicago, Illinois
December 20, 1999
30
<PAGE> 31
NOTES
31
<PAGE> 32
TRUSTEES & OFFICERS
TRUSTEES OFFICERS
JOHN W. BALLANTINE MARK S. CASADY MAUREEN E. KANE
Trustee President Assistant Secretary
LEWIS A. BURNHAM PHILIP J. COLLORA CAROLINE PEARSON
Trustee Vice President and Assistant Secretary
Secretary
DONALD L. DUNAWAY BRENDA LYONS
Trustee JOHN R. HEBBLE Assistant Treasurer
Treasurer
ROBERT B. HOFFMAN
Trustee J. PATRICK BEIMFORD, JR.
Vice President
DONALD R. JONES
Trustee ANN M. MCCREARY
Vice President
THOMAS W. LITTAUER
Trustee and Vice President ROBERT C. PECK, JR.
Vice President
SHIRLEY D. PETERSON
Trustee KATHRYN L. QUIRK
Vice President
CORNELIA M. SMALL
Trustee LINDA J. WONDRACK
Vice President
WILLIAM P. SOMMERS
Trustee
- --------------------------------------------------------------------------------
LEGAL COUNSEL VEDDER, PRICE KAUFMAN & KAMMHOLZ
222 North LaSalle Street
Chicago, IL 60601
- --------------------------------------------------------------------------------
SHAREHOLDER KEMPER SERVICE COMPANY
SERVICE AGENT P.O. Box 219557
Kansas, City, MO 64121
- --------------------------------------------------------------------------------
TRANSFER AGENT INVESTORS FIDUCIARY TRUST COMPANY
801 Pennsylvania Avenue
Kansas City, MO 64105
- --------------------------------------------------------------------------------
INDEPENDENT AUDITORS ERNST & YOUNG LLP
233 South Wacker Drive
Chicago, IL 60606
- --------------------------------------------------------------------------------
CUSTODIAN STATE STREET BANK AND TRUST COMPANY
225 Franklin Street
Boston, MA 02109
- --------------------------------------------------------------------------------
PRINCIPAL UNDERWRITER KEMPER DISTRIBUTORS, INC.
222 South Riverside Plaza
Chicago, IL 60606-5808
www.kemper.com
[KEMPER FUNDS]
LOGO Long-term investing in a short-term world(SM)
Printed on recycled paper in the U.S.A.
This report is not to be distributed unless preceded
or accompanied by a Kemper Income funds prospectus.
KSIF - 2 (12/23/99) 1096650
