FPA CAPITAL FUND INC, 497, 1999-08-02

FPA CAPITAL FUND INC
497, 1999-08-02

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- - FPA Capital Fund, Inc. -
- - -

PROSPECTUS

FPA Capital Fund, Inc.
seeks long-term capital
growth. Current income is
a factor, but a secondary
consideration. The Fund's
investment adviser, First
Pacific Advisors, Inc.,
generally invests the
Fund's assets in common
stocks and other
securities which it
believes have the
potential to increase in
market value. Fund shares
are presently offered for
sale only to existing
shareholders and to
directors, officers and
employees of the Fund, the
Adviser, and affiliated
companies.
THE SECURITIES AND
EXCHANGE COMMISSION HAS
NOT APPROVED OR
DISAPPROVED THESE
SECURITIES OR PASSED UPON
THE ACCURACY OR ADEQUACY
OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE
CONTRARY IS A CRIMINAL
OFFENSE.

AUGUST 2, 1999

[LOGO]

DISTRIBUTOR:

FPA FUND DISTRIBUTORS, INC.

11400 West Olympic Boulevard, Suite 1200
Los Angeles, CA 90064

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- - -
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FPA CAPITAL FUND, INC.
11400 West Olympic Boulevard, Suite 1200
Los Angeles, California 90064
(310) 473-0225

<TABLE>
<S> <C>
INVESTMENT First Pacific Advisors, Inc.
ADVISER: 11400 W. Olympic Boulevard, Suite 1200
Los Angeles, California 90064

DISTRIBUTOR: FPA Fund Distributors, Inc.
11400 West Olympic Boulevard, Suite 1200
Los Angeles, California 90064
(310) 473-0225
(800) 982-4372 except
Alaska, Hawaii and Puerto Rico

SHAREHOLDER Boston Financial Data
SERVICE AGENT: Services, Inc.
P.O. Box 8115
Boston, Massachusetts 02266-8115
(617) 483-5000
(800) 638-3060 except
Alaska, Hawaii, Massachusetts and
Puerto Rico

CUSTODIAN AND State Street Bank and
TRANSFER AGENT: Trust Company
225 Franklin Street
Boston, Massachusetts 02110
</TABLE>

INQUIRIES CONCERNING TRANSFER OF REGISTRATION, DISTRIBUTIONS, REDEMPTIONS AND
SHAREHOLDER SERVICE SHOULD BE DIRECTED TO THE SHAREHOLDER SERVICE AGENT.
INQUIRIES CONCERNING SALES SHOULD BE DIRECTED TO FPA FUND DISTRIBUTORS, INC.

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
<S> <C>
Risk/Return Summary........................................................................................ 3
Investment Results......................................................................................... 5
Fees and Expenses of the Fund.............................................................................. 6
Investment Objectives, Principal Investment Strategies, and Principal Risks................................ 7
Management and Organization................................................................................ 9
Purchase, Pricing and Sale of Shares....................................................................... 9
Exchange of Shares and Shareholder Services................................................................ 13
Dividends, Distributions and Taxes......................................................................... 15
Financial Highlights....................................................................................... 17
</TABLE>

2
<PAGE>
RISK/RETURN SUMMARY

INVESTMENT OBJECTIVES. The Fund's primary investment objective is long-term
growth of capital. Current income is a secondary consideration.

WHO MAY WANT TO INVEST IN THE FUND? You can invest in the Fund only if you are
currently a shareholder. Shares of the Fund are presently offered for sale only
to existing shareholders and to directors, officers and employees of the Fund,
the Adviser, and affiliated companies. The Fund may be appropriate for
investors:

- Seeking long-term growth of capital

- Willing to own shares over the course of a market cycle or longer

PRINCIPAL INVESTMENT STRATEGIES. The Adviser purchases common stocks it
believes undervalued when considering various valuation criteria. The Adviser
deems the following attributes of companies important in its stock selection
process:

- Current as well as future levels of profitability

- Book value

- Replacement cost of assets

- Free cash flow

PRINCIPAL INVESTMENTS. The Fund invests primarily in the common stocks of U.S.
companies in a variety of industries and market segments. The Fund can also
invest in both government and corporate debt securities, preferred stocks and
convertible securities. Up to 15% of the Fund's assets may be invested in
lower-rated or comparable unrated debt securities. No more than 10% of the
Fund's assets will be invested in the securities of foreign issuers.

PRINCIPAL INVESTMENT RISKS. Even though the Adviser attempts to not overpay for
earnings of even the best companies, you can lose money by investing in the Fund
for many reasons, including but not limited to:

- The U.S. or foreign stock market goes down.

- The market favors growth stocks over value stocks or favors companies at a
different capitalization level.

- An adverse event, such as an unfavorable earnings report, depresses the
value of a particular stock.

- Prices of the Fund's foreign securities go down because of unfavorable
changes in foreign currency exchange rates, foreign government actions or
political instability.

- The Adviser's judgments about the attractiveness, value and potential
appreciation of particular stocks prove to be incorrect.

The Adviser's emphasis on a value-oriented investment approach generally results
in the Fund's portfolio being invested primarily in medium or smaller sized
companies. In light of the greater volatility and

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lower trading volume of smaller companies and their securities, the Fund may be
subject to greater risk than that assumed when investing in the equity
securities of larger companies.

Changes in market prices and the assets of the Fund may from time to time cause
more of the Fund's assets to be invested in securities of a single company,
which increases the volatility of the Fund.

If interest rates rise, the market price of fixed-income securities held by the
Fund will fall, and investments in fixed-income securities with longer
maturities generally produce higher yields but are subject to greater market
fluctuation.

To the extent that convertible securities or other debt securities acquired by
the Fund are rated lower than investment grade or are not rated, there is a
greater risk as to the timely repayment of principal and interest.

An investment in the Fund is not a bank deposit and is not insured or guaranteed
by the Federal Deposit Insurance Company or any other government agency, entity
or person.

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INVESTMENT RESULTS

The bar chart and table below provide an indication of the risk of investing in
the Fund. The bar chart shows the Fund's performance for the last ten calendar
years. The table shows how the Fund's average annual returns for one calendar
year, five calendar years and ten calendar years compared with those of a
comparable securities market index. Keep in mind that the Fund's past
performance does not indicate how it will perform in the future.
Here are the Fund's results calculated without a sales
charge on a CALENDAR YEAR basis. (If a sales charge were
included, results would be lower.)

EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC

The year to date return for the Fund as of March 31, 1999 was (2.26)%.

The Fund's highest/lowest QUARTERLY results during this time period were:

<TABLE>
<S> <C> <C>
HIGHEST 36.98% (Quarter ended 03/31/91)
LOWEST (31.24)% (Quarter ended 09/30/90)
</TABLE>

For the periods ended December 31, 1998:

<TABLE>
<CAPTION>
FUND WITH LIPPER
MAXIMUM GROWTH
SALES CHARGE RUSSELL FUND
AVERAGE ANNUAL TOTAL RETURN DEDUCTED 2000 AVERAGE
- ----------------------------------------------------------------------- -------------- ----------- ---------
<S> <C> <C> <C>
One Year............................................................... (6.89)% (2.55)% 22.86%
Five Years............................................................. 18.19 % 11.86% 19.03%
Ten Years.............................................................. 19.25 % 12.92% 17.16%
</TABLE>

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FEES AND EXPENSES OF THE FUND

THE FOLLOWING DESCRIBES THE FEES AND EXPENSES THAT YOU MIGHT PAY IF YOU BUY AND
HOLD SHARES OF THE FUND.

<TABLE>
<S> <C>
SHAREHOLDER FEES
(FEES PAID DIRECTLY FROM YOUR INVESTMENT)
Maximum Sales Load Imposed on Purchases (as a percentage of offering
price).................................................................... 6.50%
Deferred Sales Load (as a percentage of original sales price or redemption
proceeds, as applicable).................................................. *
Redemption Fee (as a percentage of amount redeemed)....................... None**
Exchange Fee.............................................................. $5.00

ANNUAL FUND OPERATING EXPENSES
(EXPENSES THAT ARE DEDUCTED FROM FUND ASSETS)
Management Fees........................................................... 0.67%
Distribution (12b-1) Fees................................................. None
Other Expenses (including financial services)............................. 0.19%
---------
Total Annual Fund Operating Expenses...................................... 0.86%
</TABLE>

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* An account management fee is charged by unaffiliated investment advisers or
broker-dealers to certain accounts entitled to purchase shares without sales
charge.

**Redemptions by wire are subject to a $3.50 charge per wire.

EXAMPLE

This Example is intended to help you compare the cost of investing in the Fund
with the cost of investing in other mutual funds.

The Example assumes you invest $10,000 in the Fund for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Example also assumes that your investment has a 5% return each year and that the
Fund's operating expenses remain the same. Although your actual costs may be
higher or lower, based on these assumptions your costs would be:

<TABLE>
<S> <C>
One year........................................................... $ 732
Three years........................................................ $ 907
Five years......................................................... $ 1,096
Ten years.......................................................... $ 1,642
</TABLE>

6
<PAGE>

INVESTMENT OBJECTIVES, PRINCIPAL INVESTMENT STRATEGIES, AND PRINCIPAL RISKS

INVESTMENT OBJECTIVES. The Fund's primary investment objective is long-term
growth of capital. Providing you current income is a secondary consideration.
The Fund seeks to make your investment grow over the long-term by investing
principally in common stocks the Adviser deems to possess above-average ability
to increase in market value.

PRINCIPAL INVESTMENT STRATEGIES. The Fund's Adviser favors investments in
common stocks it believes undervalued when considering various valuation
criteria. The Adviser deems the following important in its stock selection
process: current as well as future levels of profitability, book value,
replacement cost of assets and free cash flow. The Adviser attempts to lessen
price risk by not overpaying for earnings of even the best companies.
Furthermore, investments tend to be concentrated in areas which are viewed as
temporarily out-of-favor as evidenced by such factors as low price-to-normalized
earnings ratios and price-to-book value ratios. When attractive equity
securities meeting these criteria are scarce, holdings of short-term and
long-term debt securities may be increased.

PRINCIPAL RISKS. Your investment in the Fund is subject to a number of risks
related to principal investment strategies, including the following.

- The Adviser's emphasis on a value-oriented investment approach generally
results in the Fund's portfolio being invested primarily in medium or
smaller sized companies. Smaller companies typically are subject to a
greater degree of change in earnings and business prospects than larger,
more established companies. In addition, securities of smaller companies
are traded in lower volumes than those issued by larger companies and may
be more volatile than those of larger companies. In light of these
characteristics of smaller companies and their securities, the Fund may be
subject to greater risk than that assumed when investing in the equity
securities of larger companies.

- The Adviser's emphasis on a value-oriented investment approach could
result in a portfolio that does not reflect the national economy, differs
significantly from broad market indices and consists of companies
considered by the average investor to be unpopular or unfamiliar.

- Like other investment companies, financial and business organizations
around the world, the Fund could be adversely affected if the computer
systems used by the Adviser and its other major service providers do not
properly process and calculate date-related information and data from and
after January 1, 2000. This is commonly known as the "Year 2000 Issue."
The Adviser has assessed its computer systems and the systems compliance
issues of the Fund's major service providers. The Adviser is taking steps
that it believes are reasonably designed to address the Year 2000 Issue
with respect to the computer systems it uses and has obtained satisfactory
assurances that comparable steps are being taken by the Fund's major
service providers. At this time, however, there can be no assurance that
these steps will be sufficient to address all Year 2000 Issues. The
inability of the Adviser or the Fund's other third party providers to
timely complete all necessary procedures to address the Year 2000 Issue
could have a material adverse effect on the Fund's operations. The Adviser
will continue to monitor the status of, and the Fund's exposure to, this
issue. For the year ended March 31, 1999, the Fund incurred no significant
Year 2000 related expenses and it does not expect to incur significant
Year 2000 expenses in the future. The Adviser

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<PAGE>
is in the process of establishing a contingency plan to address recovery
from unavoided or unavoidable Year 2000 problems, if any, affecting the
Fund.

- The Year 2000 Issue may result in material adverse effects to issuers of
the securities the Fund holds, resulting in decreases in the prices of
equity securities held by the Fund.

- Although the Fund may not invest more than 5% of its total assets in the
securities of any one issuer (except the U.S. Government) at the time of
purchase, changes in market prices and the assets of the Fund may from
time to time cause more than 5% or even 10% of the Fund's assets to be
invested in securities of a single company. Such relative concentration is
likely to increase the volatility of the Fund's net asset value per share.

- The market price of fixed-income securities held by the Fund will rise as
rates fall. Investments in fixed-income securities with longer maturities
generally produce higher yields but are subject to greater market
fluctuation.

- To the extent that convertible securities or other debt securities
acquired by the Fund are rated lower than investment grade or are not
rated, there is a greater risk as to the timely repayment of principal and
interest. Decisions to purchase and sell these securities are based on the
Adviser's evaluation of their investment potential and not on the ratings
assigned by credit agencies. Because investment in lower-rated securities
involves greater investment risk, achievement of the Fund's investment
objective is more dependent on the Adviser's credit analysis than with
respect to the Fund's investments in higher-rated securities. Lower-rated
securities may be more susceptible to real or perceived adverse economic
and competitive industry conditions than investment grade securities. A
projection of an economic downturn, for example, could cause a decline in
the prices of lower-rated securities because the advent of a recession
could lessen the ability of a highly leveraged company to make principal
and interest payments on its debt securities. In addition, the secondary
trading market for lower-rated securities may be less liquid than the
market for higher-rated securities.

- Fund shares could decline in value in response to certain events, such as
changes in markets or economies.

- The prices of equity securities held by the Fund can be affected by events
specifically involving the issuers of these securities.

- The price of debt securities held by the Fund can be affected by changing
interest rates, effective maturities and credit ratings.

- Investing outside the U.S. can also involve additional risks, such as
currency fluctuations or political, social and economic instability.

- For temporary defensive purposes or to meet liquidity needs, the Fund may
take larger than usual positions in cash or high-quality short-term debt
securities (U.S. government or government agency securities, obligations
of domestic banks, prime commercial paper notes and repurchase
agreements). These positions could detract from the achievement of the
Fund's objectives over the short-term.

8
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MANAGEMENT AND ORGANIZATION

DISCONTINUANCE OF SALES TO NEW INVESTORS

The Fund has discontinued indefinitely the sale of its shares to new investors,
except directors, officers and employees of the Fund, the Adviser and affiliated
companies. The Fund continues to accept additional investments from existing
shareholders, and continues to reinvest dividends and capital gains
distributions with respect to the accounts of existing shareholders who elect
such options. The decision to discontinue sales to new investors reflects
management's belief that unrestrained growth in the Fund's net assets might
impair investment flexibility. The Fund may recommence at any time the offering
of shares to new investors if in the Board of Directors' opinion doing so would
be in the best interests of the Fund and its shareholders.

INVESTMENT ADVISER

First Pacific Advisors, Inc. is the Fund's investment adviser. The Adviser,
together with its predecessors, has been in the investment advisory business
since 1954 and has served as the Fund's investment adviser since July 11, 1984.
The Adviser manages assets of approximately $3.2 billion for eight investment
companies, including one closed-end investment company, and 21 institutional
accounts. First Pacific Advisors, Inc. is headquartered at 11400 West Olympic
Boulevard, Suite 1200, Los Angeles, California 90064. The Adviser selects
investments for the Fund, provides administrative services and manages the
Fund's business. The total management fee paid by the Fund, as a percentage of
average net assets, for the previous fiscal year was 0.67%.

PORTFOLIO MANAGER

Robert L. Rodriguez, President of the Fund, and Principal, Chief Investment
Officer and director of the Adviser, is primarily responsible for the day-to-day
management of the Fund's portfolio. Mr. Rodriguez has been the Chief Investment
Officer of the Fund for over fifteen years.

PURCHASE, PRICING AND SALE OF SHARES

PURCHASE AND INVESTMENT MINIMUMS. You can purchase shares, if you fall into one
of the classes of investors described above, by contacting any investment dealer
authorized to sell the Fund's shares. You can use the account information form
for initial purchases. The minimum initial investment is $1,500, and each
subsequent investment must be at least $100. All purchases made by check should
be in U.S. dollars and made payable to the FPA Funds or State Street Bank and
Trust Company. Third party checks will not be accepted. A charge may be imposed
if a check does not clear.

SHARE PRICE. The Fund calculates its share price, also called net asset value,
as of 4:00 p.m. New York time, which is the normal close of trading on the New
York Stock Exchange ("NYSE"), every day the NYSE is open. Share price is rounded
to the nearest cent per share and equals the market value of all portfolio
securities plus other assets, less all liabilities, divided by the number of
Fund shares outstanding. Orders received by dealers before the NYSE closes on
any business day are priced based on the share price for that day if Boston
Financial Data Services, Inc. receives the order prior to its close of business.
Orders received by Boston Financial Data Services, Inc. after such time
generally are priced based on the share price for the next business day.
However, orders received by certain retirement plans

9
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and certain other financial intermediaries before the NYSE closes and
communicated to Boston Financial Data Services, Inc. by 9:30 a.m., Eastern time,
on the following business day are priced at the share price for the prior
business day. Share prices for sales (redemptions) of Fund shares is the first
share price determined after Boston Financial Data Services, Inc. receives a
properly completed request, except that sale orders received by an authorized
dealer, certain retirement plans and certain other financial intermediaries
before the NYSE closes are priced at the closing price for that day if
communicated to Boston Financial Data Services, Inc. within the times specified
above.

SALES CHARGES. The offering price is the share price plus any applicable sales
charge. A sales charge may apply to your purchase. As indicated in the table
below, your sales charge can be reduced for larger purchases. You, your spouse
and the following related people (and their spouses) can combine your investment
to reduce your sales charge: grandparents, parents, siblings, children or
grandchildren; or by the individual, his or her spouse and a trustee or other
fiduciary purchasing securities for related trusts, estates or fiduciary
accounts, including employee benefit plans.

<TABLE>
<CAPTION>
SALES SALES REALLOWED
SIZE OF INVESTMENT CHARGE(1) CHARGE(2) TO DEALERS(2)
- -------------------------------------------------------------------------- ----------- ----------- -------------
<S> <C> <C> <C>
Less than $10,000......................................................... 6.95% 6.50% 6.00%
$10,000 but less than $25,000............................................. 6.38% 6.00% 5.50%
$25,000 but less than $50,000............................................. 5.54% 5.25% 4.75%
$50,000 but less than $100,000............................................ 4.71% 4.50% 4.25%
$100,000 but less than $250,000........................................... 3.90% 3.75% 3.50%
$250,000 but less than $500,000........................................... 2.04% 2.00% 1.75%
$500,000 but less than $1,000,000......................................... 1.01% 1.00% 0.80%
$1,000,000 and over....................................................... 0.00% 0.00% 0.00%
</TABLE>

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(1) As a percentage of net amount invested.

(2) As a percentage of public offering price.

REDUCING YOUR SALES CHARGE

INVESTMENTS IN OTHER FPA FUNDS. To determine the sales charge, you can add the
current value, at offering price, of all presently held shares of the FPA Funds,
which are:

- FPA Capital Fund, Inc. (this Fund, which is currently closed to new
investors)

- FPA New Income, Inc.

- FPA Paramount Fund, Inc.

- FPA Perennial Fund, Inc.

If your holdings of other FPA Funds qualify you for a reduced sales charge, you
must provide information to verify your holdings.

LETTER OF INTENT. A letter of intent will allow you to obtain a reduced sales
charge by aggregating investments made during a thirteen-month period. The value
of all presently held shares of the FPA Funds (see above list) can also be used
to determine the applicable sales charge. The account information form contains
the Letter of Intent that must be signed at the time of initial purchase, or
within

10
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30 days. Each investment made under a Letter of Intent during the period
receives the sales charge for the total investment goal. IF YOU DO NOT REACH
YOUR INVESTMENT GOAL, YOU MUST PAY THE DIFFERENCE BETWEEN THE SALES CHARGES
APPLICABLE TO THE AMOUNT PURCHASED MINUS THOSE ACTUALLY PAID.

PURCHASES NOT SUBJECT TO SALES CHARGE. You and your spouse (and your immediate
relatives) can
purchase shares without a sales charge, if you fall into one of the following
categories and you represent that the shares you purchase are for investment and
will not be resold except through redemption or repurchase by the Fund.
Immediate relatives include grandparents, parents, siblings, children and
grandchildren of a qualified investor, and the spouse of any immediate relative.

(a) current and former directors, officers and employees of the Adviser,
United Asset Management Corporation (the Adviser and FPA Fund
Distributors, Inc. are indirect wholly owned subsidiaries of United
Asset Management Corporation) and its affiliates;

(b) current and former directors, officers and employees of Angeles
Corporation (the former parent of the Adviser) and its affiliates;

(c) current and former directors of, and partners and employees of legal
counsel to, the investment companies advised by the Adviser;

(d) investment advisory clients of the Adviser and pension consultants to
such clients and their directors, officers and employees;

(e) employees (including registered representatives) of a dealer that has a
selling group agreement with FPA Fund Distributors, Inc. and consents to
the purchases;

(f) any employee benefit plan maintained for the benefit of such qualified
investors; and

(g) directors, officers and employees of a company whose employee benefit
plan holds shares of one or more of the FPA Funds.

Because FPA Fund Distributors, Inc. anticipates that certain purchases will
result in economies of scale in the sales effort and related expenses compared
to sales made through normal distribution channels, upon satisfaction of certain
conditions the following persons can purchase without a sales charge:

(a) trustees or other fiduciaries purchasing shares for employee benefit
plans of employers with 20 or more employees;

(b) trust companies, bank trust departments and registered investment
advisers purchasing for accounts over which they exercise investment
authority and which are held in a fiduciary, agency, advisory, custodial
or similar capacity, provided that the amount collectively invested or
to be invested by such accounts during the subsequent 13-month period in
the Fund or other FPA Funds totals at least $1,000,000;

(d) accounts upon which an investment adviser, financial planner or
broker-dealer charges an account management or consulting fee, provided
it has entered into an agreement with FPA Fund Distributors, Inc.
regarding those accounts or purchases Fund shares for such accounts

11
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or for its own accounts through an omnibus account maintained by a
broker-dealer that has entered into such an agreement with the Fund or
FPA Fund Distributors, Inc.

If you qualify, you must submit a special application form available from FPA
Fund Distributors, Inc. with your initial purchase, and you must notify FPA Fund
Distributors, Inc. of your eligibility when you place the order. If you place
the order through a broker, the broker may charge you a service fee. No such fee
is charged if you purchase directly from FPA Fund Distributors, Inc. or the
Fund.

SELLING (REDEEMING) YOUR SHARES

You can sell (redeem) for cash without charge any or all of your Fund shares at
any time by sending a written request to Boston Financial Data Services, Inc.
Faxes are not acceptable. You can also place redemption requests through
dealers, but they may charge a fee. If you are selling Fund shares from a
retirement plan, you should consult the plan documentation concerning federal
tax consequences and consult your plan custodian about procedures.

A check will be mailed to you within seven days after Boston Financial Data
Services, Inc. receives a properly completed request. If Fund shares sold were
recently purchased by check, payment of the redemption proceeds will be delayed
until confirmation that the purchase check has cleared, which may take up to 15
days.

WRITTEN REQUESTS. Requests must be signed by the registered shareholder(s). If
you hold a stock certificate, it must be included with your written request. A
signature guarantee is required if the redemption is:

- Over $10,000;

- Made payable to someone other than the registered shareholder or to
somewhere other than the registered address; or

- If the shareholder is a corporation, partnership, trust or fiduciary.

A signature guarantee can be obtained from a bank or trust company; a broker or
dealer; a credit union; a national securities exchange, registered securities
association or clearing agency; or a savings and loan association. Additional
documents are required for sales by corporations, partnerships, trusts,
fiduciaries, executors or administrators.

TELEPHONE TRANSACTIONS. You must elect the option on the shareholder services
form to have the right to sell your shares by telephone. If you wish to make an
election to have the right to sell your shares via telephone or to change such
an election after opening an account, you will need to complete a request with a
signature guarantee. Sales via telephone are not available for shares held in a
Fund-sponsored retirement account or in certificate form.

When you obtain the right to sell your Fund shares by telephone, you designate a
bank account to which the proceeds of such redemptions are sent. Telephone
redemptions of $5,000 or more are wired unless the designated bank cannot
receive Federal Reserve wires. Telephone redemptions under $5,000 are mailed
unless you request otherwise. There is a $3.50 charge per wire.

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recording telephone instructions. Neither Boston Financial Data Services, Inc.
nor the Fund is liable for losses due to unauthorized or fraudulent instructions
if reasonable procedures are employed; otherwise, they may be liable. During
periods of significant economic or market changes, it may be difficult to sell
your shares by telephone.

The Fund can change or discontinue telephone redemption privileges without
notice.

REINVESTING IN THE FUND WITH PROCEEDS FROM REDEMPTION OF SHARES. If you
reinvest in the Fund within 30 days, you do not have to pay a sales charge. Your
reinvestment is made at the first share price determined after Boston Financial
Data Services, Inc. receives your order. You can only do this once for each Fund
investment, and you must provide sufficient information to verify your
reinvestment when you make your purchase. A sale and reinvestment is a taxable
transaction, but losses on the sale are not deductible for federal income tax
purposes.

AUTOMATIC REDEMPTION (SALE) OF YOUR SHARES. If as a result of a redemption your
account value is less than $500, the Fund can direct Boston Financial Data
Services, Inc. to sell your remaining Fund shares. In such case, you will be
notified in writing that your account value is insufficient and be given up to
60 days to increase it to $500.

EXCHANGE OF SHARES AND SHAREHOLDER SERVICES

EXCHANGING YOUR FUND SHARES

EXCHANGING YOUR SHARES FOR SHARES OF OTHER FPA FUNDS. You can exchange your
shares of the Fund for shares of other FPA Funds.

You can increase an existing account or start a new account in the selected FPA
Fund. Shares of the Fund acquired must be registered for sale in your state.

A $5.00 service fee applies to each exchange. In addition, a sales charge
applies unless

- you paid a sales charge on the exchanged shares equivalent to that
applicable to the acquired shares;

- you are otherwise entitled to purchase shares without a sales charge (as
noted under "Purchases Not Subject to Sales Charge"); or

- the shares you are exchanging were acquired by reinvestment.

EXCHANGING YOUR SHARES FOR SHARES OF A MONEY MARKET FUND. FPA Fund
Distributors, Inc. has made arrangements to allow you to exchange your shares
for shares of the money market portfolio of the Cash Equivalent Fund, a no-load
diversified money market mutual fund. Shares of the money market fund you
acquire through exchange plus any shares acquired by reinvestment of dividends
and distributions may be re-exchanged for shares of any FPA Fund without a sales
charge. However, in the case of the Fund, you must have maintained your account
in the Fund in order to re-exchange your shares in the money market fund for
shares in the Fund. If your shares are held in a Fund-sponsored individual
retirement account, you cannot exchange them into shares of the money market
fund.

The $5.00 exchange fee is paid by FPA Fund Distributors, Inc., which receives a
fee from Kemper Financial Services, the administrator of the money market fund,
of 0.15 of 1% per year or more of the

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average daily net asset value of shares of the money market fund acquired
through this exchange program.

The money market fund is not an FPA Fund and is separately managed. The fact
that you have the ability to exchange your shares for shares of the money market
fund is not a Fund recommendation of the money market fund.

HOW TO EXCHANGE YOUR SHARES. You can exercise your exchange privileges either
by written instructions or telephone (telephone exchange privileges are
available unless you specifically decline them on the account information form).
Exchanges are subject to the following restrictions:

- You are limited to four exchanges in one account during any calendar year;
if we give you notice you have exceeded this limit, any further exchanges
will be null and void;

- Shares must be owned 15 days before exchanging, and cannot be in
certificate form unless you deliver the certificate when you request the
exchange;

- An exchange requires the purchase of shares with a value of at least
$1,000; and

- Exchanges are subject to the same signature and signature guarantee
requirements applicable to the redemption of shares.

Exchanges and purchases are at the share price next determined after receipt of
a proper request by Boston Financial Data Services, Inc. In the case of
exchanges into the money market fund, dividends generally start on the following
business day.

For federal and state income tax purposes, an exchange is treated as a sale and
could result in a capital gain or loss. If the shares exchanged have been held
less than 91 days, the sales charge paid on them is not included in the tax
basis of the exchanged shares, but is carried over and included in the tax basis
of the shares acquired. See the Statement of Additional Information for further
information.

DISCONTINUATION OF THE EXCHANGE PROGRAMS. The Fund and FPA Fund Distributors,
Inc. can change or discontinue the rights to exchange Fund shares into other FPA
Funds or the money market fund upon 60 days' notice. If you have exchanged your
shares into shares of the money market fund, you will have at least 60 days
after being given notice of the end of the exchange program to reacquire Fund
shares without a sales charge.

FOR MORE INFORMATION OR FOR PROSPECTUSES FOR OTHER FPA FUNDS AND/OR THE MONEY
MARKET FUND, PLEASE CONTACT A DEALER OR FPA FUND DISTRIBUTORS, INC. YOU SHOULD
READ THE PROSPECTUSES OF THESE OTHER FUNDS AND CONSIDER DIFFERENCES IN
OBJECTIVES AND POLICIES BEFORE MAKING ANY EXCHANGE.

OTHER SHAREHOLDER SERVICES

INVESTMENT ACCOUNT. Each shareholder has an investment account in which Boston
Financial Data Services, Inc. holds Fund shares. You will receive a statement
showing account activity after each transaction. Unless you make a written
request, stock certificates will not be issued. Stock certificates are only
issued for full shares.

PRE-AUTHORIZED INVESTMENT PLAN. To make automatic monthly investments of at
least $100, you must complete the optional shareholder services form available
from dealers or FPA Fund Distributors, Inc.

14
<PAGE>
Boston Financial Data Services, Inc. will withdraw funds from your bank account
monthly for $100 or more as specified through the Automated Clearing House.

RETIREMENT PLANS. If you are eligible, you can establish an IRA (individual
retirement account) and/or other retirement plan with a $100 minimum initial
investment and an expressed intention to increase the investment to $1,500
within 12 months. Each subsequent investment must be at least $100. Neither the
Fund nor FPA Fund Distributors, Inc. imposes additional fees for these plans,
but the plan custodian does.

You should consult your tax adviser about the implications of establishing a
retirement plan with Fund shares. Persons with earned income ineligible for
deductible contributions generally may make non-deductible contributions into an
IRA. The earnings on shares held in an IRA are generally tax-deferred. In
addition, the Taxpayer Relief Act of 1997 expanded opportunities for certain
investors to make deductible contributions to IRAs and also created two new
tax-favored accounts, the Roth IRA and the Education IRA, in which earnings
(subject to certain restrictions) are not taxed even on withdrawal. Tax matters
are complicated; you should consult your tax adviser. FPA Fund Distributors,
Inc. and dealers have applicable forms and information regarding plan
administration, custodial fees and other plan documents.

SYSTEMATIC WITHDRAWAL PLAN. If you have an account with a value of $10,000 or
more, you can make monthly, quarterly, semi-annual or annual withdrawals of $50
or more by completing the optional shareholder services form. Under this
arrangement, sufficient Fund shares will be sold to cover the withdrawals and
the proceeds will be forwarded to you as directed on the optional shareholder
services form. Dividends and capital gains distributions are automatically
reinvested in the Fund at net asset value. If withdrawals continuously exceed
reinvestments, your account will be reduced and ultimately exhausted. PLEASE
NOTE THAT CONCURRENT WITHDRAWALS AND PURCHASES ARE ORDINARILY NOT IN YOUR BEST
INTEREST BECAUSE OF ADDITIONAL SALES CHARGES, AND YOU WILL RECOGNIZE ANY TAXABLE
GAINS OR LOSSES ON THE AUTOMATIC WITHDRAWALS.

DIVIDENDS, DISTRIBUTIONS AND TAXES

DIVIDENDS AND DISTRIBUTIONS

The Fund's investment income consists principally of dividends and interest
earned on its portfolio securities. This income, after payment of expenses, will
be distributed to you semi-annually. Net capital gains realized from the sale of
securities are distributed at least annually. Dividends and capital gain
distributions are automatically reinvested in the Fund at the share price
determined at the close of business the day after the record date, unless before
the record date for receipt of the dividend or capital gain distribution you
request cash payment of dividends and capital gains distributions. You can use
the account information form to request a cash payment.

TAX CONSEQUENCES

Dividends and capital gains are generally taxable whether they are reinvested or
received in cash-- unless you are exempt from taxation or entitled to tax
deferral. Dividends and distributions are taxed at ordinary rates while capital
gains may be taxed at a different rate. Furthermore, capital gains may be taxed
at different rates depending on the length of time the Fund holds its assets.

15
<PAGE>
Redemptions from a retirement plan account and an ordinary shareholder account
could have different tax treatment.

You must provide the Fund with a certified correct taxpayer identification
number (generally your social
security number) and certify that you are not subject to backup withholding. You
can use the account information form for this purpose. If you fail to do so, the
IRS can require the Fund to withhold 31% of your taxable distributions and
redemptions. Federal law also requires the Fund to withhold 30% or the
applicable tax treaty rate from dividends paid to certain nonresident aliens,
non-U.S. partnership and non-U.S. corporation shareholder accounts.

Federal tax law generally requires that a holder (such as the Fund) of a debt
security purchased at a discount (including a zero coupon security) accrue a
portion of the discount at which the security was purchased as income each year
even though the holder receives no interest payment in cash on the security
during the year. Periodic adjustments for inflation in the principal value of
inflation-indexed bonds also may give rise to original issue discount which is
includable in the Fund's gross income on a current basis. Similarly, the Fund
generally must recognize as income interest accrued on accrual bonds and other
debt securities even though not paid in cash. As an investment company, the Fund
must pay dividends equal to substantially all of its net investment income each
year. Since most shareholders reinvest dividends declared by the Fund, it is not
expected that cash dividend payments would exceed the total amount of cash
interest the Fund actually receives. Cash distributions are made from the cash
assets of the Fund or by liquidation of portfolio securities, if necessary. If
the principal value of an inflation-indexed bond is adjusted downward in any
period as a result of deflation, the reduction may be treated as a loss to the
extent the reduction exceeds coupon payments received in that period; in that
case, the amount distributable by the Fund may be reduced and amounts
distributed previously in the taxable year may be characterized in some
circumstances as return of capital.

Please see the Statement of Additional Information and consult with your tax
adviser.

16
<PAGE>
FINANCIAL HIGHLIGHTS

The financial highlights table is intended to help you understand the Fund's
financial performance for the past five (5) years. Certain information reflects
financial results for a single Fund share. The total returns in the table
represent the rate that an investor would have earned or lost on an investment
in the Fund purchased at net asset value and assuming reinvestment of all
dividends and distributions. This information has been audited by Ernst & Young
LLP, whose report, along with the Fund's financial statements, are included in
the Statement of Additional Information, which is available upon request.

<TABLE>
<CAPTION>
FOR THE YEARS ENDED MARCH 31,
--------------------------------------------
1999 1998 1997 1996 1995
-------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Per share operating performance:
Net asset value at beginning of year.......... $ 38.30 $ 32.28 $ 27.55 $ 22.40 $ 19.30
-------- ------- ------- ------- -------
Net investment income......................... $ .40 $ .49 $ .38 $ .33 $ .09
Net realized and unrealized gain (loss) on
investment securities........................ (4.76) 8.74 6.98 7.63 3.62
-------- ------- ------- ------- -------
Total from investment operations.............. $ (4.36) $ 9.23 $ 7.36 $ 7.96 $ 3.71
-------- ------- ------- ------- -------

Less distributions:
Dividends from net investment income........ $ (.40) $ (.47) $ (.37) $ (.26) $ (.08)
Distributions from net realized capital
gains..................................... (3.20) (2.74) (2.26) (2.55) (.53)
-------- ------- ------- ------- -------
Total distributions........................... $ (3.60) $ (3.21) $ (2.63) $ (2.81) $ (.61)
-------- ------- ------- ------- -------
Net asset value at end of year................ $ 30.34 $ 38.30 $ 32.28 $ 27.55 $ 22.40
-------- ------- ------- ------- -------
-------- ------- ------- ------- -------
Total investment return*...................... (12.45)% 30.10% 27.30% 36.84% 19.77%

Ratios/supplemental data:
Net assets at end of year (in $000's)......... 513,894 789,436 597,184 399,282 236,656
Ratio of expenses to average net assets....... .86% .83% .84% .87% .95%
Ratio of net investment income to average net
assets....................................... 1.20% 1.38% 1.27% 1.28% .48%
Portfolio turnover rate....................... 19% 24% 21% 21% 11%
</TABLE>

- ------------

* Return is based on net asset value per share, adjusted for reinvestment of
distributions, and does not reflect deduction of the sales charge.

17
<PAGE>
- - -
- --- ---

<TABLE>
<S> <C> <C>
FOR SHAREHOLDER SERVICES CALL FOR RETIREMENT PLAN SERVICES FOR DEALER SERVICES CALL
BOSTON FINANCIAL DATA CALL YOUR EMPLOYER OR PLAN FPA FUND DISTRIBUTORS, INC.
SERVICES, INC. ADMINISTRATOR (310) 473-0225 or
(617) 483-5000 or FOR 24-HOUR INFORMATION GO TO (800) 982-4372 except
(800) 638-3060 except Alaska FUNDMASTER MARKETING GROUP Alaska, Hawaii and
Hawaii, Massachusetts and INTERNET WEB SITE Puerto Rico
Puerto Rico HTTP://WWW.FUNDMASTER.COM
</TABLE>

Telephone conversations may be recorded or monitored for verification, record
keeping and quality assurance purposes.

MULTIPLE TRANSLATIONS

This Prospectus may be translated into other languages. If there are any
inconsistencies or ambiguities, the English text will prevail.

OTHER FUND INFORMATION

ANNUAL/SEMI-ANNUAL REPORT TO SHAREHOLDERS

Additional information about the Fund's investments is available in the Fund's
annual and semi-annual reports to shareholders. In the Fund's annual report, you
will find a discussion of the market conditions and investment strategies that
significantly affected the Fund's performance during its last fiscal year.

STATEMENT OF ADDITIONAL INFORMATION (SAI)

The SAI contains more detailed information on all aspects of the Fund, including
the Fund's financial statements.

A current SAI has been filed with the Securities and Exchange Commission ("SEC")
and is incorporated by reference into this Prospectus. The SAI and other related
materials about the Fund are available for review or to be copied at the SEC's
Public Reference Room in Washington, D.C. (1-800-SEC-0330) or on the SEC's
Internet Web Site at http://www.sec.gov.

FOR MORE INFORMATION OR TO REQUEST A FREE COPY OF ANY OF THE DOCUMENTS ABOVE
CONTACT FPA FUND DISTRIBUTORS, INC. AT 11400 WEST OLYMPIC BOULEVARD, SUITE 1200,
LOS ANGELES, CALIFORNIA 90064, AT (800) 982-4372, EXCEPT FROM ALASKA, HAWAII AND
PUERTO RICO (WHERE YOU MAY CALL COLLECT (310) 473-0225).

Securities Act File No. 2-28157

Investment Company Act No. 811-01596

- - -
- --- ---

<PAGE>

STATEMENT OF ADDITIONAL INFORMATION
FPA CAPITAL FUND, INC.

August 2, 1999

This Statement of Additional Information supplements the current Prospectus of
FPA Capital Fund, Inc. ("Fund") dated August 2, 1999. This Statement does not
present a complete picture of the various topics discussed and should be read in
conjunction with the Fund's Prospectus. Although this Statement of Additional
Information is not itself a Prospectus, it is, in its entirety, incorporated by
reference into the Prospectus. The Fund's Prospectus can be obtained by
contacting your securities dealer or the Fund's principal underwriter, FPA Fund
Distributors, Inc. ("Distributor"), at 11400 West Olympic Boulevard, Suite 1200,
Los Angeles, California 90064; telephone (310) 473-0225 or (800) 982-4372,
except Alaska, Hawaii and Puerto Rico.

TABLE OF CONTENTS

<TABLE>
<CAPTION>
Page
<S> <C>
Investment Objectives and Policies..................................................... 1
Description of Certain Securities and Investment Techniques............................ 1

Equity Securities.............................................................. 1
Fixed-Income Securities ....................................................... 2
Inflation-Indexed Bonds ....................................................... 2
Mortgage-Backed Securities..................................................... 3
Guaranteed Mortgage Pass-Through Securities.................................... 4
Collateralized Mortgage Obligations and Multiclass Pass-Through Securities .... 4
Stripped Mortgage-Backed Securities............................................ 5
Lower Rated Debt Securities ................................................... 6
Risk Factors Relating to Lower Rated Securities ............................... 7
Securities of Foreign Issuers.................................................. 8
Covered Call Options........................................................... 8
Short Sales Against the Box.................................................... 8
Repurchase Agreements.......................................................... 9
Rule 144A and Other Restricted Securities...................................... 9
Investment Restrictions................................................................ 9
Additional Restrictions........................................................ 11

Fund Organization...................................................................... 11
Directors and Officers of the Fund..................................................... 12
Five Percent Shareholders.............................................................. 16

Management............................................................................. 16
Investment Adviser............................................................. 16
Investment Advisory and Service Agreement...................................... 16
Principal Underwriter.......................................................... 18

Portfolio Transactions and Brokerage................................................... 18
Portfolio Turnover..................................................................... 19
Capital Stock.......................................................................... 19

Common Stock................................................................... 19
Voting Rights.................................................................. 20
</TABLE>

<PAGE>

<TABLE>
<S> <C>
Purchase and Redemption of Shares...................................................... 20
Net Asset Value................................................................ 20
Sales Charges.................................................................. 20
Authorized Financial Intermediaries............................................ 20
Sales at Net Asset Value....................................................... 20
Letter of Intent............................................................... 21
FPA Exchange Privilege......................................................... 21
Redemption of Shares........................................................... 22
Telephone Redemption........................................................... 22

Tax Sheltered Retirement Plans......................................................... 23
Dividends, Distributions and Taxes..................................................... 23
Distributor............................................................................ 24
Prior Performance Information.......................................................... 25
Financial Statements................................................................... 27
</TABLE>

<PAGE>

INVESTMENT OBJECTIVES AND POLICIES

The following limitations and guidelines are considered at the time of purchase,
under normal market conditions, and are based on a percentage of FPA Capital
Fund, Inc.'s (the "Fund") net assets unless otherwise noted. This summary is not
intended to reflect all of the Fund's investment limitations.

INVESTMENT OBJECTIVE

- - The Fund's primary objective is long-term growth of capital.
Providing you current income is a secondary consideration. The
Adviser believes that the Fund's goals can best be achieved by
investing primarily in common stocks the Adviser deems to possess
above-average ability to increase in market value. The Fund may also
invest in United States Government and government agency obligations,
corporate debt securities, preferred stocks and convertible
securities. Up to 15% of the Fund's net assets may be invested in
lower-rated or comparable unrated debt securities.

- - Investments in the Fund are not limited by a specific industry, and
substantially all common stocks purchased by the Fund will be listed on
a national securities exchange or the National Association of Securities
Dealers Automated Quotation (NASDAQ) National Market System or National
List.

FIXED-INCOME SECURITIES

- - Up to 15% of the Fund's net assets can be invested in fixed-income
securities, including convertible securities, that are rated BB or
lower, by Standard & Poor's Corporation or Ba or lower by Moody's
Investor Services, Inc.

- - The Fund can invest in inflation-indexed bonds which are fixed-income
securities whose principal value is periodically adjusted to reflect the
rate of inflation.

- - The Fund can invest in mortgage-backed securities which represent an
interest in a pool of mortgage loans. Collateralized mortgage
obligations are a type of bond secured by an underlying pool of
mortgages or mortgage pass-through certificates that are structured to
direct payments on underlying collateral to different series or classes
of the obligations. A variety of CMO certificates may be issued in
sequential pay structures. These securities include accrual certificates
(also known as "Z- bonds") which only accrue interest at a specified
rate until all other certificates having an earlier final distribution
date have been retired and are converted thereafter to an
interest-paying security. Up to 5% of the Fund's assets can be invested
in interest-only classes of stripped mortgage-backed securities.

NON-U.S. SECURITIES

- - The Fund can invest up to 10% of its net assets in securities of
foreign issuers.

DESCRIPTION OF CERTAIN SECURITIES AND INVESTMENT TECHNIQUES

EQUITY SECURITIES -- The Fund will invest primarily in equity securities. Equity
securities represent an ownership position in a company. The prices of equity
securities fluctuate based on changes in the

<PAGE>

financial conditions of their issuers and on market and economic conditions.
These fluctuations can be severe and can generate large losses.

FIXED-INCOME SECURITIES -- The Fund can invest in fixed-income securities. Bonds
and other fixed-income securities are used by issuers to borrow money. Issuers
pay investors interest and generally must repay the amount borrowed at maturity.
Some fixed-income securities, such as zero coupon bonds, do not pay current
interest but are purchased at a discount from their face value. The market price
of fixed-income securities held by the Fund can be expected to vary inversely to
changes in prevailing interest rates and can also be affected by the financial
conditions of the issuers. Investments in fixed-income securities with longer
maturities generally produce higher yields but are subject to greater market
fluctuation.

INFLATION-INDEXED BONDS. -- The Fund can invest in inflation-indexed bonds which
are fixed-income securities whose principal value is periodically adjusted to
reflect the rate of inflation. Such bonds generally are issued at an interest
rate lower than comparable non-indexed bonds, but are expected to retain their
principal value over time. The interest rate on these bonds is fixed at
issuance, but over the life of the bond this interest may be paid on an
increasing principal value, which has been adjusted for inflation.
Inflation-indexed bonds issued by the U.S. Treasury have maturities of five,
ten, and thirty years, although it is anticipated that securities with other
maturities will be issued in the future. If the periodic adjustment rate
measuring inflation falls, the principal value of inflation-indexed bonds will
be adjusted downward, and consequently the interest payable on these securities
(calculated with respect to a smaller principal amount) will be reduced.
Repayment of the original bond principal upon maturity (as adjusted for
inflation) is guaranteed in the case of U.S. Treasury inflation-indexed bonds,
even during a period of deflation. However, the current market value of the
bonds is not guaranteed, and will fluctuate. Any increase in the principal
amount of an inflation-indexed bond is considered taxable ordinary income, even
though investors do not receive their principal until maturity.

Inflation-indexed bonds issued by the U.S. Treasury pay interest on a
semi-annual basis, equal to a fixed percentage of the inflation-adjusted
principal amount. For example, if a Fund purchased an inflation-indexed bond
with a par value of $1,000 and a 3% real rate of return coupon (payable 1.5%
semi-annually), and inflation over the first six months were 1%, the mid-year
par value of the bond would be $1,010 and the first semi-annual interest payment
would be $15.15 ($1,010 times 1.5%). If inflation continued during the second
half of the year and reached 3% by year end, the end-of-year par value of the
bond would be $1,030 and the second semi-annual interest payment would be $15.45
($1,030 times 1.5%).

The value of inflation-indexed bonds is expected to change in response to
changes in real interest rates. Real interest rates in turn are tied to the
relationship between nominal interest rates and the rate of inflation.
Therefore, if inflation were to rise at a faster rate than nominal interest
rates, real interest rates might decline, leading to an increase in the value of
inflation-indexed bonds. In contrast, if nominal interest rates increased at a
faster rate than inflation, real interest rates might rise, leading to a
decrease in the value of inflation-indexed bonds.

While these securities are expected to be protected from long-term inflationary
trends, short-term increases in inflation may lead to a decline in value. If
interest rates rise due to reasons other than inflation (for example, due to
changes in currency exchange rates), investors in these securities may not be
protected to the extent that the increase is not reflected in the bond's
inflation measure.

The periodic adjustment of U.S. inflation-indexed bonds is tied to the Consumer
Price Index for Urban

<PAGE>

Consumers ("CPI-U"), which is calculated monthly by the U.S. Bureau of Labor
Statistics. The CPI-U is a measurement of changes in the cost of living, made up
of components such as housing, food, transportation and energy. There can be no
assurance that the CPI-U will accurately measure the real rate of inflation in
the prices of goods and services.

MORTGAGE-BACKED SECURITIES. -- The Fund can invest in mortgage-backed securities
which represent an interest in a pool of mortgage loans. The primary issuers or
guarantors of mortgage-backed securities are the Government National Mortgage
Association ("GNMA"), the Federal National Mortgage Association ("FNMA"), and
the Federal Home Loan Mortgage Corporation ("FHLMC") (securities issued by GNMA,
but not those issued by FNMA or FHLMC, are backed by the "full faith and credit"
of the United States). Mortgage-backed securities are also issued by certain
private, nongovernmental corporations, such as financial institutions.
Mortgage-backed securities provide a monthly payment consisting of interest and
principal payments. Additional payments may be made out of unscheduled
repayments of principal resulting from the sale of the underlying residential
property, refinancing or foreclosure, net of fees or costs that may be incurred.
Prepayments of principal on mortgage-related securities may tend to increase due
to refinancing of mortgages as interest rates decline. Prompt payment of
principal and interest on GNMA mortgage pass-through certificates is backed by
the full faith and credit of the United States. FNMA guaranteed mortgage
pass-through certificates and FHLMC participation certificates are solely the
obligations of those entities but are supported by the discretionary authority
of the U.S. Government to purchase the agencies' obligations. To the extent that
the Fund purchases mortgage-backed securities at a premium, prepayments may
result in some loss of the Fund's principal investment to the extent of the
premium paid. In addition, like other debt securities, the value of
mortgage-related securities will generally fluctuate in response to market
interest rates.

The mortgage-backed securities in which the Fund may invest may include those
backed by the full faith and credit of the United States. Government National
Mortgage Association ("GNMA"), the principal U.S. guarantor of such securities,
is a wholly owned U.S. Government corporation within the Department of Housing
and Urban Development. The Fund may also invest in government-related
mortgage-backed securities which are not backed by the full faith and credit of
the United States such as those issued by Federal National Mortgage Association
("FNMA") and Federal Home Loan Mortgage Corporation ("FHLMC"). Pass-through
securities issued by FNMA are guaranteed as to timely payment of principal and
interest by FNMA. Participation certificates representing interests in mortgages
from FHLMC's national portfolio are guaranteed as to the timely payment of
interest and ultimate collection of principal by FHLMC. The Fund may also invest
in mortgage-backed securities issued by private non-governmental corporations,
such as financial institutions.

The average maturity of pass-through pools of mortgage-backed securities varies
with the maturities of the underlying mortgage instruments. In addition, a
pool's stated maturity may be shortened by unscheduled payments on the
underlying mortgages. Factors affecting mortgage prepayments include the level
of interest rates, general economic and social conditions, the location of the
mortgaged property and the age of the mortgage. Because prepayment rates of
individual mortgage pools vary widely, it is not possible to accurately predict
the average life of a particular pool. Common industry practice, for example, is
to assume that prepayments will result in a 7- to 9-year average life for pools
of fixed-rate 30-year mortgages. Pools of mortgages with other maturities of
different characteristics will have varying average life assumptions.

<PAGE>

GUARANTEED MORTGAGE PASS-THROUGH SECURITIES. -- The Fund can invest in mortgage
pass-through securities representing participation interests in pools of
residential mortgage loans originated by United States governmental or private
lenders and guaranteed, to the extent provided in such securities, by a Federal
Agency. Such securities, which are ownership interests in the underlying
mortgage loans, differ from conventional debt securities, which provide for
periodic payment of interest in fixed amounts (usually semiannually) and
principal payments at maturity or on specified dates. Mortgage pass-through
securities provide for monthly payments (not necessarily in fixed amounts) that
are a "pass-through" of the monthly interest and principal payments (including
any prepayments) made by the individual borrowers on the pooled mortgage loans,
net of any fees paid to the guarantor of such securities and the servicer of the
underlying mortgage loans.

The guaranteed mortgage pass-through securities in which the Fund may invest
include those issued or guaranteed by GNMA, FNMA and FHLMC. GNMA certificates
are direct obligations of the U.S. Government and, as such, are backed by the
"full faith and credit" of the United States. FNMA and FHLMC are federally
chartered, privately owned corporations which are instrumentalities of the
United States. FNMA and FHLMC certificates are not backed by the full faith and
credit of the United States.

Certificates for these types of mortgage-backed securities evidence an interest
in a specific pool of mortgages. These certificates are, in most cases,
"modified pass-through" instruments, wherein the issuing agency guarantees the
payment of principal and interest on mortgages underlying the certificates,
whether or not such amounts are collected by the issuer on the underlying
mortgages.

COLLATERALIZED MORTGAGE OBLIGATIONS AND MULTICLASS PASS-THROUGH SECURITIES. --
Collateralized mortgage obligations ("CMOs") are a type of bond secured by an
underlying pool of mortgages or mortgage pass-through certificates that are
structured to direct payments on underlying collateral to different series or
classes of the obligations. CMOs issue a series of bonds or certificates in
multiple classes. Each class, often referred to as a "tranche," is issued at a
specific fixed or floating coupon rate and has a stated maturity or final
distribution date. Interest is paid or accrues on all classes of the CMOs on a
monthly, quarterly or semi-annual basis. Principal prepayments on the underlying
pool of mortgages may cause the CMOs to be retired substantially earlier than
their stated maturities or final distribution dates. Changes in estimated
prepayment rates alter the expected life of mortgage-backed securities. In
periods of sharp interest rate movements and/or in periods of supply and demand
imbalances in the market for such securities, the prices of certain CMOs may
fluctuate to a greater extent than would be expected from interest rate
movements alone. For example, an increase in interest rates would not only
likely decrease the value of CMOs owned by the Fund but would also increase the
inherent volatility of the Fund by effectively lengthening the expected life of
these securities.

A variety of CMO certificates may be issued in sequential pay structures. These
securities include accrual certificates (also known as "Z-bonds") which only
accrue interest at a specified rate until all other certificates having an
earlier final distribution date have been retired and are converted thereafter
to an interest-paying security. The market prices of CMOs structured as accrual
bonds are affected to a greater extent by interest rate changes and therefore
tend to be more volatile than securities which pay interest periodically and in
cash.

The Fund may invest in CMOs which are debt obligations collateralized by
mortgage loans or mortgage pass-through securities. Typically, CMOs are
collateralized by GNMA, FNMA or FHLMC certificates, but also may be
collateralized by whole loans or private mortgage pass-through securities (such
collateral

<PAGE>

is collectively hereinafter referred to as "Mortgage Assets"). Multiclass
pass-through securities are equity interests in a trust composed of Mortgage
Assets. Payments of principal of and interest on the Mortgage Assets, and any
reinvestment income thereon, provide the funds to pay debt service on the CMOs
or make scheduled distributions on the multiclass pass-through securities. CMOs
may be issued by Federal Agencies, or by private originators of, or investors
in, mortgage loans, including savings and loan associations, mortgage banks,
commercial banks, investment banks and special purpose subsidiaries of the
foregoing. The issuer of a series of CMOs may elect to be treated as a Real
Estate Mortgage Investment Conduit ("REMIC"). REMICs include governmental and/or
private entities that issue a fixed pool of mortgages secured by an interest in
real property. REMICs are similar to CMOs in that they issue multiple classes of
securities, but unlike CMOs, which are required to be structured as debt
securities, REMICs may be structured as indirect ownership interests in the
underlying assets of the REMICs themselves. However, the Fund's investment in a
CMO is not effected by the issuer's election to be treated as a REMIC, and all
future references to CMOs shall also be deemed to include REMICs.

In CMOs, a series of bonds or certificates is issued in multiple classes. Each
class of CMOs, often referred to as a "tranche," is issued at a specific fixed
or floating coupon rate and has a stated maturity or final distribution date.
Principal prepayments on the Mortgage Assets may cause the CMOs to be retired
substantially earlier than their stated maturities or final distribution dates.
Interest is paid or accrues on all classes of the CMOs on a monthly, quarterly
or semiannual basis. Certain CMOs may have variable or floating interest rates
and others may be Stripped Mortgage Securities.

The principal of and interest on the Mortgage Assets may be allocated among the
several classes of a CMO series in a number of different ways. Generally, the
purpose of the allocation of the cash flow of a CMO to the various classes is to
obtain a more predictable cash flow to certain of the individual tranches than
exists with the underlying collateral of the CMO. As a general rule, the more
predictable the cash flow is on a CMO tranche, the lower the anticipated yield
will be on that tranche at the time of issuance relative to prevailing market
yields on other mortgage-backed securities. As part of the process of creating
more predictable cash flows on most of the tranches in a series of CMOs, one or
more tranches generally must be created that absorb most of the volatility in
the cash flows on the underlying mortgage loans. The yields on these tranches
are generally higher than prevailing market yields on mortgage-backed securities
with similar maturities. As a result of the uncertainty of the cash flows of
these tranches, the market prices of and yield on these tranches generally are
more volatile.

STRIPPED MORTGAGE-BACKED SECURITIES. -- The Fund can invest in stripped
mortgage-backed securities. Up to 5% of the Fund's net assets can be invested in
interest-only classes of stripped mortgage-backed securities. The prices of
these securities are likely to be volatile in the event of changes in mortgage
prepayment rates, or expectations related thereto. In addition, these securities
tend to be less liquid than other CMOs.

Stripped mortgage-backed securities represent beneficial ownership interests in
either periodic principal distributions (the principal-only or "PO" class) or
interest distributions (the interest-only or "IO" class) on mortgage-backed
certificates. The certificates underlying the stripped mortgage-backed
securities represent all or part of the beneficial interest in pools of
fixed-rate Mortgage Assets. The Fund may invest in IO securities in order to
enhance yield or to benefit from anticipated appreciation in value of the
securities at times when the Adviser believes that interest rates will remain
stable or increase. In periods of rising interest rates, the value of IO
securities may be expected to increase because of the diminished expectation
that the underlying mortgages will be prepaid. In this situation, the expected
increase in the value of IO

<PAGE>

securities may offset all or a portion of any decline in value of other debt
securities owned by the Fund. Investing in stripped mortgage-backed securities
involves the risks normally associated with investing in mortgage-backed
securities. In addition, the yields on IO and PO securities are extremely
sensitive to the prepayment experience on the mortgage loans underlying the
certificates collateralizing the securities. If a decline in the level of
prevailing interest rates results in a rate of principal prepayments higher than
anticipated, distributions of principal will be accelerated, thereby reducing
the yield to maturity on IO securities and increasing the yield to maturity on
PO securities. Conversely, if an increase in the level of prevailing interest
rates results in a rate of principal prepayments lower than anticipated,
distributions of principal will be deferred, thereby increasing the yield to
maturity on IO securities and decreasing the yield to maturity on PO securities.
Sufficiently high prepayments rates could result in the Fund's not fully
recovering its initial investment in an IO security. There can be no assurance
that the Fund will be able to effect a trade of a stripped mortgage-backed
security at a time when it wishes to do so. Stripped mortgage-backed securities
will be considered illiquid securities unless (i) issued by the United States
Government or an agency or instrumentality thereof, (ii) backed by fixed-rate
mortgages, and (iii) there appears to be a liquid secondary market for the
security.

LOWER RATED DEBT SECURITIES -- The Fund can invest up to 15% of its net assets
in fixed-income securities, including convertible securities, which are rated BB
or lower, by Standard & Poor's Corporation ("S&P") or Ba or lower by Moody's
Investor Services, Inc. ("Moody's"), which ratings are considered by the rating
agencies to be speculative, and unrated securities considered by the Adviser to
be of comparable quality. Debt securities with a rating of BB/Ba or lower are
commonly referred to as "junk bonds."

To the extent the Fund acquires convertible securities or other debt
securities that are rated lower than investment grade or are not rated, there
is a greater risk that payment of principal and interest will not be made on
a timely basis or at all. Decisions to purchase and sell these securities are
based on the Adviser's evaluation of their investment potential and not on
the ratings assigned by credit agencies. Because investment in lower-rated
securities involves greater investment risk, achievement of the Fund's
investment objective depends more on the Adviser's credit analysis than it
does with respect to the Fund's investments in higher-rated securities.
Lower-rated securities may be more susceptible to real or perceived adverse
economic and competitive industry conditions than investment grade
securities. A projection of an economic downturn, for example, could cause a
decline in the prices of lower-rated securities because the advent of a
recession could lessen the ability of a highly leveraged company to make
principal and interest payments on its debt securities. In addition, the
secondary trading market for lower-rated securities may be less liquid than
the market for higher-rated securities.

Prices of lower-rated securities may decline rapidly if many holders decide to
sell. Changes in expectations regarding an individual issuer, an industry or
lower-rated securities generally could reduce market liquidity for such
securities and make it harder to sell them. The lower-rated bond market has
grown primarily during a period of long economic expansion, and it is uncertain
how it would perform during an extended economic downturn. An economic downturn
or an increase in interest rates could severely disrupt the market for
lower-rated bonds and adversely affect the value of outstanding bonds and the
ability of the issuers to repay principal and interest.

The lower-rated securities in which the Fund can invest include debt securities
of companies that are financially troubled, in default or are in bankruptcy or
reorganization ("Deep Discount Securities"). These securities could be rated C,
C1 or D by S&P or C by Moody's or may be unrated. Debt obligations of

<PAGE>

such companies are usually available at a deep discount from the face value of
the instrument. The Fund may invest in Deep Discount Securities when the Adviser
believes that existing factors are likely to improve the company's financial
condition. These factors include a restructuring of debt, management changes,
existence of adequate assets, or other special circumstances.

A debt instrument purchased at a deep discount, but before default, may
currently pay a very high effective yield. In addition, if the financial
condition of the issuer improves the underlying value of the securities could
increase, resulting in a capital gain. If the issuer defaults on its obligations
or remains in default, or if the plan of reorganization is insufficient for
debt-holders, the Deep Discount Securities could stop generating income and lose
value or become worthless. The Adviser will balance the benefits of Deep
Discount Securities with their risks. While a diversified portfolio may reduce
the overall impact of a Deep Discount Security that is in default or loses its
value, the risk cannot be eliminated.

As of March 31, 1999, 1.1% of the Fund's net assets were invested in convertible
securities, 5.6% of the Fund's net assets were invested in non-convertible
bonds and debentures (of which 86.2% represent U.S. Government and agency
securities), and 0.4% of the Fund's net assets were held in high grade
short-term investments.

RISK FACTORS RELATING TO LOWER RATED SECURITIES

1. SENSITIVITY TO INTEREST RATE AND ECONOMIC CHANGES. The economy and
interest rates affect high yield securities differently from other
securities. The prices of high yield bonds have been found to be less
sensitive to interest rate changes than higher rated investments, but
more sensitive to adverse economic changes or individual issuer
developments. During an economic downturn or substantial period of
rising interest rates, highly leveraged issuers are likely to experience
financial stress which would adversely affect their ability to service
their principal and interest payment obligations, to meet projected
business goals, and to obtain additional financing. If the issuer of a
bond owned by the Fund defaults, the Fund may incur additional expenses
to seek recovery. In addition, periods of economic uncertainty and
changes can be expected to result in increased volatility of market
prices of high yield bonds and the Fund's asset value. Furthermore, the
market prices of high yield bonds structured as zero coupon or
pay-in-kind securities are affected to a greater extent by interest rate
changes and thereby tend to be more volatile than securities that pay
interest periodically and in cash.

2. LIQUIDITY AND VALUATION. To the extent that there is no established
retail secondary market, there may be thin trading of high yield bonds,
and there could be a negative impact on the Fund's Board of Directors'
ability to accurately value high yield bonds and the Fund's assets and
on the Fund's ability to dispose of the bonds. Adverse publicity and
investor perceptions, whether or not based on fundamental analysis, can
decrease the values and liquidity of high yield bonds, especially in a
thinly traded market. To the extent the Fund owns or may acquire
illiquid high yield bonds, these securities may involve special
liquidity and valuation difficulties.

3. LEGISLATION. New laws and proposed new laws could have a negative impact
on the market for high yield bonds. For example, several years ago
legislation required federally-insured savings and loan associations to
divest their investments in high yield bonds.

<PAGE>

4. TAXATION. Special tax considerations are associated with investing in
high yield bonds structured as zero coupon or pay-in-kind securities.
The Fund accrues the interest on these securities as income even though
it receives no cash interest until the security's maturity or payment
date. The Fund is required to distribute such income to its shareholders
in order to maintain its qualification for pass-through treatment under
the Internal Revenue Code. Thus, the Fund may have to dispose of
portfolio securities at a time it otherwise might not want to do so in
order to provide the cash necessary to make distributions to those
shareholders who do not reinvest dividends.

5. CREDIT RATINGS. Certain risks are associated with applying credit
ratings as a method of evaluating high yield bonds. Credit ratings
evaluate the safety of principal and interest payments, not market value
risk of high yield bonds. Since credit rating agencies may fail to
timely change the credit ratings to reflect subsequent events, the
Adviser monitors the issuers of high yield bonds in the Fund's portfolio
to determine if the issuers appear to have sufficient cash flow to meet
required principal and interest payments. The Fund may retain a
portfolio security whose rating has been changed.

SECURITIES OF FOREIGN ISSUERS. -- The Fund can invest up to 10% of its net
assets in securities of foreign issuers. Investments in securities of foreign
issuers can be affected favorably or unfavorably by changes in currency rates
and exchange control regulations. Compared to U.S. companies, there might be
less publicly available information about foreign companies, which generally are
subject to less stringent accounting, auditing and financial reporting standards
and requirements. Securities of some foreign companies might be less liquid or
more volatile than those of U.S. companies. Foreign brokerage commissions and
custodial fees are generally higher than in the United States. Investments in
foreign securities can involve additional risks, including local political or
economic developments, expropriation or nationalization of assets and imposition
of withholding taxes on dividend or interest payments. In the event of a default
on any foreign debt obligation, it could be more difficult for the Fund to
obtain or enforce a judgment against the issuer.

COVERED CALL OPTIONS. -- In an effort to increase potential income, the Fund is
authorized to write (i.e. sell) covered call options listed on a national
securities exchange. When the Fund writes a listed call option, the purchaser
has the right to buy a security from the Fund at a fixed exercise price any time
before the option contract expires, regardless of changes in the market price of
the underlying security. The Fund writes options only on securities it owns
(covered options) and must retain ownership of the underlying security while the
option is outstanding. Until the option expires, the Fund cannot profit from a
rise in the market price of the underlying security over the exercise price,
except insofar as the premium which the Fund receives, net of commissions,
represents a profit. The premium paid to the Fund is the consideration for
undertaking this obligation.

The Fund may not write any option which, at the time, would cause its
outstanding options to cover securities comprising more than 10% of its asset
value. Writing option contracts is a highly specialized activity and could limit
investment flexibility at certain times. The maximum term for listed options
exceeds two years, but the Fund expects that most options it writes will not
exceed six months.

SHORT SALES AGAINST THE BOX. -- The Fund can make short sales of securities or
maintain a short position if the Fund contemporaneously owns or has the right to
obtain at no added cost identical securities to those sold short (short sales
"against the box") or if the securities sold are "when issued" or "when
distributed" securities that the Fund expects to receive in a recapitalization,
reorganization, or other exchange for

<PAGE>

securities the Fund contemporaneously owns or has the right to obtain at no
added cost. The principal purpose of short sales is to enable the Fund to obtain
the current market price of a security that the Fund desires to sell but which
cannot be currently delivered for settlement. The Fund will not make short sales
or maintain a short position if to do so would cause more than 25% of its total
net assets (exclusive of proceeds from short sales) to be allocated to a
segregated account in connection with short sales.

REPURCHASE AGREEMENTS. -- The Fund can invest up to 20% of its total assets in
repurchase agreements with domestic banks or dealers to earn interest on
temporarily available cash. A repurchase agreement is a short-term investment in
which the purchaser (i.e., the Fund) acquires a debt security that the seller
agrees to repurchase at a future time and set price, thereby determining the
yield during the holding period. Repurchase agreements are collateralized by the
underlying debt securities and may be considered loans under the Investment
Company Act of 1940 ("Investment Company Act"). In the event of bankruptcy or
other default by the seller, the Fund could experience delays and expenses
liquidating the underlying security, loss from decline in value of such
security, and lack of access to income on such security. The Fund will not
invest more than 10% of its total assets in repurchase agreements that mature in
more than seven days and/or other securities which are not readily marketable.

RULE 144A AND OTHER RESTRICTED SECURITIES. -- The Fund can invest up to 5% of
its net assets in Rule 144A securities or other securities subject to legal or
contractual restrictions on resale.

Rule 144A was adopted under the Securities Act of 1933 (the "1933 Act") to allow
a broader institutional trading market for securities subject to restriction on
resale to the general public. The Rule provides a "safe harbor" for the resale
of certain restricted securities among qualified institutional investors without
registration under the 1933 Act. Other securities subject to legal or
contractual restrictions on resale generally may be resold only in a privately
negotiated transaction with a limited number of purchasers or in a public
offering registered under the 1933 Act. Considerable delay could be encountered
in either event. These difficulties and delays could result in the Fund's
inability to realize a favorable price upon disposition of restricted
securities, and in some cases may make disposition of such restricted securities
at the time desired by the Fund impossible.

INVESTMENT RESTRICTIONS

The Fund has adopted investment restrictions stated below. They apply at the
time securities are purchased or other relevant action is taken. These
restrictions and the Fund's investment objectives cannot be changed without
approval of the holders of a majority of outstanding Fund shares. The
Investment Company Act defines this majority as the lesser of (a) 67% or more
of the voting securities present in person or represented by proxy at a
meeting, if the holders of more than 50% of the outstanding voting securities
are present or represented by proxy; or (b) more than 50% of the outstanding
voting securities. In addition to those described in the Prospectus, these
restrictions provide that the Fund will not:

1. Borrow any amount other than as a temporary measure for extraordinary
or emergency purposes as determined by the Fund's Board of Directors;

2. Concentrate more than 25% of the value of its assets in a particular
industry;

<PAGE>

3. Purchase the securities of any one issuer (except securities issued by
the United States of America, or any instrumentality thereof) if the
holdings of the Fund in the securities of such issuer exceed 5% of the
market value of the Fund's total assets;

4. Purchase the securities of any one issuer causing the Fund's holdings
to exceed 10% of the outstanding voting securities of such issuer or
10% of any class of securities of such issuer.

5. Issue any class of senior security nor sell any senior security of
which it is the issuer, except that the Fund is permitted to borrow
from any bank; provided that such borrowing may only be as a temporary
measure for extraordinary or emergency purposes, but not for investment
purposes and shall not, in the aggregate, exceed 10% of its total
assets taken at cost or 5% of its total assets taken at current value,
whichever is less; and provided that immediately after such borrowing,
there is an asset coverage of at least 300% for all borrowings of the
Fund;

6. Underwrite the sale of any securities other than Fund shares;

7. Purchase or sell commodities, commodity contracts or real estate;

8. Lend money or securities to any person, firm, or corporation for any
purpose whatsoever; provided, however, that the following are not
construed as the making of a loan: (a) the acquisition of a portion of
publicly distributed bonds, debentures, notes and other obligations or
evidence of interest in or indebtedness of any corporation, domestic or
foreign, or of any government or municipality; (b) the acquisition of
obligations of, or obligations guaranteed by, national or state banks or
bank holding companies (including certificates of deposit and bankers
acceptances); and (c) the entry into repurchase agreements if the
following conditions are met: (1) that the securities or instruments
subject to the agreement are of the type in which the Fund may otherwise
invest, (2) that at the time the repurchase agreement is made the value
of the securities or instruments involved is equal to the purchase
price, (3) that not more than 20% of the Fund's total assets, at the
time the agreement is made, will be invested pursuant to such
agreements, and (4) that such agreements with any one entity, together
with any other investments in that entity, shall not exceed in the
aggregate 5% of the Fund's total assets, at market value, computed at
the time the agreement is made;

9. Mortgage, pledge, hypothecate or in any manner transfer, as security for
any indebtedness, any security owned or held by the Fund;

10. Participate on a joint or a joint and several basis in any trading
account in securities;

11. Purchase from or sell to any officer or director of the Fund, or firms
of which any of them are members, any securities other than Fund shares;
but such persons or firms may act as brokers for the Fund for customary
commissions;

12. Purchase or retain any securities of any issuer if those officers and
directors of the Fund or of its manager or investment adviser owning
individually more than 0.5% of the securities of such issuer together
own beneficially more than 5% of the securities of such issuer;

13. Invest for the purpose of exercising control over or management of any
company;

<PAGE>

14. Invest in securities issued by other investment companies;

15. Effect short sales of securities, except that the Fund may make certain
short sales of securities or maintain a short position if the Fund
contemporaneously owns or has the right to obtain at no added cost
securities identical to those sold short (short sales "against the box")
or if the securities sold are "when issued" or "when distributed"
securities which the Fund expects to receive in a recapitalization,
reorganization, or other exchange for securities the Fund
contemporaneously owns or has the right to obtain at no added cost;

16. Buy securities on margin;

17. Purchase or sell securities other than Fund shares through any brokerage
or investment organization in which any officer or director of the Fund
is a partner, officer, director or shareholder;

18. Invest more than 5% of its assets in securities of corporations which
have a record of less than three years continuous operation; or

19. Write options, except the Fund may write covered call options and effect
closing transactions; provided the Fund shall: (i) write options only on
securities which it owns and which are traded on a national securities
exchange; (ii) retain ownership of the underlying security for the
duration of said options and (iii) not write any option which would, at
the time, cause outstanding options written by the Fund to cover
securities comprising more than 10% of the value of the Fund's assets.

ADDITIONAL RESTRICTIONS. The Fund is also subject to the following policies
which its Board of Directors can amend and which apply at the time of purchase
of securities. The Fund will not:

1. Invest more than 10% of total net assets in repurchase agreements with
maturities over seven days and/or other securities which are not
readily marketable;

2. Purchase warrants exceeding 2% of total assets;

3. Invest in oil, gas or other mineral exploration or development
programs; or

4. Purchase Rule 144A securities in an amount exceeding 5% of the Fund's
net assets or purchase other securities subject to legal or contractual
restrictions on resale in an amount exceeding 5% of the Fund's net
assets.

FUND ORGANIZATION

The Fund is a Maryland corporation and a diversified, open-end management
investment company, generally called a mutual fund, which was organized in 1966.
A mutual fund provides the investor a practical and convenient way to invest in
a diversified portfolio of securities by combining resources with others who
have similar investment goals.

A board of three directors is responsible for overseeing the Fund's affairs.

<PAGE>

DIRECTORS AND OFFICERS OF THE FUND

All directors and officers of the Fund are also directors and/or officers of one
or more of four other investment companies advised by the Adviser, which is an
indirect wholly owned subsidiary of United Asset Management Corporation ("UAM").
These investment companies are FPA New Income, Inc., FPA Paramount Fund, Inc.,
FPA Perennial Fund, Inc. and Source Capital, Inc. (collectively, the "FPA Fund
Complex").

The directors and officers of the Fund, their ages on the date hereof and their
principal occupations during the past five years follow. Their address is 11400
West Olympic Boulevard, Suite 1200, Los Angeles, California 90064.

<PAGE>

FUND DIRECTORS AND OFFICERS
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
AGGREGATE
AGGREGATE COMPENSATION (1) TOTAL
COMPENSATION FROM THE FPA NUMBER
(1) FROM THE FUND COMPLEX OF BOARDS
FUND DURING DURING THE FISCAL ON WHICH
POSITION HELD WITH PRINCIPAL OCCUPATION(S) THE FISCAL YEAR YEAR ENDED DIRECTOR
NAME/AGE FUND DURING PAST 5 YEARS ENDED 3/31/99 3/31/99 SERVED
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Willard H. Altman, 63 Director Former Partner of Ernst & Young $ 7,500 $33,750 4
(Elected 7/98) LLP, independent auditors for the
the Fund. Director of Source
Capital, Inc., of FPA New Income,
Inc. and of FPA Perennial Fund,
Inc. Director of Current Income
Shares, Inc., a closed-end
investment company. Vice President
of Evangelical Council for Financial
Accountability, an accreditation
organization for Christian non-profit
entities.
- -----------------------------------------------------------------------------------------------------------------------------------
Donald E. Cantlay, 77 Director $ 9,000 $18,000 2
(Until 5/99)
- -----------------------------------------------------------------------------------------------------------------------------------
DeWayne W. Moore, 85 Director Former Director, Senior Vice $10,000 $20,000 2
President and Chief Financial Officer
of Guy F. Atkinson Company of
California (construction). Director
of FPA New Income, Inc.
- -----------------------------------------------------------------------------------------------------------------------------------
Lawrence J. Sheehan, 67* Director Of counsel to, and partner (1969 to $10,000 $41,000 4
1994) of, the law firm of O'Melveny
& Myers LLP, legal counsel to the
Fund. Director of Source Capital,
Inc., of FPA Perennial Fund, Inc. and
of FPA New Income, Inc. Director of TCW
Convertible Securities Fund, Inc., a
closed-end investment company. Trustee
of the World Wide Index Funds, a
mutual fund complex with thirteen
separate investment portfolios.
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
- -----------------------------

(1) No pension or retirement benefits are provided to directors by
the Fund or the FPA Fund Complex.
* Director who is an interested person, as defined in the
Investment Company Act, by virtue of his affiliation with legal
counsel to the Fund in the case of Mr. Sheehan.

<PAGE>

OFFICERS

<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
NAME/AGE POSITION HELD WITH FUND PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Robert L. Rodriguez, 50 President & Chief Director, Principal and Chief Investment Officer of
Investment Officer First Pacific Advisors, Inc. since March 1996;
President and Chief Investment Officer of FPA
New Income, Inc. for more than the past five
years; and Director and Senior Vice President of
Source Capital, Inc. since March 1996. Director
of FPA Fund Distributors, Inc. since March 1996.
Executive Vice President from January 1996 to
March 1996 and Senior Vice President from
February 1993 to January 1996, of First Pacific
Advisors, Inc.
- ----------------------------------------------------------------------------------------------------------------
Julio J. de Puzo, Jr., 45 Executive Vice President Director (since October 1995), Principal and Chief
Executive Officer (since March 1996) of First
Pacific Advisors, Inc.; Director and President
(since March 1996) of Source Capital, Inc.;
Director and Executive Vice President (since April
1996) of FPA Paramount Fund, Inc. and of FPA
Perennial Fund, Inc.; and Executive Vice President
(since August 1996) of FPA New Income, Inc.
President and Chief Executive Officer (since
January 1997), and Director for more than the past
five years of FPA Fund Distributors, Inc.
Executive Vice President from October 1995 to
March 1996, Chief Administrative Officer from
October 1995 to March 1996, Chief Financial
Officer from June 1991 to March 1996, Treasurer
from June 1991 to March 1996, and Senior Vice
President from February 1993 to October 1995, of
First Pacific Advisors, Inc. Treasurer from July
1984 to August 1996 of the Fund and of FPA New
Income, Inc.; from June 1981 to August 1996 of
FPA Paramount Fund, Inc.; from May 1982 to
August 1996 of Source Capital, Inc.; and from
September 1983 to August 1996 of FPA Perennial
Fund, Inc. Chief Financial Officer from October
1991 to March 1998, and Executive Vice President
(or Senior Vice President or First Vice President)
from October 1991 to January 1997 of FPA Fund
Distributors, Inc.
- ----------------------------------------------------------------------------------------------------------------
Dennis M. Bryan, 37 Vice President Vice President of First Pacific Advisors, Inc. since
January 1996. Investment Analyst of First Pacific
Advisors, Inc. from July 1993 to January 1996.
Student at the University of Southern California
from July 1991 to May 1993.
- ----------------------------------------------------------------------------------------------------------------
</TABLE>

<PAGE>

<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
NAME/AGE POSITION HELD WITH FUND PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Eric S. Ende, 54 Vice President Senior Vice President of First Pacific Advisors,
Inc. for more than the past five years; President
and Chief Investment Officer of FPA Perennial
Fund, Inc. since September 1995; Chief Investment
Officer since May 1997 and Senior Vice President
for more than the past five years of Source Capital,
Inc.; and Vice President of FPA New Income, Inc.
and of FPA Paramount Fund, Inc. for more than
the past five years. Executive Vice President of
FPA Perennial Fund, Inc. from August 1995 to
September 1995, and Vice President of FPA
Perennial Fund, Inc. from May 1985 to August
1995.
- ----------------------------------------------------------------------------------------------------------------
Janet M. Pitman, 55 Vice President Vice President of First Pacific Advisors, Inc. for
more than the past five years, of Source Capital,
Inc., of FPA Perennial Fund, Inc. and of FPA
Paramount Fund, Inc. since April 1996, and of
FPA New Income, Inc. since February 1997.
- ----------------------------------------------------------------------------------------------------------------
J. Richard Atwood, 39 Treasurer Senior Vice President, Chief Financial Officer and
Treasurer of First Pacific Advisors, Inc. since
January 1997; and Chief Financial Officer since
March 1998, Senior Vice President and Treasurer
of FPA Fund Distributors, Inc. since January
1997. Treasurer of Source Capital, Inc., of FPA
Paramount Fund, Inc., of FPA Perennial Fund,
Inc., and of FPA New Income, Inc. since January
1997. Vice President and Chief Financial Officer
of Transamerica Investment Services, Inc. from
January 1995 to January 1997. Vice President (or
Assistant Vice President) and Controller of First
Pacific Advisors, Inc. from August 1988 to January
1995, and Assistant Treasurer of FPA Fund
Distributors, Inc. from May 1991 to January 1995.
Assistant Treasurer of the Fund, of FPA New
Income, Inc., of FPA Paramount Fund, Inc., of
FPA Perennial Fund, Inc., and of Source Capital,
Inc. from August 1988 to January 1995.
- ----------------------------------------------------------------------------------------------------------------
Sherry Sasaki, 44 Secretary Assistant Vice President and Secretary for more
than the past five years of First Pacific Advisors,
Inc.; and Secretary of Source Capital, Inc., of
FPA New Income, Inc., of FPA Paramount Fund,
Inc., of FPA Perennial Fund, Inc., and of FPA
Fund Distributors, Inc. for more than the past five
years.
- ----------------------------------------------------------------------------------------------------------------
</TABLE>

<PAGE>

All officers of the Fund are also officers of the Adviser. The Directors and
officers of the Fund as a group own less than 1% of the outstanding Fund shares.
During the last fiscal year, the Directors then in office who were not
affiliated with the Adviser received as a group $36,500 in Directors' fees. Such
Directors were also reimbursed for certain travel expenses by the Fund.

FIVE PERCENT SHAREHOLDERS

As of June 30, 1999, no person was known by the Fund to own of record or
beneficially 5% or more of the outstanding Fund shares, except Merrill Lynch,
Pierce, Fenner & Smith, Inc., for the sole benefit of its customers,
Attention: Fund Administration 97224, 4800 Deer Lake Drive, East Floor 2,
Jacksonville, Florida 32246-6484, which held 836,055 shares (5.1%). Such
broker-dealer advises that the shares are held for the benefit of its
customers.

MANAGEMENT

INVESTMENT ADVISER. First Pacific Advisors, Inc., together with its
predecessors, has been in the investment advisory business since 1954,
serving as investment adviser to the Fund since July 11, 1984. Presently, the
investment adviser manages assets of approximately $3.2 billion for eight
investment companies, including one closed-end investment company, and 21
institutional accounts. Currently, the personnel of First Pacific Advisors,
Inc. consists of nine persons engaged full time in portfolio management or
investment research in addition to 27 persons engaged full time in trading,
administrative, financial or clerical activities. FPA Fund Distributors, Inc.
is a wholly owned subsidiary of First Pacific Advisors, Inc., which is itself
a wholly owned subsidiary of United Asset Management Holdings, Inc. United
Asset Management Holdings, Inc. is a wholly owned subsidiary of UAM, a New
York Stock Exchange listed holding company principally engaged, through
affiliated firms, in providing institutional investment management and
acquiring institutional investment management firms. No person is known by
UAM to own or hold with power to vote 25% or more of its outstanding shares
of common stock.

INVESTMENT ADVISORY AND SERVICE AGREEMENT. The Fund has entered into an
Investment Advisory Agreement dated August 1, 1994 ("Advisory Agreement"), with
the Adviser pursuant to which the Adviser provides continuing supervision of the
Fund's investment portfolio. The Adviser is authorized, subject to the control
of the Fund's Board of Directors, to determine which securities are to be bought
or sold and in what amounts. In addition to providing investment advisory and
management services, the Adviser furnishes office space, facilities and
equipment, and maintains the Fund's books and records. It also

<PAGE>

compensates all officers and other personnel of the Fund, all of whom are
employed by the Adviser, subject to reimbursement from the Fund for personnel
involved in providing financial services as indicated below.

Other than the expenses the Adviser specifically assumes under the Advisory
Agreement, the Fund bears all costs of its operation. These costs include the
charges and expenses of any custodian or depository appointed by the Fund for
the safekeeping of its cash, portfolio securities and other property; the
charges and expenses of auditors; the charges and expenses of any stock transfer
or dividend agent or agents appointed by the Fund; brokers' commissions
chargeable to the Fund in connection with portfolio securities transactions to
which the Fund is a party; all taxes, including issuance and transfer taxes, and
corporate fees payable by the Fund to federal, state or other governmental
agencies; the cost of stock certificates representing Fund shares; fees involved
in registering and maintaining registrations of the Fund and of Fund shares with
the Securities and Exchange Commission ("SEC") and various states and other
jurisdictions; all expenses of shareholders' and Directors' meetings and of
preparing, printing and mailing proxy statements and semi-annual and annual
reports to shareholders except as set forth in the Distribution Agreement
between the Fund and the Distributor; fees and travel expenses of independent
and unaffiliated Directors; the expense of furnishing, or causing to be
furnished, to all shareholders a statement of account after every transaction
affecting their account, including the expense of mailing; charges and expenses
of legal counsel in connection with matters relating to the Fund, including,
without limitation, legal services rendered in connection with the Fund's
corporate and financial structure and relations with its shareholders, issuance
of Fund shares, and registrations and qualifications of securities under
federal, state and other laws; association dues; interest payable on Fund
borrowings; postage; and reimbursement of the Adviser's expenses in providing
financial services to the Fund as described below.

For services rendered, the Adviser is paid a monthly fee computed at the
annual rate of 0.75% of the first $50 million, and 0.65% of the excess over
$50 million, of the Fund's average net assets. The average net assets are
determined by taking the average of all the daily determinations of net
assets made, in the manner provided in the Fund's Articles of Incorporation,
during a calendar month.

In addition to the advisory fee, the Fund reimburses the Adviser monthly for
costs incurred in providing financial services to the Fund. Such financial
services include (a) maintaining the accounts, books and other documents forming
the basis for the Fund's financial statements, (b) preparing such financial
statements and other Fund documents and reports of a financial nature required
by federal and state laws, (c) calculating daily net assets and (d)
participating in the production of the Fund's registration statements,
prospectuses, proxy materials and reports to shareholders (including
compensation of the Treasurer or other principal financial officer of the Fund,
compensation of personnel working under such person's direction and expenses of
office space, facilities and equipment such persons use to perform their
financial services duties). However, for any fiscal year, the cost of such
financial services paid by the Fund cannot exceed 0.10% of the average daily net
assets of the Fund.

The advisory fee and cost of financial services is reduced in the amount by
which certain defined operating expenses of the Fund (including the advisory fee
and cost of financial services) for any fiscal year exceed 1.50% of the first
$30 million of average net assets, plus 1% of the remaining average net assets.
Such values are calculated at the close of business on the last business day of
each calendar month. Any required reduction or refund is computed and paid
monthly. Operating expenses (as defined in the Advisory Agreement) exclude (a)
interest, (b) taxes, (c) brokerage commissions and (d) any extraordinary
expenses, such as litigation, merger, reorganization or recapitalization, to the
extent such extraordinary

<PAGE>

expenses can be excluded under the rules or policies of the states in which Fund
shares are registered for sale. All expenditures, including costs connected with
the purchase, retention or sale of portfolio securities, which are capitalized
in accordance with generally accepted accounting principles applicable to
investment companies, are accounted for as capital items and not as expenses.
This expense limitation provision does not require any payment by the Adviser
beyond the return of the advisory fee and cost of financial services paid to it
by the Fund for a fiscal year.

The Advisory Agreement provides that the Adviser does not have any liability to
the Fund or any of its shareholders for any error of judgment, any mistake of
law or any loss the Fund suffers in connection with matters related to the
Advisory Agreement, except for liability resulting from willful misfeasance, bad
faith or negligence on the part of the Adviser or the reckless disregard of its
duties under the Advisory Agreement.

The Advisory Agreement is renewable annually if specifically approved each year
(a) by the Fund's Board of Directors or by the vote of a majority (as defined in
the Investment Company Act) of the Fund's outstanding voting securities and (b)
by the vote of a majority of the Fund's directors who are not parties to the
Advisory Agreement or interested persons (as defined in the Investment Company
Act) of any such party, by votes cast in person at a meeting called for the
purpose of voting on such approval. The continuation of the Advisory Agreement
to September 30, 2000, has been approved by the Board of Directors and a
majority of the Fund's directors who are not parties to the Advisory Agreement
or interested persons of any such party (as defined in the Investment Company
Act). The Advisory Agreement may be terminated without penalty upon 60 days'
written notice at the option of either party or by the vote of the Fund's
shareholders. The Advisory Agreement automatically terminates in the event of
its assignment.

For the fiscal years ended March 31, 1997, 1998 and 1999, the Adviser received
gross advisory fees of $3,361,166, $4,622,631 and $4,508,974, respectively, plus
$509,410, $703,482 and $685,996, respectively, for costs incurred in providing
financial services to the Fund.

PRINCIPAL UNDERWRITER. FPA Fund Distributors, Inc. (the "Distributor"), located
at 11400 West Olympic Boulevard, Suite 1200, Los Angeles, California 90064, acts
as principal underwriter of Fund shares pursuant to a Distribution Agreement
dated August 1, 1994 (the "Distribution Agreement"). Please see "Distributor"
for more information.

PORTFOLIO TRANSACTIONS AND BROKERAGE

The Adviser makes decisions to buy and sell securities for the Fund, selects
broker-dealers and negotiates commission rates or net prices. In
over-the-counter transactions, orders are placed directly with a principal
market maker unless the Adviser believes better prices and executions are
available elsewhere. Portfolio transactions are effected with broker-dealers
selected for their abilities to give prompt execution at prices favorable to the
Fund. In selecting broker-dealers and in negotiating commissions, the Adviser
considers: the best net price available; each firm's reliability, integrity and
financial condition; the size of and difficulty in executing the order; and the
value of the firm's expected contribution to the Fund's investment performance
on a continuing basis. Accordingly, the net price to the Fund in any transaction
may be less favorable than that available from another broker-dealer if the
difference is reasonably justified by other aspects of its services. Subject to
policies determined by the Fund's Board of Directors, the Adviser shall not be
deemed to have acted unlawfully or to have breached any duty created by the
Advisory Agreement or otherwise solely because the Fund paid a broker-dealer
providing brokerage and research services

<PAGE>

commissions for effecting a transaction in excess of the commission another
broker-dealer would have charged for the same transaction. The Adviser must
determine in good faith that such commission was reasonable relative to the
value of the brokerage and research services provided, considering either that
particular transaction or the Adviser's overall responsibilities to the Fund.
The Adviser is further authorized to allocate orders it places for the Fund to
broker-dealers providing products or services which assist in making investment
decisions. The Adviser shall allocate the amounts and proportions of such costs
and shall regularly report on such allocations to the Fund's Board of Directors.

Brokerage and research services are defined by Section 28(e) of the Securities
Exchange Act of 1934 to include (a) providing advice as to the value of
securities, the advisability of investing in, purchasing or selling securities,
and the availability of securities or purchasers or sellers of securities; (b)
furnishing analyses and reports concerning issuers, industries, securities,
economic factors and trends, portfolio strategy and performance of accounts; and
(c) effecting securities transactions and performing functions incidental
thereto, such as clearance, settlement and custody.

Research services furnished by broker-dealers effecting securities transactions
for the Fund can be used by the Adviser for all advisory accounts. However, the
Adviser might not use all such research services in managing the Fund's
portfolio. In the Adviser's opinion, it is not possible to measure separately
the benefits from research services to each advisory account. Because the volume
and nature of the trading activities of advisory accounts are not uniform, the
amount of commissions in excess of the lowest available rate paid by each
advisory account for brokerage and research services will vary. However, the
Adviser believes the total commissions the Fund pays are not disproportionate to
the benefits it receives on a continuing basis.

The Adviser attempts to allocate portfolio transactions equitably whenever
concurrent decisions are made to purchase or sell securities for the Fund and
another advisory account. In some cases, this procedure could have an adverse
effect on the price or amount of securities available to the Fund. The main
factors considered in such allocations are the respective investment objectives,
the relative amount of portfolio holdings of the same or comparable securities,
the availability of cash for investment, the size of investment commitments
generally held, and the opinion of the persons responsible for recommending the
investments.

Brokerage commissions paid by the Fund on portfolio transactions for the fiscal
years ended March 31, 1997, 1998 and 1999, totaled $199,529, $370,377 and
$376,934, respectively. During the last fiscal year, $328,838 of commissions
were paid on transactions having a total value of $85,812,772 to brokers
selected because of research services provided to the Adviser.

PORTFOLIO TURNOVER

The portfolio turnover rate is calculated by dividing the lesser of purchases or
sales of portfolio securities for a fiscal year by the average monthly value of
the portfolio securities during such fiscal year. Securities maturing in one
year or less at the time of acquisition are not included in this computation.
The turnover rate for prior periods is shown in the Prospectus under the caption
"Financial Highlights." This rate may vary greatly from year to year as well as
within a year.

CAPITAL STOCK

COMMON STOCK. Each Fund share outstanding participates equally in dividends,
distributions and liquidation of the Fund's net assets. Fund shares are
transferable, fully paid and non-assessable, and do

<PAGE>

not have any preemptive, preferential, subscription or conversion rights. The
Fund has authorized 100 million shares of $0.01 par value Common Stock.

VOTING RIGHTS. The By-Laws of the Fund require shareholder meetings to elect
directors only when required by the Investment Company Act which is likely to
occur infrequently. In addition, a special meeting of the shareholders will be
called, if requested by the holders of ten percent of the Fund's outstanding
shares, for the purposes, and to act upon the matters, specified in the request
(which may include election or removal of directors). When matters are submitted
for a shareholder vote, each shareholder is entitled to one vote for each share
owned. Shares of the Fund do not have cumulative voting rights, which means
holders of more than 50% of Fund shares voting for the election of directors can
elect 100% of the directors if they so choose. In such event, holders of the
remaining Fund shares are not able to elect any person or persons to the Fund's
Board of Directors.

PURCHASE AND REDEMPTION OF SHARES

NET ASSET VALUE. The net asset value is computed as of the close of the New York
Stock Exchange ("NYSE") on each business day during which the NYSE is open. Net
asset value, rounded to the nearest cent per share, is the total market value of
all the Fund's portfolio securities plus other assets (including any accrued
reimbursement of expenses), less all liabilities, divided by the total number of
Fund shares outstanding. The NYSE is closed not only on weekends but also on
customary holidays, which currently are New Year's Day, Martin Luther King, Jr.
Day, President's Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day. Computation is made by valuing (a)
securities listed or traded on a national securities exchange or on the National
Association of Securities Dealers Automated Quotations NASDAQ National Market
System ("NASDAQ") at the last sale price or, if there has been no sale that day,
at the last bid price, (b) unlisted securities for which quotations are readily
available at the last representative bid price as supplied by the NASDAQ or by
dealers, and (c) securities for which there are no readily available market
quotations and all other assets at fair value in such manner as determined in
good faith by the Fund's Board of Directors.

SALES CHARGES. The maximum sales charge is 6.5%, as a percentage of the offering
price, but lower sales charges apply to larger purchases. A portion of the sales
charge is allocated to dealers selling Fund shares in amounts ranging from 80%
to 94%, depending on the size of the investment. During special promotions, the
Distributor may reallow up to 100% of the sales charge to dealers. At such times
dealers may be deemed to be underwriters for purposes of the Securities Act of
1933. Discounts are alike to all dealers.

AUTHORIZED FINANCIAL INTERMEDIARIES. The Fund has authorized certain financial
intermediaries including one or more brokers to accept on its behalf purchase
and redemption orders. These brokers are authorized to designate other
intermediaries to accept purchase and redemption orders on the Fund's behalf.
The Fund is deemed to have received a purchase or redemption order when an
authorized financial intermediary including an authorized broker or if
applicable a broker's authorized designee accepts the order. Customer orders are
priced at the Fund's net asset value next computed after they are accepted by an
authorized financial intermediary, including an authorized broker or the
broker's authorized designee.

SALES AT NET ASSET VALUE. Full-time employees of the Adviser can purchase Fund
shares at net asset value via payroll deduction, provided the minimum initial
investment is $250. Each subsequent investment must be at least $50.

<PAGE>

LETTER OF INTENT. To be eligible for reduced sales charges, the investor must
sign at the time of initial purchase, or within 30 days, a Letter of Intent
("LOI") covering investments to be made within a period of 13 months ("Period")
from the initial purchase. The investor then becomes eligible for a reduced
sales charge based on the total amount of the specified intended investment
("LOI Goal"), provided the amount is not less than $10,000. A minimum initial
purchase of $1,500 and minimum subsequent purchases of $100 each are required.
Fund shares can also be purchased to fulfill a letter of intent entered into
with respect to shares of the other FPA Funds. The account information form,
which should be used to establish an LOI, is available from dealers or the
Distributor.

All transactions under an LOI must be indicated as such and must be placed by
the dealer (in the case of an initial purchase) or the shareholder (in the case
of any subsequent purchase) directly through Boston Financial Data Services,
Inc. ("Shareholder Service Agent"). Shareholders should review for accuracy all
confirmations of transactions, especially purchases made pursuant to an LOI.

If the LOI Goal is completed before the end of the Period, any subsequent
purchases within the Period receive the applicable reduced sales charge. In
addition, during the Period, the shareholder can increase his or her LOI Goal,
and all subsequent purchases are treated as a new LOI (including escrow of
additional Fund shares) except as to the Period, which does not change.

Signing an LOI does not bind the shareholder to complete his or her LOI Goal,
but the LOI Goal must be completed to obtain the reduced sales charge. The LOI
is binding on the Fund and the Distributor. However, the Distributor may
withdraw a shareholder's LOI privileges for future purchases upon receiving
information that the shareholder has resold or transferred his or her Fund
shares within the Period.

The LOI requires the Shareholder Service Agent, as escrow agent, to hold 5% of
the LOI Goal in escrow until completion of the LOI Goal within the Period. The
escrowed Fund shares are taken from the first purchase and, if necessary, from
each successive purchase. If the LOI Goal is completed within the Period, the
escrowed Fund shares are promptly delivered to, or as directed by, the
shareholder.

If the LOI Goal is not completed within the Period, the shareholder must pay the
Distributor an amount equal to the sales charge applicable to a single purchase
in the total amount of the purchases made under the LOI minus the sales charges
actually paid. If the Distributor does not receive such unpaid sales charge
within 20 days after requesting payment in writing, the Distributor instructs
the Shareholder Service Agent to redeem escrowed Fund shares sufficient to cover
the unpaid sales charge. Under the LOI, the shareholder irrevocably appoints the
Shareholder Service Agent as his or her attorney with full power of substitution
to surrender for redemption any or all escrowed Fund shares. If the redemption
proceeds are inadequate, the shareholder is liable to the Distributor for the
difference. The Shareholder Service Agent delivers to, or as directed by, the
shareholder all Fund shares remaining after such redemption, together with any
excess cash proceeds.

Any income dividends and capital gains distributions on the escrowed Fund shares
are paid or reinvested as directed by, the shareholder.

FPA EXCHANGE PRIVILEGE. The procedures for exchanging shares between FPA Funds
are described under "Exchanging Your Fund Shares" in the Fund's Prospectus. If
the account registration information for the two FPA Fund accounts involved in
the exchange are different in any respect, the exchange instructions must be in
writing and must contain a signature guarantee as described under "Selling
(Redeeming) Your Shares" in the Fund's Prospectus.

<PAGE>

By use of the exchange privilege, the investor authorizes the Shareholder
Service Agent ("Agent") to act on telephonic, telegraphic or written exchange
instructions from any person representing himself to be the investor or the
agent of the investor and believed by the Agent to be genuine. The Agent's
records of such instructions are binding.

For purposes of determining the sales charge rate previously paid, all sales
charges paid on the exchanged security and on any security previously exchanged
for such security or for any of its predecessors will be included. If the
exchanged security was acquired through reinvestment, that security may be
exchanged without a sales charge. If a shareholder exchanges less than all of
his securities, the security requiring no or the lowest incremental sales charge
is deemed exchanged first.

Exchange requests received on a business day before shares of the Funds involved
in the request are priced, are processed on the date of receipt by the
Shareholder Service Agent. "Processing" a request means that shares in the Fund
from which the shareholder is withdrawing an investment will be redeemed at the
net asset value per share next determined after receipt. Shares of the new Fund
into which the shareholder is investing will also normally be purchased at the
net asset value per share, plus any applicable sales charge, next determined
after receipt by the Agent. Exchange requests received on a business day after
the time shares of the Funds involved in the request are priced, are processed
on the next business day as described above.

Boston Financial Data Services, Inc. uses procedures it considers reasonable
to confirm exchange instructions via telephone, including requiring account
registration verification from the caller and recording telephone
instructions. Neither Boston Financial Data Services, Inc. nor the Fund is
liable for losses due to unauthorized or fraudulent instructions if
reasonable procedures are employed; otherwise, they may be liable.

REDEMPTION OF SHARES. Redemptions are not made on days when the NYSE is closed,
including those holidays listed under "Purchase and Redemption of Shares - Net
Asset Value." The right of redemption can be suspended and the payment therefore
may be postponed for more than seven days during any period when (a) the NYSE is
closed for other than customary weekends or holidays; (b) trading on the NYSE is
restricted; (c) an emergency exists as a result of which disposal by the Fund of
securities it owns is not reasonably practicable or it is not reasonably
practical for the Fund to fairly determine the value of its net assets; or (d)
the Securities and Exchange Commission, by order, so permits. The Articles of
Incorporation of the Fund provide that if the Board of Directors determines that
conditions exist which make payment of the redemption price wholly in cash
unwise or undesirable, the Fund may make payment wholly or partly in securities
or other assets. While the Fund generally does not reserve the right to pay
redemption proceeds "in-kind," it may do so if requested by a large shareholder
and approved by the Board.

TELEPHONE REDEMPTION. Redemptions can be made by telephone once the shareholder
has properly completed and returned to the Agent the optional shareholder
services form, including the designation of a bank account to which the
redemption payment is to be sent ("Designated Bank"). The proceeds will not be
mailed or wired to other than the Designated Bank. New investors who wish to
establish the telephone redemption privilege must complete the appropriate
section on the optional shareholder services form. Existing shareholders who
wish to establish the telephone redemption privilege or change the Designated
Bank should either enter the new information on an optional shareholder services
form, marking it for "change of information" purposes, or send a letter
identifying the Fund account and specifying the exact information to be changed.
The letter must be signed exactly as the shareholder's name(s) appear on the
account. All signatures require a guarantee as described under "Selling
(Redeeming) Your Shares" in the Fund's Prospectus. The optional shareholder
services form is available from authorized security dealers or the Distributor.

Shareholders who want to use a savings and loan ("S&L") as their Designated Bank
are advised that if the S&L is not a participant in the Federal Reserve System,
redemption proceeds must be wired through a commercial bank which is a
correspondent of the S&L. As this may delay receipt by the shareholder's
account, it is suggested that shareholders who wish to use an S&L discuss wire
procedures with their S&L

<PAGE>

and submit any special wire transfer information with the telephone redemption
authorization. If appropriate wire information is not supplied, redemption
proceeds will be mailed to such Designated Bank.

A shareholder can cancel the telephone redemption authorization upon written
notice. If the shareholder has authorized telephone redemptions, neither the
Fund nor the Agent is responsible for any unauthorized telephone redemptions. If
the Fund shares to be redeemed by telephone (technically a repurchase by
agreement between the Fund and the shareholder) were recently purchased by
check, the Agent can delay transmitting the proceeds until the purchasing check
has cleared but no more than 15 days from purchase.

Boston Financial Data Services, Inc. uses procedures it considers reasonable
to confirm redemption instructions via telephone, including requiring account
registration verification from the caller and recording telephone
instructions. Neither Boston Financial Data Services, Inc. nor the Fund is
liable for losses due to unauthorized or fraudulent instructions if
reasonable procedures are employed; otherwise, they may be liable.

TAX SHELTERED RETIREMENT PLANS

Through the Distributor, prototype retirement plans are available for purchase
of Fund shares. These include plans for self-employed individuals and plans for
individuals buying shares under an Individual Retirement Account. A penalty tax
applies, in general, to distributions made before age 59-1/2, excess
contributions and failure to start distribution of the account at age 70-1/2.
Borrowing from or against the account could also result in plan
disqualification. Distributions from these retirement plans generally are
taxable as ordinary income when received.

State Street Bank and Trust Company ("Bank") presently acts as custodian for
retirement plans and imposes fees for administering them. Purchases of Fund
shares for a retirement plan must be made by direct remittance to the Bank.

When contributions for any tax-qualified plan are invested in Fund shares, all
dividends and capital gains distributions paid on those Fund shares are retained
in the plan and automatically reinvested in additional Fund shares at net asset
value. All earnings accumulate tax-free until distribution.

The investor should consult his or her own tax adviser concerning the tax
ramifications of establishing, and distributions from, a retirement plan.

DIVIDENDS, DISTRIBUTIONS AND TAXES

The Fund qualified during the last fiscal year for the tax treatment applicable
to regulated investment companies under the Internal Revenue Code ("Code") and
intends to so qualify in the future. Such qualification requires distributing at
least 90% of its investment company taxable income to shareholders and meeting
asset diversification and other requirements of the Code. As long as the Fund so
qualifies, it does not pay federal income tax on its net investment income or on
any net realized capital gains provided such income and capital gains are
distributed to shareholders. If for any taxable year the Fund does not so
qualify, all of its taxable income, including any net realized capital gains,
will be taxed at regular corporate rates (without any deduction for
distributions to shareholders).

The Fund is subject to a 4% excise tax to the extent it does not make certain
distributions to its shareholders. Such distributions must total (1) at least
98% of ordinary income (investment company taxable income subject to certain
adjustments) for any calendar year and (2) 98% of capital gains net income for
the 12 months ended October 31 of such year. The Fund intends to distribute
sufficient amounts to avoid liability for this excise tax.

If shares of the Fund are sold or exchanged within 90 days of acquisition, and
shares of the same or a related mutual fund are acquired, to the extent the
sales charge is reduced or waived on the subsequent acquisition, the sales
charge may not be used to determine the basis in the disposed shares for
purposes of

<PAGE>

determining gain or loss. To the extent the sales charge is not allowed in
determining gain or loss on the initial shares, it is capitalized in the basis
of the subsequent shares.

Under federal tax law, any loss a shareholder realizes on redemption of Fund
shares held for less than six months is treated as a long-term capital loss to
the extent of any long-term capital gain distribution which was paid on such
Fund shares.

Prior to purchasing Fund shares, the impact of dividends or capital gains
distributions should be carefully considered. Any such payments made to a
shareholder shortly after purchasing Fund shares reduce the net asset value of
such Fund shares to that extent and unnecessarily increase sales charges. All or
a portion of such dividends or distributions, although in effect a return of
capital, is subject to taxes, possibly at ordinary income tax rates.

Dividends and distributions declared payable to shareholders of record after
September 30 of any year and paid before February 1 of the following year are
considered taxable income to shareholders on the record date even though paid in
the next year. To the extent determined each year, a portion of the dividends
paid to shareholders from the Fund's net investment income qualifies for the 70%
dividends received deduction for corporations.

Some shareholders may be subject to 31% withholding on reportable dividends,
capital gains distributions and redemption payments ("backup withholding").
Generally, shareholders subject to backup withholding are those for whom a
taxpayer identification number is not on file with the Fund or who, to the
Fund's knowledge, furnished an incorrect number. When establishing an account,
an investor must certify under penalty of perjury that such number is correct
and that he or she is not subject to backup withholding.

Under existing provisions of the Code, dividends paid to shareholders who are
nonresident aliens may be subject to a 30% federal withholding tax applicable to
foreign individuals and entities unless a reduced rate of withholding or a
withholding exemption is provided under applicable treaty law. Nonresident
shareholders are urged to consult their own tax advisers concerning the
applicability of the federal withholding tax.

The foregoing is a general and abbreviated summary of the applicable provisions
of the Code and Treasury Regulations presently in effect. For the complete
provisions, reference should be made to the pertinent Code sections and Treasury
Regulations. The Code and these Treasury Regulations are subject to change by
legislative or administrative action either prospectively or retroactively.

Each investor should consult his or her own tax adviser as to federal tax laws
and the effect of state and local tax laws which may differ from federal tax
laws.

DISTRIBUTOR

The Distributor acts as principal underwriter of Fund shares pursuant to the
Distribution Agreement. The Distributor receives commissions from the sale of
Fund shares and has the exclusive right to distribute Fund shares through
dealers. From commissions received, the Distributor pays sales commissions to
dealers; its own overhead and general administrative expenses; the cost of
printing and distributing Fund prospectuses; and the cost of printing and
distributing sales literature and advertising relating to the Fund. The Fund
pays expenses attributable to registering Fund shares under federal and state
laws (including registration and filing fees) and related legal and audit
expenses.

<PAGE>

The Distribution Agreement is renewable annually if specifically approved each
year (a) by the Fund's Board of Directors or by a vote of a majority (as defined
in the Investment Company Act) of the Fund's outstanding voting securities and
(b) by a majority of the Fund's directors who are not parties to the
Distribution Agreement or interested persons (as defined in the Investment
Company Act) of any such party, by votes cast in person at a meeting called for
such purpose. The continuation of the Distribution Agreement to September 3,
2000 has been approved by the Board of Directors and a majority of the Fund's
directors who are not parties to the Distribution Agreement or interested
persons of any such party (as defined in the Investment Company Act). The
Distribution Agreement terminates if assigned (as defined in the Investment
Company Act) and may be terminated at any time on 60 days' written notice,
without penalty, by the Fund's Board of Directors, the vote of a majority of the
Fund's outstanding voting securities or the Distributor.

The Distributor's obligation under the Distribution Agreement is an agency or
best efforts arrangement pursuant to which the Distributor is required to take
and pay for only those Fund shares sold to the public.

The Distributor is not obligated to sell any stated number of Fund shares.

For the fiscal years ended March 31, 1997, 1998 and 1999, underwriting
commissions on the sale of Fund shares were $1,426,002, $518,766 and $269,968,
respectively. Of such totals, the amount retained each year by the Distributor,
after reallowance to other dealers, was $59,953, $40,556 and $21,376,
respectively.

PRIOR PERFORMANCE INFORMATION

For the purposes of quoting and comparing the performance of the Fund to that of
other mutual funds and to other relevant market indices in advertisements,
performance may be stated in terms of total return. Under regulations adopted by
the Securities and Exchange Commission ("SEC"), funds that intend to advertise
performance must include total return quotations calculated according to the
following formula:

n
P(1 + T) = ERV

Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years (1, 5 or 10)

ERV = ending redeemable value of a hypothetical
$1,000 payment, made at the beginning of the 1, 5 or
10 year period, at the end of such period (or
fractional portion thereof).

Under the foregoing formula, the time periods used in advertising will be based
on rolling calendar quarters, updated to the last day of the most recent quarter
prior to submission of the advertising for publication, and cover 1, 5 and
10-year periods of a fund's existence or such shorter period dating from the
effectiveness of a fund's registration statement. In calculating the ending
redeemable value, the maximum sales load is deducted from the initial $1,000
payment and all dividends and distributions by a fund are assumed to have been
reinvested at net asset value as described in the Prospectus on the reinvestment
dates during the period. Total return, or "T" in the formula above, is computed
by finding the average annual compounded rates of return over the 1, 5 and
10-year periods (or fractional portion thereof) that would equate the initial
amount invested to the ending redeemable value.

<PAGE>

The Fund may also from time to time include in such advertising a total return
figure that is not calculated according to the formula set forth above in order
to compare the performance of the Fund with other measures of investment return.
For example, in comparing the Fund's total return with a stock index such as the
Russell 2000 Index, the Fund calculates its aggregate total return for the
specified periods of time by assuming the investment of $10,000 in Fund shares
and assuming the reinvestment of each dividend or other distribution at net
asset value on the reinvestment date. Percentage increases are determined by
subtracting the initial value of the investment from the ending value and by
dividing the remainder by the beginning value. The Fund does not, for these
purposes, deduct from the initial value invested any amount representing sales
charges. The Fund, however, discloses the maximum sales charge and also
discloses that inclusion of sales charges would reduce the performance quoted.
Such alternative total return information will be given no greater prominence in
such advertising than the information prescribed under SEC regulations.

The Fund's average annual total return (calculated in accordance with the SEC
regulations described above) for the one, five and ten-year periods ended
March 31, 1999 was (18.14)%, 17.31% and 17.97%, respectively. The Fund's
average annual total return (determined pursuant to the alternative
computation which does not include the maximum initial sales charge of 6.5%
of the offering price) for the same periods was (12.45)%, 18.90% and 18.76%,
respectively. These results are based on historical earnings and asset value
fluctuations and are not intended to indicate future performance.

The foregoing information should be considered in light of the Fund's investment
objectives and policies, as well as the risks incurred in the Fund's investment
practices. Future results will be affected by the future composition of the
Fund's portfolio, as well as by changes in the general price level of equity
securities, and general economic and other market conditions. The past 1, 5 and
10-year periods have been ones of generally rising common stock prices subject
to short-term fluctuations.

<PAGE>

PORTFOLIO OF INVESTMENTS
March 31, 1999

<TABLE>
<CAPTION>
COMMON STOCKS Shares Value
- ------------------------------------------------------ ------------ ------------
<S> <C> <C>
TECHNOLOGY -- 26.7%
AVX Corporation....................................... 625,000 $ 10,000,000
Arrow Electronics, Inc.*.............................. 1,319,500 19,792,500
Exabyte Corporation*+................................. 1,176,600 5,588,850
Hutchinson Technology Incorporated*................... 161,100 4,007,362
Keithley Instruments, Inc............................. 168,100 1,092,650
KEMET Corporation*.................................... 1,410,000 16,215,000
Komag, Incorporated*.................................. 1,034,500 4,525,937
Lam Research Corporation*............................. 476,300 13,812,700
Marshall Industries*.................................. 804,200 10,856,700
Seagate Technology, Inc.*............................. 378,200 11,180,538
Storage Technology Corporation*....................... 1,445,600 40,296,100
------------
$137,368,337
------------
RETAILING -- 26.4%
Consolidated Stores Corporation*...................... 1,200,000 $ 36,375,000
Craig Corporation (Class "A")*........................ 269,000 1,916,625
Good Guys, Inc., The*................................. 441,300 1,710,037
Gymboree Corporation, The*+........................... 1,428,800 12,769,900
HomeBase, Inc.*+...................................... 2,049,400 9,094,213
Michaels Stores, Inc.*................................ 1,260,700 31,123,531
Ross Stores, Inc...................................... 973,100 42,633,944
------------
$135,623,250
------------
FINANCIAL -- 15.9%
Comdisco, Inc......................................... 1,400,000 $ 25,025,000
Conseco, Inc.......................................... 1,286,355 39,716,211
Countrywide Credit Industries, Inc.................... 126,100 4,728,750
Foremost Corporation of America....................... 126,100 2,537,762
Horace Mann Educators Corporation..................... 336,200 7,795,638
Westcorp.............................................. 247,100 1,915,025
------------
$ 81,718,386
------------
CONSUMER DURABLES -- 8.5%
Champion Enterprises, Inc.*........................... 168,100 $ 3,256,937
Coachmen Industries, Inc.+............................ 840,500 17,230,250
Flexsteel Industries, Inc............................. 134,500 1,765,313
Recoton Corporation*+................................. 630,400 8,825,600
Thor Industries, Inc.................................. 550,000 12,443,750
------------
$ 43,521,850
------------
</TABLE>

<PAGE>

PORTFOLIO OF INVESTMENTS
March 31, 1999

<TABLE>
<CAPTION>
Shares or
Principal
COMMON STOCKS--CONTINUED Amount Value
- ------------------------------------------------------ ------------ ------------
<S> <C> <C>
CONSUMER NON-DURABLES -- 3.9%
Rawlings Sporting Goods Company, Inc.*................ 189,100 $ 1,560,075
Reebok International Ltd.*............................ 1,176,600 18,678,525
------------
$ 20,238,600
------------
BASIC MATERIALS -- 3.5%
International Aluminum Corporation.................... 168,100 $ 4,181,487
Oregon Steel Mills, Inc............................... 990,100 10,334,169
Rouge Industries, Inc. (Class "A").................... 420,300 3,677,625
------------
$ 18,193,281
------------
ENERGY -- 2.8%
ENSCO International Incorporated...................... 1,063,400 $ 14,156,512
------------
INDUSTRIAL PRODUCTS -- 1.7%
Belden Inc............................................ 504,300 $ 8,604,619
------------
INDUSTRIAL SERVICES -- 1.4%
Angelica Corporation+................................. 504,300 $ 7,060,200
------------
CONSUMER SERVICES -- 1.3%
CPI Corp.............................................. 300,300 $ 6,719,213
------------
DEFENSE -- 0.7%
DRS Technologies, Inc.*+.............................. 428,700 $ 3,429,600
------------
TOTAL COMMON STOCKS -- 92.8%
(Cost $371,670,248)................................. $476,633,848
------------
CONVERTIBLE SECURITIES -- 1.1%
Lam Research Corporation-- 5% 2002.................... $3,474,000 $ 2,892,105
Worthington Industries, Inc.-- 7 1/4% 2000............ 5,146,000 2,988,000
------------
TOTAL CONVERTIBLE SECURITIES
(Cost $5,942,706)................................... $ 5,880,105
------------
</TABLE>

<PAGE>

PORTFOLIO OF INVESTMENTS
March 31, 1999

<TABLE>
<CAPTION>
Principal
Amount Value
------------ ------------
<S> <C> <C>
NON-CONVERTIBLE BONDS & DEBENTURES -- 5.6%
Federal Home Loan Mortgage Corporation
--7% 2020 (PAC-IO-CMO)............................... $ 3,156,714 $ 428,129
Trump Atlantic City Associates -- 11 1/4% 2006........ 4,000,000 3,540,000
U.S. Treasury Inflation-Indexed Notes -- 3 3/8% 2007.. 25,868,293 24,890,148
------------
TOTAL NON-CONVERTIBLE BONDS & DEBENTURES
(Cost $29,383,317)................................. $ 28,858,277
------------
TOTAL INVESTMENT SECURITIES -- 99.5%
(Cost $406,996,271)................................ $511,372,230
------------
SHORT-TERM CORPORATE NOTE -- 0.4% (Cost $1,933,000)
American Express Credit Corporation -- 4.92% 4/1/99... $ 1,933,000 $ 1,933,000
------------
TOTAL INVESTMENTS -- 99.9%
(Cost $408,929,271)................................ $513,305,230
Other assets less liabilities-- 0.1%.................. 589,109
------------

TOTAL NET ASSETS -- 100.0%............................ $513,894,339
------------
------------
</TABLE>

*Non-income producing securities
+Affiliate as defined in the Investment Company Act of 1940 by reason of
ownership of 5% or more of its outstanding voting securities. Following is a
summary of transactions in securities of these affiliates during the year ended
March 31, 1999. Sales are comprised of securities redeemed in-kind (See Note 2).

<TABLE>
<CAPTION>
Purchases Sales Realized Dividend
at Cost at Cost Gain (Loss) Income
---------------------------------------------------
<S> <C> <C> <C> <C>
Angelica Corporation $ 2,289,500 $1,835,139 -- $553,032
Coachmen Industries, Inc. -- 538,059 -- 192,025
DRS Technologies, Inc. -- 133,046 -- --
Exabyte Corporation 3,003,000 2,231,643 -- --
Gymboree Corporation, The 19,141,181 2,031,242 -- --
HomeBase, Inc. 4,906,678 2,208,143 -- --
Recoton Corporation 5,497,350 1,693,297 -- --
</TABLE>

See notes to financial statements.

<PAGE>

STATEMENT OF ASSETS AND LIABILITIES
March 31, 1999

<TABLE>
<S> <C> <C>
ASSETS
Investments at value:
Investment securities -- at market value
(identified cost $406,996,271).................. $511,372,230
Short-term investments -- at cost plus
interest earned
(maturities 60 days or less).................... 1,933,000 $513,305,230
------------
Cash................................................ 27
Receivable for:
Investment securities sold........................ $ 8,734,633
Dividends and accrued interest.................... 901,947
Capital Stock sold................................ 256,101 9,892,681
------------ ------------
$523,197,938

LIABILITIES
Payable for:

Capital Stock repurchased......................... $ 5,450,659
Investment securities purchased................... 3,441,161
Advisory fees and financial services.............. 331,557
Accrued expenses and other liabilities............ 80,222 9,303,599
------------ ------------

NET ASSETS ........................................... $513,894,339
------------
------------

SUMMARY OF SHAREHOLDERS' EQUITY

Capital Stock -- par value $0.01 per share; authorized
100,000,000 shares; outstanding 16,936,620 shares. $ 169,366
Additional Paid-in Capital.......................... 393,603,915
Undistributed net realized gain on investments...... 13,485,691
Undistributed net investment income................. 2,259,408
Unrealized appreciation of investments.............. 104,375,959
------------
NET ASSETS.......................................... $513,894,339
------------
------------

NET ASSET VALUE, REDEMPTION PRICE AND MAXIMUM
OFFERING PRICE PER SHARE
Net asset value and redemption price per share
(net assets divided by shares outstanding)......... $30.34
------
------
Maximum offering price per share
(100/93.5 of per share net asset value)............ $32.45
------
------
</TABLE>

See notes to financial statements.

<PAGE>

STATEMENT OF OPERATIONS
For the Year Ended March 31, 1999

<TABLE>
<S> <C> <C>
INVESTMENT INCOME

Interest.......................................... $ 10,294,517
Dividends (including $745,057 from
securities of affiliates)....................... 3,515,906
--------------
$ 13,810,423
EXPENSES

Advisory fees..................................... $ 4,508,974
Financial services................................ 685,996
Transfer agent fees and expenses.................. 284,845
Custodian fees and expenses....................... 60,213
Registration fees................................. 56,528
Directors' fees and expenses...................... 36,938
Postage........................................... 33,862
Insurance......................................... 28,392
Audit fees........................................ 27,850
Reports to shareholders........................... 20,577
Legal fees........................................ 18,541
Other expenses.................................... 7,190 5,769,906
------------ --------------
Net investment income..................... $ 8,040,517
--------------
NET REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
Net realized gain on investments:
Proceeds from sales of investment securities
(excluding short-term investments with
maturities of 60 days or less)................... $142,864,265
Cost of investment securities sold................ 120,679,871
------------
Net realized gain on investments.............. $ 22,184,394

Unrealized appreciation of investments:

Unrealized appreciation at beginning of year...... $282,880,397
Unrealized appreciation at end of year............ 104,375,959
------------
Decrease in unrealized appreciation
of investments............................... (178,504,438)
Net unrealized appreciation reclassified
on investments redeemed in-kind--Note 2.............. 50,764,552
--------------
Net realized and unrealized
loss on investments...................... $(105,555,492)
--------------
NET DECREASE IN NET ASSETS RESULTING
FROM OPERATIONS..................................... $ (97,514,975)
--------------
--------------
</TABLE>

See notes to financial statements.

<PAGE>

STATEMENT OF CHANGES IN NET ASSETS

<TABLE>
<CAPTION>
For the Year Ended March 31,
------------------------------------------------------------
1999 1998
---------------------------- ----------------------------
<S> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
Operations:
Net investment income............................ $ 8,040,517 $ 9,718,899
Net realized gain on investments................. 22,184,394 90,751,629
Increase (decrease) in unrealized
appreciation of investments.................... (178,504,438) 84,207,829
Net unrealized appreciation reclassified
on investments redeemed in-kind................ 50,764,552 --
------------ ------------
Increase (decrease) in net assets
resulting from operations........................ $ (97,514,975) $184,678,357

Distributions to shareholders from:
Net investment income............................ $ (8,475,386) $ (9,124,117)
Net realized capital gains....................... (67,364,919) (75,840,305) (53,573,352) (62,697,469)
------------ ------------
Capital Stock transactions:
Proceeds from Capital Stock sold................. $112,648,442 $124,393,171
Proceeds from shares issued to
shareholders upon reinvestment
of dividends and distributions................. 67,687,754 55,553,713
Cost of Capital Stock repurchased................ (282,522,710) (102,186,514) (109,675,323) 70,271,561
------------ ------------ ------------ ------------
Total increase (decrease) in net assets............ $(275,541,794) $192,252,449

NET ASSETS
Beginning of year, including
undistributed net investment income
of $2,694,277 and $2,099,495..................... 789,436,133 597,183,684
------------- -----------
End of year, including undistributed
net investment income
of $2,259,408 and $2,694,277..................... $ 513,894,339 $789,436,133
------------- -----------
------------- -----------
CHANGE IN CAPITAL STOCK
OUTSTANDING
Shares of Capital Stock sold....................... 3,365,864 3,531,612
Shares issued to shareholders upon
reinvestment of dividends and
distributions.................................... 1,948,828 1,631,634
Shares of Capital Stock repurchased................ (8,989,993) (3,052,450)
------------- -----------
Increase (decrease) in Capital
Stock outstanding................................. (3,675,301) 2,110,796
------------- -----------
------------- -----------
</TABLE>

See notes to financial statements.

<PAGE>

NOTES TO FINANCIAL STATEMENTS
March 31, 1999

NOTE 1 -- SIGNIFICANT ACCOUNTING POLICIES

The Fund is registered under the Investment Company Act of 1940, as a
diversified, open-end investment company. The Fund's primary investment
objective is long-term capital growth. Current income is a factor, but a
secondary consideration. The following is a summary of significant accounting
policies consistently followed by the Fund in the preparation of its financial
statements.

A. Security Valuation

Securities listed or traded on a national securities exchange or on the
NASDAQ National Market System are valued at the last sale price on the last
business day of the year, or if there was not a sale that day, at the last
bid price. Unlisted securities are valued at the most recent bid price.
Short-term investments with maturities of 60 days or less are valued at cost
plus interest earned, which approximates market value.

B. Federal Income Tax

No provision for federal income tax is required because the Fund has
elected to be taxed as a "regulated investment company" under the Internal
Revenue Code and intends to maintain this qualification and to distribute
each year to its shareholders, in accordance with the minimum distribution
requirements of the Code, all of its taxable net investment income and
taxable net realized gains on investments.

C. Securities Transactions and Related Investment Income

Securities transactions are accounted for on the date the securities are
purchased or sold. Dividend income and distributions to shareholders are
recorded on the ex-dividend date. Interest income and expenses are recorded
on an accrual basis.

D. Use of Estimates

The preparation of the financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported. Actual results could differ
from those estimates.

NOTE 2 -- PURCHASES OF INVESTMENT SECURITIES

Cost of purchases of investment securities (excluding short-term investments
with maturities of 60 days or less) aggregated $177,708,822 for the year ended
March 31, 1999. Investments with a market value of $106,427,788 and a cost of
$55,663,236, were redeemed in-kind during the year ended March 31, 1999. Net
unrealized appreciation on these investments redeemed in-kind of $50,764,552 was
reclassified to paid-in capital. Realized gains or losses are based on the
specific-certificate identification method. Cost of securities held at March 31,
1999 was the same for federal income tax and financial reporting purposes. Gross
unrealized appreciation and depreciation for all investments at March 31, 1999
for federal income tax purposes was $173,365,399 and $68,989,440, respectively.

NOTE 3 -- ADVISORY FEES AND OTHER AFFILIATED TRANSACTIONS

Pursuant to an Investment Advisory Agreement, advisory fees were paid by the
Fund to First Pacific Advisors, Inc. (the "Adviser"). Under the terms of this
Agreement, the Fund pays the Adviser a monthly fee calculated at the annual rate
of 0.75% of the first $50 million of the Fund's average daily net assets and
0.65% of the average daily net assets in excess of $50 million. In addition, the
Fund pays the Adviser an amount equal to 0.1% of the average daily net assets
for each fiscal year in reimbursement for the provision of financial services to
the Fund. The Agreement provides that the Adviser will reimburse the Fund for
any annual expenses (exclusive of interest, taxes, the cost of any supplemental
statistical and research information, and extraordinary expenses such as
litigation) in excess of 1 1/2% of the first $30 million and 1% of the remaining
average net assets of the Fund for the year.

<PAGE>

NOTES TO FINANCIAL STATEMENTS
CONTINUED

For the year ended March 31, 1999, the Fund paid aggregate fees of $36,500 to
all Directors who are not affiliated persons of the Adviser. Legal fees were for
services rendered by O'Melveny & Myers LLP, counsel for the Fund. A Director of
the Fund is of counsel to, and a retired partner of, that firm. Certain officers
of the Fund are also officers of the Adviser and FPA Fund Distributors, Inc.

NOTE 4 -- DISTRIBUTOR

For the year ended March 31, 1999, FPA Fund Distributors, Inc.
("Distributor"), a wholly owned subsidiary of the Adviser, received $21,376 in
net Fund share sales commissions after reallowance to other dealers. The
Distributor pays its own overhead and general administrative expenses, the cost
of supplemental sales literature, promotion and advertising.

NOTE 5 -- SALES OF FUND SHARES

Shares of the Fund are presently offered for sale only to existing
shareholders and to directors, officers, and employees of the Fund, the Adviser,
and affiliated companies. The discontinuation of sales to new investors reflects
Management's belief that unrestrained growth in the Fund's net assets might
impair investment flexibility. The Fund may resume at any time the sale of its
shares to new investors if, in the Board of Directors' opinion, doing so would
be in the best interests of the Fund and its shareholders.

<PAGE>

REPORT OF INDEPENDENT AUDITORS

TO THE BOARD OF DIRECTORS AND
SHAREHOLDERS OF FPA CAPITAL FUND, INC.

We have audited the accompanying statement of assets and liabilities of FPA
Capital Fund, Inc. (the "Fund"), including the portfolio of investments, as of
March 31, 1999, the related statement of operations for the year then ended, the
statement of changes in net assets for each of the two years in the period then
ended, and the financial highlights on page 17 of the Prospectus for each of the
five years in the period then ended. These financial statements and financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and financial highlights
based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements and
financial highlights are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements and financial highlights, including confirmation
of securities owned as of March 31, 1999 by correspondence with the
custodian and brokers. 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 FPA
Capital Fund, Inc. at March 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 on page 17 of the Prospectus,
for each of the five years in the period then ended in conformity with generally
accepted accounting principles.

/s/ ERNST & YOUNG LLP
ERNST & YOUNG LLP

Los Angeles, California
April 30, 1999