<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 31, 1997
FILE NO. 2-30393
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [X]
PRE-EFFECTIVE AMENDMENT NO. [ ]
POST-EFFECTIVE AMENDMENT NO. 38 [X]
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [X]
AMENDMENT NO. 19 [X]
FPA NEW INCOME, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
11400 WEST OLYMPIC BOULEVARD, SUITE 1200
LOS ANGELES, CALIFORNIA 90064
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(310)473-0225
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
----------------------
JULIO J. DE PUZO, JR., EXEC. V.P. COPY TO:
FPA NEW INCOME, INC. LAWRENCE J. SHEEHAN, ESQ.
11400 WEST OLYMPIC BOULEVARD, SUITE 1200 O'MELVENY & MYERS LLP
LOS ANGELES, CALIFORNIA 90064 1999 AVENUE OF THE STARS
(NAME AND ADDRESS OF AGENT FOR SERVICE) LOS ANGELES, CALIFORNIA 90067
----------------------
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING:
AS SOON AS PRACTICABLE AFTER REGISTRATION STATEMENT BECOMES
EFFECTIVE.
IT IS PROPOSED THAT THIS FILING WILL BECOME EFFECTIVE (CHECK APPROPRIATE BOX)
[X] IMMEDIATELY UPON FILING PURSUANT TO PARAGRAPH (B)
[ ] ON (DATE) PURSUANT TO PARAGRAPH (B)
[ ] 60 DAYS AFTER FILING PURSUANT TO PARAGRAPH (A)(I)
[ ] ON (DATE) PURSUANT TO PARAGRAPH (A)(I)
[ ] 75 DAYS AFTER FILING PURSUANT TO PARAGRAPH (A)(II)
[ ] ON (DATE) PURSUANT TO PARAGRAPH (A)(II) OF RULE 485
IF APPROPRIATE, CHECK THE FOLLOWING BOX:
[ ] THIS POST-EFFECTIVE AMENDMENT DESIGNATES A NEW EFFECTIVE DATE
FOR A PREVIOUSLY FILED POST-EFFECTIVE AMENDMENT.
REGISTRANT HAS REGISTERED AN INDEFINITE NUMBER OF SHARES UNDER THE
SECURITIES ACT OF 1933 PURSUANT TO RULE 24F-2 UNDER THE INVESTMENT COMPANY ACT
OF 1940, AND FILED A RULE 24F-2 NOTICE FOR ITS LAST FISCAL YEAR ON NOVEMBER 27,
1996.
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<PAGE> 2
FPA NEW INCOME, INC.
CROSS REFERENCE SHEET
Form N-1A
Item Prospectus Caption
---- ------------------
Part A
- ------
1. Cover Page............................ Cover Page
2. Synopsis.............................. Expense Synopsis
3. Condensed Financial Information....... Financial Highlights;
Current Yield (in SAI)
4. General Description of Registrant..... Investment Objective and Policies;
The Fund and Its Management;
Investment Practices
5. Management of the Fund................ Cover Page; The Fund and Its
Management; Additional Information -
Shareholder Service Agent
6. Capital Stock and Securities.......... Dividends, Distributions and Taxes;
Additional Information
7. Purchase of Securities Being Offered.. Cover Page; The Fund and Its
Management; Purchase of Shares;
Shareholder Services; Redemption of
Shares - Reinvestment Privilege;
Dividends, Distributions and Taxes
8. Redemption or Repurchase.............. Redemption of Shares
9. Legal Proceedings..................... Inapplicable
<PAGE> 3
Form N-1A Statement of Additional
Item Information Caption
---- -------------------
Part B
- ------
10. Cover Page............................. Cover Page
11. Table of Contents...................... Table of Contents
12. General Information and History........ General Information - History
13. Investment Objectives and Policies..... Investment Policies; Ratings;
Investment Restrictions; Portfolio
Turnover
14. Management of the Fund................. Directors and Officers of the Fund
15. Control Persons and Principal Holders.. Directors and Officers of the Fund
of Securities
16. Investment Advisory and Other Services. Directors and Officers of the Fund;
Investment Advisory Agreement
17. Brokerage Allocation and Other......... Portfolio Transactions
Practices
18. Capital Stock and Other Securities..... General Information - Voting Rights
19. Purchase, Redemption and Pricing of.... Purchase and Redemption of Shares;
Securities Being Offered Tax Sheltered Retirement Plans
20. Tax Status............................. Dividends, Distributions and Taxes
21. Underwriters........................... Distributor
22. Calculation of Yield Quotation of...... Inapplicable
Money Market Funds
23. Financial Statements................... Financial Statements
ii
<PAGE> 4
- --------------------------------------------------------------------------------
PROSPECTUS
FPA New Income, Inc.
("Fund") seeks current
income and long-term total
return. The Fund's
investment adviser, First
Pacific Advisors, Inc.
("Adviser"), invests the
Fund's assets primarily in
fixed-income securities,
with an emphasis on
obligations issued or
guaranteed by the United
States Government and its
agencies and
instrumentalities.
This Prospectus briefly
outlines information
prospective investors should
know before purchasing Fund
shares. Investors should
read and retain this
Prospectus for future
reference.
A Statement of Additional
Information about the Fund
dated January 31, 1997,
which is incorporated by
reference in this
Prospectus, has been filed
with the Securities and
Exchange Commission. It is
available at no charge by
contacting 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 from
Alaska, Hawaii and Puerto
Rico.
THESE SECURITIES HAVE NOT
BEEN APPROVED OR DISAPPROVED
BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY
STATE SECURITIES COMMISSION
NOR HAS THE SECURITIES AND
EXCHANGE COMMISSION OR ANY
STATE SECURITIES COMMISSION
LOGO PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS.
Distributor: ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL
OFFENSE.
FPA FUND DISTRIBUTORS, INC.
11400 West Olympic Boulevard, Suite 1200
Los Angeles, CA 90064
JANUARY 31, 1997
- -----------------------------------------------------------------------------
<PAGE> 5
FPA NEW INCOME, INC.
11400 West Olympic Boulevard, Suite 1200
Los Angeles, California 90064
(310) 473-0225
INVESTMENT First Pacific Advisors, Inc.
ADVISER: 11400 West 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 Services, Inc.
SERVICE AGENT: P.O. Box 8500
Boston, Massachusetts 02266-8500
(617) 328-5000
(800) 638-3060 except
Alaska, Hawaii,
Massachusetts and
Puerto Rico
CUSTODIAN AND State Street Bank and Trust Company
TRANSFER AGENT: 225 Franklin Street
Boston, Massachusetts 02110
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 THE DISTRIBUTOR.
TABLE OF CONTENTS
PAGE
Expense Synopsis................. 3
Financial Highlights............. 4
Investment Objective and
Policies......................... 4
The Fund and Its Management...... 6
Advisory Agreement............. 6
FPA Fund Family................ 7
Prior Performance
Information...................... 7
Purchase of Shares............... 8
Net Asset Value................ 8
Table of Sales Charges......... 8
Cumulative Purchase Discount... 9
Letter of Intent............... 9
Sales at Net Asset Value....... 9
Shareholder Services............. 10
FPA Exchange Privilege......... 10
Money Market Fund Exchange
Privilege........................ 10
How to Exchange Shares......... 10
Investment Account............. 11
Pre-Authorized Investment
Plan............................. 11
Retirement Plans............... 11
Systematic Withdrawal Plan..... 11
Redemption of Shares............. 12
Telephone Transactions......... 12
Reinvestment Privilege......... 13
Dividends, Distributions and
Taxes............................ 13
PAGE
Dividends...................... 13
Capital Gains.................. 13
Taxes.......................... 13
Investment Practices and Risks... 14
U.S. Government Securities..... 14
Mortgage-Backed Securities..... 14
Risks of Mortgage-Backed
Securities.................... 18
Asset-Backed Securities........ 19
Convertible Securities and Lower
Rated Debt Securities.......... 19
Securities of Foreign
Issuers....................... 21
Delayed Delivery............... 21
Short Sales Against the Box.... 21
Repurchase Agreements.......... 22
Portfolio Transactions......... 22
Portfolio Turnover............. 22
Additional Information........... 23
Common Stock................... 23
Voting Rights.................. 23
Shareholder Inquiries.......... 23
Shareholder Service Agent...... 23
Custodian...................... 23
Legal Counsel.................. 23
Independent Auditors........... 23
- --------------------------------------------------------------------------------
No dealer, salesman, or other person has been authorized to give any information
or to make any representations other than those contained in this Prospectus or
in supplemental sales literature distributed by the Distributor in connection
with the offer contained in this Prospectus, and, if given or made, such other
information or representations must not be relied upon as having been authorized
by the Fund or by the Distributor. This Prospectus does not constitute an
offering by the Distributor in any jurisdiction in which such offering may not
lawfully be made.
2
<PAGE> 6
EXPENSE SYNOPSIS
<TABLE>
<S> <C>
SHAREHOLDER TRANSACTION EXPENSES
Maximum Sales Load Imposed on Purchases (as a percentage
of offering price)...................................................... 4.50%
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
(as a percentage of average net assets)
Management Fees........................................................... 0.50%
12b-1 Fees................................................................ None
Other Expenses............................................................ 0.13%
-----
Total Fund Operating Expenses............................................. 0.63%
</TABLE>
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
EXAMPLE
You would pay the following expenses
on a $1,000 investment, assuming
(1) five percent annual return and
(2) redemption at the end of each time period: $51.00 $ 64.00 $ 79.00 $ 120.00
</TABLE>
- ---------------
* An account management fee is charged by unaffiliated investment advisers or
broker-dealers to certain accounts entitled to purchase shares without sales
charge.
The foregoing synopsis is intended to assist the investor in understanding the
various costs and expenses that an investor in the Fund will bear directly or
indirectly. See "Purchase of Shares" and "The Fund and Its Management." The
example is included to provide a means for the investor to compare expense
levels of funds with different fee structures over varying investment periods.
To facilitate such comparison, all funds are required to utilize a five percent
annual return assumption. This assumption is unrelated to the Fund's prior
performance and is not a projection of future performance. THE EXAMPLE SHOULD
NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES. ACTUAL EXPENSES
MAY BE GREATER OR LESSER THAN THOSE SHOWN.
3
<PAGE> 7
FINANCIAL HIGHLIGHTS
The following information has been audited by the Fund's independent auditors.
Their report appears in the Statement of Additional Information. This
information should be read in conjunction with the related financial statements
included in the Statement of Additional Information, which can be obtained
without charge from the Distributor at the address shown on the cover page of
this Prospectus.
For one share outstanding throughout each year
<TABLE>
<CAPTION>
FOR THE YEARS ENDED SEPTEMBER 30,
-------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
------- ------- ------- ------- ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Per share operating
performance:
Net asset value at beginning
of year................... $ 11.05 $ 10.52 $ 11.32 $ 10.90 $10.47 $ 9.47 $ 9.92 $ 9.72 $ 9.10 $ 9.46
------- ------- ------- ------- ------ ------ ------ ------ ------ ------
Net investment income....... $ 0.68 $ 0.67 $ 0.68 $ 0.70 $ 0.73 $ 0.84 $ 0.79 $ 0.73 $ 0.67 $ 0.77
Net realized and unrealized
gain (loss) on investment
securities................ 0.06 0.55 (0.51) 0.49 0.66 1.02 (0.40) 0.24 0.55 (0.26)
------- ------- ------- ------- ------ ------ ------ ------ ------ ------
Total from investment
operations................ $ 0.74 $ 1.22 $ 0.17 $ 1.19 $ 1.39 $ 1.86 $ 0.39 $ 0.97 $ 1.22 $ 0.51
------- ------- ------- ------- ------ ------ ------ ------ ------ ------
Less distributions:
Dividends from net
investment income......... $ (0.66) $ (0.69) $ (0.70) $ (0.70) $(0.76) $(0.85) $(0.77) $(0.72) $(0.59) $(0.84)
Distributions from net
realized capital gains.... (0.16) -- (0.27) (0.07) (0.20) (0.01) (0.07) (0.05) (0.01) (0.03)
------- ------- ------- ------- ------ ------ ------ ------ ------ ------
Total distributions......... $ (0.82) $ (0.69) $ (0.97) $ (0.77) $(0.96) $(0.86) $(0.84) $(0.77) $(0.60) $(0.87)
------- ------- ------- ------- ------ ------ ------ ------ ------ ------
Net asset value at end of
year...................... $ 10.97 $ 11.05 $ 10.52 $ 11.32 $10.90 $10.47 $ 9.47 $ 9.92 $ 9.72 $ 9.10
======= ======= ======= ======= ====== ====== ====== ====== ====== ======
Total investment return *... 7.00% 12.14% 1.60% 11.42% 14.10% 20.69% 4.10% 10.54% 13.78% 5.47%
Ratios/supplemental data:
Net assets at end of year
(in $000's)............... 338,297 207,018 122,708 115,062 80,489 41,859 34,889 20,887 12,009 6,955
Ratio of expenses to average
net assets................ 0.63% 0.68% 0.74% 0.73% 0.78% 0.87% 0.94% 1.10% 1.52% 1.52%
Ratio of net investment
income to average net
assets.................... 6.44% 6.50% 6.41% 6.48% 7.17% 8.46% 8.48% 8.16% 7.76% 8.28%
Portfolio turnover rate..... 16% 31% 39% 41% 22% 26% 29% 18% 55% 103%
</TABLE>
- ---------------
* Return is based on net asset value per share, adjusted for reinvestment of
distributions, and does not reflect deduction of the sales charge.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to seek current income and long-term
total return. At least 65% of the Fund's net assets are invested in income
producing securities. The Fund generally invests a significant portion (50% or
more) of its assets in debt obligations issued or guaranteed by the United
States Government and its agencies and instrumentalities, including
mortgage-backed securities. See "Investment Practices and Risks -- U.S.
Government Securities" and
4
<PAGE> 8
"-- Mortgage-Backed Securities." There is no assurance that the Fund will
succeed in achieving its investment objectives. Fund shares are not insured or
guaranteed.
The Fund invests primarily in fixed-income securities, including convertible
securities. The market price of fixed-income securities held by the Fund
generally can be expected to vary inversely to changes in prevailing interest
rates. Investments in fixed-income securities with longer maturities generally
produce higher yields but are subject to greater market fluctuation. The average
maturity, which is likely to vary substantially from time to time, of the debt
securities owned by the Fund on September 30, 1996 was 4.9 years.
The Fund's current operating policy is to invest at least 75% of its total
assets, calculated at market value at the time of investment, in the following
types of securities:
(1) securities issued or guaranteed by the United States Government, its
agencies or instrumentalities;
(2) marketable, non-convertible debt securities rated at the time of purchase
within the two highest grades as determined by either Moody's Investors
Service, Inc. ("Moody's") (Aaa and Aa) or by Standard & Poor's Corporation
("S&P") (AAA and AA) (see "Ratings" in the Statement of Additional
Information);
(3) commercial paper of U.S. issuers which at the time of investment is (a)
rated in the highest category by Moody's (Prime-1) or S&P (A-1) or (b)
issued by a company which, at the date of investment, has any outstanding
debt securities rated at least Aa by Moody's or AA by S&P; and
(4) repurchase agreements with a member bank of the Federal Reserve System or a
U.S. securities dealer (see "Investment Practices and Risks -- Repurchase
Agreements").
Up to 25% of the Fund's assets, calculated at market value at the time of
investment, may be invested in: (a) non-convertible debt securities which are
not rated in the highest two grades by Moody's or S&P; (b) convertible debt
securities; and (c) preferred stocks in an amount not exceeding 5% of the Fund's
assets. Such debt securities may include so-called junk bonds. See "Investment
Practices and Risks -- Convertible Securities and Lower Rated Debt Securities."
Up to 30% of the Fund's net assets may be invested, or committed for investment,
in securities offered on a delayed delivery basis. Up to 15% of the Fund's net
assets may be invested in interest only and principal only classes of stripped
mortgage securities, collateralized mortgage obligations structured as accrual
certificates, also known as Z-Bonds, and inverse floaters. The prices of these
derivative securities are likely to be volatile in the event of changes in
interest rates or in mortgage prepayment rates, or expectations related thereto.
See "Investment Practices and Risks -- Mortgage-Backed Securities" and "-- Risks
of Mortgage-Backed Securities." The Fund may invest up to 10% of its net assets
in securities of foreign issuers. Such investments involve additional risks and
opportunities compared with securities of United States issuers. The foregoing
limitations may be changed by the Board of Directors.
Percentage limitations are calculated and applied at the time of investment. See
"Investment Practices and Risks" for additional information concerning the
Fund's investment practices and the risks thereof.
5
<PAGE> 9
At September 30, 1996, the percentage of the Fund's total net assets invested in
debt securities (including convertible securities) within the various rating
categories (based on the higher of the S&P or Moody's ratings) were as follows:
<TABLE>
<S> <C>
U. S. Government.............................. 52%
AAA/AA........................................ 4
BBB........................................... 2*
BB/Ba......................................... 2
B/B........................................... 5*
Nonrated...................................... 1**
Preferred Stock............................... 1
Cash and Equivalents.......................... 33
----
Total Net Assets 100%
====
</TABLE>
- ---------------
* Includes Convertible Securities
** The nonrated debt securities as a percentage of total net assets were
considered by the Adviser to be comparable to securities rated by S&P as B.
THE FUND AND ITS MANAGEMENT
The Fund is a diversified, open-end management investment company, generally
called a mutual fund, which was incorporated in Delaware on June 24, 1966, and
reincorporated in Maryland on December 27, 1994. 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 four directors is responsible for overseeing the Fund's affairs. The
Adviser selects investments for the Fund, provides administrative services and
manages the Fund's business. The Adviser, together with its predecessors, has
been in the investment advisory business since 1954, serving as invesment
adviser to the Fund since July 11, 1984. 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 twelve
years. Presently, the Adviser manages assets of approximately $3.8 billion for
six investment companies, including one closed-end investment company, and 39
institutional accounts. All officers of the Fund are also officers of the
Adviser. Certain officers of the Fund are also officers of the Distributor. The
Adviser and the Distributor are indirect wholly owned subsidiaries of United
Asset Management Corporation ("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.
ADVISORY AGREEMENT. Under the Investment Advisory Agreement dated December 27,
1994, the Fund pays the Adviser a monthly fee computed on the average daily net
assets of the Fund at the annual rate of 0.50%. The Adviser reimburses the Fund
if operating expenses (exclusive of interest and taxes) exceed 1.50% of the
first $15 million and 1% of the Fund's remaining average net assets for any
fiscal year. For the last fiscal year, the advisory fee was $1,283,864.
6
<PAGE> 10
The Adviser pays for office space, facilities, business equipment and salaries,
including the salaries of the Fund's officers. The Fund pays all other expenses,
including the expense of the continuous public offering of Fund shares (such as
registering Fund shares for sale), preparation of prospectuses and reports to
shareholders and printing those prospectuses and reports furnished to existing
shareholders, the cost of transfer agency services, postage, custodial fees,
taxes, and legal and audit expenses. For the last fiscal year, the Fund's total
operating expenses, including taxes, were 0.63% of average net assets.
FPA FUND FAMILY. The Fund is one of four funds in the FPA Fund Family
(collectively, "FPA Funds"). FPA Capital Fund, Inc. ("Capital"), which currently
is not open to new investors, seeks long-term capital growth but current income
is also a factor. FPA Paramount Fund, Inc. ("Paramount") seeks a high total
investment return, including capital appreciation and income. FPA Perennial
Fund, Inc. ("Perennial"), which is primarily designed for retirement plans,
seeks long-term growth of capital with current income as a secondary
consideration.
The FPA Funds offer exchange privileges and telephone redemptions plus combined
shareholdings for cumulative purchase discounts and letters of intent. These
privileges are described under "Purchase of Shares," "Shareholder Services" and
"Redemption of Shares." The account information form should be used to change
information and authorize these services. Authorizing exchange privileges or
telephone redemptions requires a signature guarantee, which is described under
"Redemption of Shares." The account information form is available from
authorized securities dealers ("dealers") or the Distributor.
PRIOR PERFORMANCE INFORMATION. From time to time, the Fund's total average
annual return for 1, 5 and 10 year periods may be quoted in advertisements.
Other total return quotations, aggregate or average, over other time periods may
also be included. Average annual total return reflects the average annual
percentage change in value of an investment in the Fund over the measuring
period. Aggregate total return reflects the total percentage change in value
over the measuring period. Total return calculations assume that dividends and
capital gain distributions paid by the Fund during the period are reinvested in
Fund shares at net asset value. Quotations of total returns reflect the maximum
sales charge, except that the Fund may also provide, in conjunction with such
quotations additional quotations, that do not reflect a sales charge.
Comparative performance information may also be used from time to time in
advertising or marketing of the Fund's shares. The Fund's total return may be
compared to that of other mutual funds with similar investment objectives and to
bond and other relevant indices or to rankings prepared by independent services
or other financial or industry publications that monitor the performance of
mutual funds. For example, the total return on Fund shares may be compared to
data prepared by Lipper Analytical Services, Inc. or to an index of fixed-income
securities, such as the Lehman Brothers Government/Corporate Bond Index. Such
comparative performance information may be stated in the same terms in which the
comparative data and indices are stated. For these purposes, the performance of
the Fund, as well as the performance of other mutual funds or indices, would not
reflect sales charges, the inclusion of which would reduce such performance
quotations.
Performance figures represent historic earnings, and should not be considered as
representative of future results. The investment return and principal value of
an investment in the Fund will fluctuate so that an investor's shares, when
redeemed, may be worth more or less than their original cost.
7
<PAGE> 11
Since performance will fluctuate, performance data for the Fund should not be
used to compare an investment in the Fund's shares with bank deposits, savings
accounts and similar investment alternatives which often provide an agreed or
guaranteed fixed yield for a stated period of time. Investors should remember
that performance is generally a function of the kind and quality of the
instruments held in a portfolio, portfolio maturity, operating expenses and
market conditions.
Further information about the Fund's performance is contained in the annual
report to shareholders which may be obtained without charge from the Distributor
at the address shown on the cover page of this Prospectus.
PURCHASE OF SHARES
Fund shares are sold through dealers in a continuous offering. The Distributor
serves as principal underwriter. The account information form should be used for
initial purchases. The minimum initial investment is $1,500. Each subsequent
investment must be at least $100. Minimum investment requirements can be changed
by the Fund or waived by the Distributor. 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 any
check used for investment does not clear.
Offering price equals net asset value per share plus the applicable sales
charge. Orders dealers receive before the New York Stock Exchange ("NYSE")
closes (currently 4:00 p.m., New York time) on any business day are priced based
on net asset value for that day if Boston Financial Data Services, Inc.
("Shareholder Service Agent"), as agent for the Distributor, receives the order
prior to its close of business. Orders received by the Shareholder Service Agent
after such time are priced based on net asset value for the next business day.
NET ASSET VALUE. Net asset value is computed as of the close of the NYSE on each
day the NYSE is open. Net asset value, rounded to the nearest cent per share,
equals the market value of all portfolio securities plus other assets, less all
liabilities, divided by the number of Fund shares outstanding.
TABLE OF SALES CHARGES. The following table shows the sales charge at various
investment levels. The sales charge applies to purchases made at one time by any
combination of an individual, his or her spouse and these related investors (and
their spouses): 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.
8
<PAGE> 12
<TABLE>
<CAPTION>
SALES SALES REALLOWED
SIZE OF INVESTMENT CHARGE(1) CHARGE(2) TO DEALERS(2)
- ----------------------------------------------------------- --------- --------- -------------
<S> <C> <C> <C>
Less than $10,000.......................................... 4.71% 4.50% 4.00%
$ 10,000 but less than $25,000........................... 4.43% 4.25% 3.75%
$ 25,000 but less than $50,000........................... 4.17% 4.00% 3.50%
$ 50,000 but less than $100,000.......................... 3.90% 3.75% 3.25%
$ 100,000 but less than $250,000.......................... 3.36% 3.25% 2.75%
$ 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>
- ---------------
(1) As a percentage of net amount invested.
(2) As a percentage of public offering price.
CUMULATIVE PURCHASE DISCOUNT. The size of investment may be determined by adding
the amount being invested to the current value, at offering price, of all
presently held shares of the FPA Funds. If such holdings qualify for a reduced
sales charge, information sufficient to permit verification must be furnished to
the Shareholder Service Agent on the account information form or when the order
is placed.
LETTER OF INTENT. A letter of intent ("LOI") allows investors to obtain a
reduced sales charge by aggregating investments made during a 13-month period.
The value of all presently held shares of the FPA Funds may also be used to
determine the applicable sales charge. The minimum initial purchase for an LOI
is $1,500. The account information form contains the LOI which must be signed at
the time of initial purchase, or within 30 days. Each investment made pursuant
to an LOI during the period receives the sales charge for the total investment
goal. If the goal is not achieved within the period, the shareholder must pay
the amount equal to the sales charge applicable to the purchases made minus
those actually paid.
SALES AT NET ASSET VALUE. Fund shares may be purchased at net asset value,
without a sales charge, by these investors and their spouses (and their
immediate relatives): (a) current and former directors, officers and employees
of the Adviser, UAM 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 which has a selling group agreement with
the Distributor and consents to such 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. Immediate relatives include grandparents, parents,
siblings, children and grandchildren of a qualified investor, and the spouse of
any immediate relative. The foregoing purchasers must represent that the shares
are purchased for investment and will not be resold except through redemption or
repurchase by the Fund.
The Fund also offers shares at net asset value without imposition of a sales
charge to the following persons: (i) trustees or other fiduciaries purchasing
shares for employee benefit plans of employers with 20 or more employees; (ii)
trust companies, bank trust departments and registered
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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
and/or the FPA Funds totals at least $1,000,000; (iii) tax-exempt organizations
enumerated in Section 501(c)(3), (9), or (13) of the Internal Revenue Code; and
(iv) accounts upon which an investment adviser, financial planner or
broker-dealer charges an account management or consulting fee, provided such
organization has entered into an agreement with the Distributor regarding such
accounts or purchases Fund shares for such accounts 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 Distributor.
No sales charge is imposed because the Distributor anticipates that such
purchases should result in economies in the sales effort and related expenses
compared to sales made through normal distribution channels. A special
application form, which is available from the Distributor, must be submitted
with the initial purchase. All net asset value sales require specific
notification to the Distributor of the purchaser's eligibility at the time the
order is placed. If a purchaser places such an order through a securities
broker, the broker may charge a service fee. No such fee is charged if the
shares are purchased directly from the Distributor or the Fund.
SHAREHOLDER SERVICES
FPA EXCHANGE PRIVILEGE. Subject to the following requirements, Fund shares may
be exchanged for shares of another FPA Fund, except FPA Capital Fund, Inc.,
whose shares may only be acquired by existing Capital shareholders. An exchange
may establish a new or increase an existing FPA Fund account. Both accounts must
bear the same registration. A sales charge applies to purchases by exchange
unless (a) a sales charge equivalent to that applicable to the acquired shares
was previously paid; (b) the shareholder is entitled to purchase shares at net
asset value; or (c) the shares being exchanged were acquired by reinvestment.
Shares of the fund to be acquired must be registered for sale in the investor's
state. A $5.00 service fee applies to each exchange.
MONEY MARKET FUND EXCHANGE PRIVILEGE. The Distributor has arranged for shares of
the money market portfolio of the Cash Equivalent Fund, a no-load diversified
open-end money market mutual fund ("Money Market Fund") to be available in
exchange for shares of the Fund. Shares of the Money Market Fund so acquired
plus any shares acquired through reinvestment of dividends and distributions may
be re-exchanged for shares of the Fund without sales charge. The $5.00 exchange
fee is paid by the Distributor which receives a fee from Kemper Financial
Services, the administrator for the Money Market Fund, of .15 of 1% per year or
more of the average daily net asset value of shares of the Money Market Fund
acquired through this exchange privilege. This exchange privilege does not
constitute an offering or recommendation by the Fund of the Money Market Fund.
The Money Market Fund is separately managed and is not one of the FPA Funds. FPA
mutual fund investments held in Fund-Sponsored Individual Retirement Accounts
may not be exchanged into the Cash Equivalent Fund.
HOW TO EXCHANGE SHARES. The above described exchange privilege may be exercised
by sending written instructions to the Shareholder Service Agent. See
"Redemption of Shares" for applicable signature and signature guarantee
requirements. Exchange privileges may also be exercised by
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telephone as described under "Redemption of Shares -- Telephone Transactions."
Only four exchanges may be made in one account during any calendar year;
exchanges exceeding this limit may be considered null and void, if the investor
has been notified that this limit has been reached. Shares must be owned for 15
days before exchanging and cannot be in certificate form unless the certificate
is tendered with the request for exchange. An exchange requires the purchase of
shares of the acquired fund with a value of at least $1,000. Exchange
redemptions and purchases are effected on the basis of the net asset values next
determined after receipt of the request in proper order by the Shareholder
Service Agent. In the case of exchanges into the Money Market Fund, dividends
generally commence on the following business day. For federal and state income
tax purposes, an exchange is treated as a sale and may result in a capital gain
or loss, although if the shares exchanged have been held less than 91 days, the
sales charge paid on such shares 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.
Additional information concerning this privilege and prospectuses for other FPA
Funds and/or for the Money Market Fund may be obtained from dealers or the
Distributor. A shareholder should read such prospectuses and consider
differences in objectives and policies before making any exchange. The Fund or
the Distributor can change or discontinue this privilege upon 60 days' advance
notice and investors who had exchanged into the Money Market Fund would be
permitted to reacquire shares of the Fund without sales charge for at least 60
days after notice of termination of the Money Market Fund exchange privilege.
INVESTMENT ACCOUNT. Each shareholder has an investment account in which the
Shareholder Service Agent holds Fund shares. Unless the Shareholder Service
Agent receives a written request, stock certificates will not be issued.
Certificates are only issued for full shares. The shareholder receives a
statement showing account activity after each transaction.
The Fund reserves the right to impose or permit a separate charge for the
maintenance of accounts, after notification to shareholders.
PRE-AUTHORIZED INVESTMENT PLAN. An investor desiring to make automatic monthly
investments may use the optional shareholder services form, available from
dealers or the Distributor. The Shareholder Service Agent withdraws funds from
the investor's bank account monthly for $100 or more as specified through the
Automated Clearing House.
RETIREMENT PLANS. An eligible investor may establish an IRA (individual
retirement account) and/or other retirement plan with a minimum initial
investment of $100 and an expressed intention to increase such investment to
$1,500 within 12 months. Each subsequent investment must be at least $100.
Neither the Fund nor the Distributor imposes additional fees for these plans,
but the plan custodian does. The Tax Reform Act of 1986 restricted deductible
contributions to an IRA by participants in an employer-sponsored retirement
plan. The maximum deductible contribution of $2,000 of earned income is phased
out for such participants with an adjusted gross income of $40,000 to $50,000
(joint) or $25,000 to $35,000 (single). However, persons ineligible for
deductible contributions generally may make non-deductible contributions of
earned income up to $2,000 per year and earnings are tax-deferred. Investors
should consult their tax advisers. Forms and information regarding the plan are
available from dealers or the Distributor.
SYSTEMATIC WITHDRAWAL PLAN. Any shareholder whose account value is $10,000 or
more may make monthly, quarterly, semi-annual or annual withdrawals of $50 or
more by completing the optional
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shareholder services form. Under this plan, sufficient Fund shares to cover
these withdrawals are redeemed each month and proceeds are forwarded as directed
on the optional shareholder services form. Dividends and capital gains
distributions on Fund shares held under this plan are automatically reinvested
in additional Fund shares at net asset value. If these withdrawals continuously
exceed reinvestments, the shareholder's account is correspondingly reduced and
ultimately exhausted. Concurrent withdrawals and purchases are ordinarily
disadvantageous to the shareholder due to additional sales charges. The
shareholder recognizes any taxable gain or loss on redemptions.
REDEMPTION OF SHARES
Shareholders can redeem for cash, without charge, any or all of their Fund
shares at any time by sending a written request in proper form to the
Shareholder Service Agent. Facsimile transmissions are not acceptable.
Shareholders can also place redemption requests through dealers, who may charge
a fee. Shareholders redeeming Fund shares from retirement plans should consult
the plan documents concerning federal tax consequences and their plan custodian
regarding procedures.
All persons in whose name the account is established must sign the redemption
request exactly as registered. If the redemption exceeds $10,000, if the
proceeds are not paid to the record owner at the record address, or if the
shareholder is a corporation, partnership, trust or fiduciary, the signature(s)
must be guaranteed by 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.
In most cases, only a properly signed request with any necessary signature
guarantee is required for a redemption. However, stock certificates, if held by
shareholders, must accompany requests. Additional documents are required if a
corporation, partnership, trust, fiduciary, executor or administrator requests
the redemption.
Redemptions are only processed on days the NYSE is open. The redemption price is
the first net asset value determined after the Shareholder Service Agent
receives the redemption request in proper form. A check for the proceeds is
mailed within seven days after the Shareholder Service Agent receives the
request in good order. If Fund shares were recently purchased by check,
redemptions will not be allowed until the investment being redeemed has been in
the account for 15 days.
The Fund may direct the Shareholder Service Agent to redeem all Fund shares of
any shareholder whose account value is less than $500 as a result of a
redemption. In such case, the shareholder is notified in writing that the
account value is insufficient and allowed up to 60 days to increase it to $500.
TELEPHONE TRANSACTIONS. Telephone exchange privileges are available unless
declined by an investor on the account information form. Telephone redemption
privileges are available only if elected on the optional shareholder services
form. A properly completed request with a signature guarantee is required if a
telephone redemption election is made or changed after the account is opened.
Telephone redemptions are not available for shares held in a Fund-sponsored
retirement account. Shares held in certificate form cannot be redeemed or
exchanged by telephone. The Shareholder Service Agent (the "Agent") employs
procedures considered by it to be reasonable to confirm that instructions
communicated by telephone are genuine, including requiring account
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registration verification from the caller and recording telephone instructions.
If reasonable procedures are employed, neither the Agent nor the Fund is
responsible for following telephone instructions the Agent reasonably believes
to be genuine. The Agent and the Fund may be liable for any losses due to
unauthorized or fraudulent instructions if such loss results from a failure to
employ reasonable procedures. Proceeds of telephone redemptions are paid to the
bank account the shareholder designates when establishing this privilege.
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 a wire is requested. There is a $3.50 charge for wires. During
periods of significant economic or market changes, telephone instructions may be
difficult to place. If an investor is unable to contact the Agent by telephone,
instructions may be sent to the Agent at the address set forth on page 2. The
Fund may change or discontinue telephone redemption privileges without notice.
REINVESTMENT PRIVILEGE. Proceeds from a redemption can be reinvested in Fund
shares within 30 days without paying a sales charge. Such reinvestment is made
at the first net asset value determined after the Shareholder Service Agent
receives the order. This privilege can be exercised only once for each Fund
investment. Information sufficient to permit verification must be furnished to
the Shareholder Service Agent when the purchase is placed. Such redemption and
reinvestment is a taxable transaction but losses on the redemption are not
deductible for federal income tax purposes.
DIVIDENDS, DISTRIBUTIONS AND TAXES
Shareholders may receive dividends and/or capital gains distributions in
addition to any increase or decrease in the value of Fund shares. Dividends and
distributions are automatically reinvested in additional Fund shares at the net
asset value determined at the close of business on the day after the record
date, unless the Shareholder Service Agent receives a written request for cash
payment before the record date. The account information form may be used for
this purpose.
DIVIDENDS. The Fund's investment income consists principally of interest earned
on its portfolio securities. All of this income, after payment of expenses, is
distributed quarterly as dividends to shareholders.
CAPITAL GAINS. When the Fund sells portfolio securities, it realizes capital
gains and losses, depending upon whether the selling price is higher or lower
than the purchase price. Net realized capital gains from sales of securities
equal profits minus losses, including any losses carried forward from prior
years. The Fund distributes any net realized capital gains to shareholders
annually.
TAXES. Because the Fund plans to distribute all of its net investment income and
net realized capital gains to shareholders, it does not expect to pay any
federal income tax. Dividends and distributions paid to shareholders are subject
to federal income tax, and any state and local income tax. Shareholders are
notified annually of the federal tax status of these distributions. Dividends
from net investment income and distributions from short-term capital gains are
taxable to shareholders as ordinary income. Distributions from long-term capital
gains are taxable to shareholders as such. All distributions are taxable whether
paid in cash or reinvested. To avoid a 31% federal withholding tax on dividends,
distributions and redemptions, shareholders must certify their tax-
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payer identification number to the Shareholder Service Agent, as agent for the
Fund. The account information form may be used for this purpose.
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. 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.
INVESTMENT PRACTICES AND RISKS
U.S. GOVERNMENT SECURITIES. The Fund invests in securities issued or guaranteed
by the United States Government, its agencies or instrumentalities. U.S.
Treasury obligations include bonds, notes and bills which are backed by the full
faith and credit of the United States. Some Government agencies and
instrumentalities, such as GNMA, issue debt securities which are supported by
the full faith and credit of the United States; others, such as those of the
Export-Import Bank of the United States, are supported by the right of the
issuer to borrow from the Treasury; others, such as those of the Federal
National Mortgage Association, are supported by the discretionary authority of
the U.S. Government to purchase the agency's obligations; still others, such as
those of the Federal Home Loan Mortgage Corporation, are supported only by the
credit of the instrumentality. No assurance can be given that the U.S.
Government would provide financial support to U.S. Government-sponsored
instrumentalities if it is not obligated to do so by law.
ZERO COUPON SECURITIES. The Fund may invest in zero coupon U.S. Government
securities which do not entitle the holder to any periodic payments of interest
prior to maturity. Accordingly, such securities usually trade at a deep discount
from their face or par value and are subject to greater fluctuations of market
value in response to changing interest rates than debt obligations of comparable
maturities which make periodic distributions of interest. On the other hand,
because there are no periodic interest payments to be reinvested prior to
maturity, zero coupon securities eliminate the reinvestment risk and lock in a
rate of return to maturity. Current federal tax law requires that a holder (such
as the Fund) of a zero coupon security accrue a portion of the discount at which
the security was purchased as income each year even though the Fund received no
interest payment in cash on the security during the year. See also "Dividends,
Distributions and Taxes."
MORTGAGE-BACKED SECURITIES. The Fund may invest in mortgage-backed securities
which include (a) obligations issued or guaranteed by Federal Agencies, such as
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); (b) collateralized
mortgage obligations ("CMOs"), including real estate mortgage investment
conduits, issued by United States or foreign private issuers that represent an
interest in or are collateralized by mortgage-backed securities issued or
guaranteed by Federal Agencies; and
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(c) obligations issued by United States or foreign private issuers that
represent an interest in or are collateralized by whole mortgage loans or
mortgage-backed securities without a government guarantee but usually having
some form of private credit enhancement.
The Fund may invest in both fixed rate and adjustable rate mortgage securities
("ARMS"), which are pass-through mortgage securities collateralized by mortgages
with adjustable rather than fixed rates. ARMs eligible for inclusion in a
mortgage pool generally provide for a fixed initial mortgage interest rate for
either the first three, six, twelve or thirteen, twenty-four, thirty-six or
longer scheduled monthly payments. Thereafter, the interest rates are subject to
periodic adjustment based on changes to a designated benchmark. ARMS will reset
off of a variety of short-term indices including, but not limited to, LIBOR
(London Interbank Offered Rate), 90-day United States Treasury Bills and the
11th District Cost of Funds Index ("COFI"). Fixed rate investments may be of
varying maturities.
GUARANTEED MORTGAGE PASS-THROUGH SECURITIES. The Fund may 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, MULTICLASS PASS-THROUGH SECURITIES AND
ACCRUAL CERTIFICATES (Z-BONDS). 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 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
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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. The market prices of CMOs structured as accrual
certificates (also known as "Z-Bonds") are affected to a greater extent by
interest rate changes and therefore tend to be more volatile than securities
which pay current interest in cash. See also "Dividends, Distributions and
Taxes." Accrual bonds have characteristics similar to those of zero coupon U.S.
Government securities and can be subject to greater volatility. 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. The Fund will not invest in CMO and REMIC residuals. See
"Multiple Class Pass-Through Securities and Collateralized Mortgage Obligations"
in the Statement of Additional Information for further discussion.
PRIVATE MORTGAGE PASS-THROUGH SECURITIES. Private mortgage pass-through
securities are structured similarly to the GNMA, FNMA and FHLMC mortgage
pass-through securities and are issued by United States and foreign private
issuers such as originators of and investors in mortgage loans, including
savings and loan associations, mortgage banks, commercial banks, investment
banks and special purpose subsidiaries of the foregoing. These securities
usually are backed by a pool of conventional fixed rate or adjustable rate
mortgage loans. Since private mortgage pass-through securities typically are not
guaranteed by an entity having the credit status of GNMA, FNMA and FHLMC, such
securities generally are structured with one or more types of credit
enhancement. The degree of credit support provided for each issue is generally
based on historical information respecting the level of credit risk associated
with the underlying assets. Delinquencies or losses in excess of those
anticipated could adversely affect the return on an investment in a security.
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<PAGE> 20
STRIPPED MORTGAGE SECURITIES. The Fund may invest in Stripped Mortgage
Securities which 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. Stripped Mortgage Securities usually are
structured with two classes that receive different proportions of the interest
and principal distribution on a pool of mortgage assets. A common type of
Stripped Mortgage Security will have one class receiving some of the interest
and most of the principal from the mortgage assets, while the other class will
receive most of the interest and the remainder of the principal. In the most
extreme case, one class will receive all of the interest (the interest-only or
"IO" class), while the other class will receive all of the principal (the
principal-only or "PO" class). PO classes generate income through the accretion
of the deep discount at which such securities are purchased, and, while PO
classes do not receive periodic payments of interest, they receive monthly
payments associated with scheduled amortization and principal prepayment from
the mortgage assets underlying the PO class. The yield to maturity on an IO
class is extremely sensitive to the rate of principal payments (including
prepayments) on the related underlying mortgage assets, and a rapid rate of
principal payments may have a material adverse effect on such security's yield
to maturity. If the underlying mortgage assets experience greater than
anticipated prepayments of principal, the Fund may fail to fully recoup its
initial investment in these securities.
The Fund may purchase Stripped Mortgage Securities for income, or for hedging
purposes to protect the Fund's portfolio against interest rate fluctuations. For
example, since an IO class will tend to increase in value as interest rates
rise, it may be utilized to hedge against a decrease in value of other
fixed-income securities in a rising interest rate environment. Yields on IO
classes are generally higher than prevailing market yields on other
mortgage-backed securities because their cash flow patterns are more volatile
and there is a greater risk that the initial investment will not be fully
recouped. There can be no assurance that the Fund will be able to effect a trade
of a Stripped Mortgage Security at a time when it wishes to do so. Stripped
Mortgage 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.
INVERSE FLOATERS. Inverse floaters constitute a class of CMOs with a coupon rate
that moves inversely to a designated index, such as LIBOR or COFI. Inverse
floaters have coupon rates that typically change at a multiple of the changes of
the relevant index rate. Any rise in the index rate (as a consequence of an
increase in interest rates) causes a drop in the coupon rate on an inverse
floater while any drop in the index rate causes an increase in the coupon rate
of an inverse floater. In some circumstances, the coupon on an inverse floater
could decrease to zero. In addition, like most other fixed-income securities,
the value of inverse floaters will decrease as interest rates increase. Inverse
floaters exhibit greater price volatility than the majority of mortgage-backed
securities. In addition, some inverse floaters display extreme sensitivity to
changes in prepayments. As a result, the yield to maturity of an inverse floater
is sensitive not only to changes in interest rates but also to changes in
prepayment rates on the related underlying mortgage assets. As described above,
inverse floaters may be used alone or in tandem with interest-only stripped
mortgage instruments.
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RISKS OF MORTGAGE-BACKED SECURITIES
CREDIT AND MARKET RISKS. Investments in fixed rate and floating rate
mortgage-backed securities entail normal credit risks (i.e., the risk of
non-payment of interest and principal) and market risks (i.e., the risk that
interest rates and other factors will cause the value of the instrument to
decline). Many issuers or servicers of mortgage-backed securities guarantee
timely payment of interest and principal on the securities, whether or not
payments are made when due on the underlying mortgages. This kind of guarantee
generally increases the quality of a security, but does not mean that the
security's market value and yield will not change. Like bond investments, the
value of fixed rate mortgage-backed securities will tend to rise when interest
rates fall, and fall when rates rise. Floating rate mortgage-backed securities
will generally tend to have minimal changes in price when interest rates rise or
fall. The value of all mortgage-backed securities may also change because of
changes in the market's perception of the creditworthiness of the organization
that issued or guarantees them. In addition, the mortgage-backed securities
market in general may be adversely affected by changes in governmental
legislation or regulation. Fluctuations in the market value of mortgage-backed
securities after their acquisition usually do not affect cash income from such
securities but are reflected in each Fund's net asset value. The liquidity of
mortgage-backed securities varies by type of security; at certain times a Fund
may encounter difficulty in disposing of investments. Other factors that could
affect the value of a mortgage-backed security include, among other things, the
types and amounts of insurance which a mortgagor carries, the amount of time the
mortgage loan has been outstanding, the loan-to-value ratio of each mortgage and
the amount of overcollateralization of a mortgage pool.
PREPAYMENT AND REDEMPTION RISK. Mortgage-backed securities reflect an interest
in monthly payments made by the borrowers who receive the underlying mortgage
loans. Although the underlying mortgage loans are for specified periods of time,
such as 20 or 30 years, the borrowers can, and typically do, pay them off
sooner. In such an event, the mortgage-backed security which represents an
interest in such underlying mortgage loan will be prepaid. A borrower is more
likely to prepay a mortgage which bears a relatively high rate of interest. This
means that in times of declining interest rates some higher yielding securities
held by the Fund might be converted to cash, and the Fund would be forced to
accept lower interest rates when that cash is used to purchase additional
securities. The increased likelihood of prepayment when interest rates decline
also limits market price appreciation of mortgage-backed securities. In
addition, a mortgage-backed security may be subject to redemption at the option
of the issuer.
RISKS OF STRIPPED MORTGAGE SECURITIES AND INVERSE FLOATERS. Both interest-only
Stripped Mortgage Securities and inverse floaters are highly sensitive to
changes in interest and prepayment rates. As a result, each individually is
highly volatile. The Adviser believes that in combination, interest-only
Stripped Mortgage Securities and inverse floaters may at times produce higher
yields than more traditional securities such as U.S. Treasuries or
mortgage-backed securities while maintaining a relatively low degree of
volatility. This results from the fact that changes in the value of inverse
floaters tend to be inversely proportional to the direction of interest rates as
is the case with traditional fixed-income securities, while the value of
interest-only stripped mortgage-backed securities often is directly proportional
to the direction of interest rates, so that used in combination, inverse
floaters and interest-only Stripped Mortgage Securities can serve as a hedging
device for the Fund. However, effective use of this hedging technique is
dependent upon the Adviser's ability to correctly hedge the securities by
forecasting interest rate volatility and corresponding prepayment
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<PAGE> 22
rates. In the event that these assumptions are erroneous, the Fund's yield and
total return may be reduced.
RISKS OF ADJUSTABLE RATE MORTGAGES. ARMs contain maximum and minimum rates
beyond which the mortgage interest rate may not vary over the lifetime of the
security. In addition, certain ARMs provide for additional limitations on the
maximum amount by which the mortgage interest rate may adjust for any single
adjustment period. Alternatively, certain ARMs contain limitations on changes in
the required monthly payment. In the event that a monthly payment is not
sufficient to pay the interest accruing on an ARM, any such excess interest is
added to the principal balance of the mortgage loan, which is repaid through
future monthly payments. The adjustable interest rate feature of the mortgages
underlying ARMs generally acts as a buffer to reduce sharp changes in the market
value of ARMs in response to normal interest rate fluctuations. As the interest
rate on the mortgages underlying ARMs are reset periodically, yields of the
securities will gradually align themselves to reflect changes in market rates.
During periods of rising interest rates, however, changes in the coupon rate lag
behind changes in the market rate. During periods of extreme fluctuations in
interest rates, the resulting fluctuation of ARM rates could affect the market
value of investments in ARMs. Since most ARMs generally have annual reset limits
or "caps" of 100 to 200 basis points, fluctuation in interest rates above these
levels could cause such mortgage-backed securities to "cap out" and to behave
more like long-term, fixed-rate debt securities. During periods of declining
interest rates, of course, the coupon rates may readjust downward, resulting in
lower yields. Because of this feature, the value of ARMs is unlikely to rise
during periods of declining interest rates to the same extent as fixed-rate
instruments.
ASSET-BACKED SECURITIES. The Fund may invest in asset-backed securities which
have structural characteristics similar to mortgage-backed securities but have
underlying assets that are not mortgage loans or interests in mortgage loans.
Various types of assets, primarily automobile and credit card receivables, are
securitized in pass-through structures similar to mortgage pass-through
structures. In general, the collateral supporting asset-backed securities is of
shorter maturity than mortgage loans and is likely to experience substantial
prepayments. As with mortgage-related securities, asset-backed securities are
often backed by a pool of assets representing the obligations of a number of
different parties and use similar credit enhancement techniques. The cash flow
generated by the underlying assets is applied to make required payments on the
securities and to pay related administrative expenses. The amount of residual
cash flow resulting from a particular issue of asset-backed securities depends
on, among other things, the characteristics of the underlying assets, the coupon
rates on the securities, prevailing interest rates, the amount of administrative
expenses and the actual prepayment experience on the underlying assets. Certain
asset-backed securities do not have the benefit of the same security interest in
the related collateral as do mortgage-backed securities. Credit card receivables
are generally unsecured, and the debtors are entitled to the protection of a
number of state and federal consumer credit laws, many of which give such
debtors the right to set off certain amounts owned on the credit cards, thereby
reducing the balance due. In addition, some issuers of automobile receivables
permit the servicers to retain possession of the underlying obligations. If the
servicer were to sell these obligations to another party, there is a risk that
the purchaser would acquire an interest superior to that of the holders of the
related automobile receivables.
CONVERTIBLE SECURITIES AND LOWER RATED DEBT SECURITIES. The Fund may invest up
to 25% of its assets in Convertible Securities, in debt securities which are not
rated in the highest two grades by
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<PAGE> 23
Moody's and S&P, and in preferred stocks (in an amount not exceeding 5% of its
assets). As used herein, a Convertible Security is a bond, debenture, or note,
that may be converted into or exchanged for a specified amount of common stock
of the same or a different issuer within a particular period of time at a
specified price or formula. A Convertible Security entitles the holder to
receive interest paid or accrued on the debt security until the Convertible
Security matures or is redeemed, converted or exchanged. Before conversion,
Convertible Securities have characteristics similar to non-convertible debt
securities in that they ordinarily provide a stable stream of income with
generally higher yields than those of common stocks of the same or similar
issuers. Convertible Securities rank senior to common stock in a corporation's
capital structure and, therefore, generally entail less risk than the
corporation's common stock, although the extent to which such risk is reduced
depends in large measure upon the degree to which the Convertible Security sells
near its value as a fixed-income security.
Convertible Securities are generally not investment grade, that is, not rated
within the four highest categories by S&P and Moody's. 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 the principal of, and timely payment of interest on, such
securities. The Fund may purchase Convertible Securities and other debt
securities rated BB or lower by S&P or Ba or lower by Moody's which ratings are
considered by the rating agencies to be speculative with respect to the issuer's
continuing ability to meet principal and interest payments. Debt securities
rated BB or lower by S&P or Ba or lower by Moody's are commonly referred to as
junk bonds. 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.
Prices of lower rated securities may decline rapidly in the event a significant
number of 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 their sale by the Fund more
difficult, at least in the absence of price concessions. 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. See "Risk Factors
Relating to Lower Rated Securities" in the Statement of Additional Information
for a further discussion.
The lower rated securities in which the Fund may invest may from time to time
include debt securities of companies that are financially troubled, in default
or are in bankruptcy or reorganization ("Deep Discount Securities"). These
securities may be rated C, CI or D by S&P or C by Moody's or may be unrated.
(See "Ratings" in the Statement of Additional Information). Debt obligations of
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<PAGE> 24
such companies are usually available at a deep discount from the face value of
the instrument. The Fund will invest in Deep Discount Securities when the
Adviser believes that existing factors are likely to improve the company's
financial condition. Such 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 prior to 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 may
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
debtholders, the Deep Discount Securities may 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.
SECURITIES OF FOREIGN ISSUERS. Investments in securities of foreign issuers may
be affected favorably or unfavorably by changes in currency rates and exchange
control regulations. Compared to U.S. companies, there may 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 may 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 may 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 may be more difficult for the Fund to obtain
or enforce a judgment against the issuer.
DELAYED DELIVERY. Some securities in which the Fund may invest are offered on a
delayed delivery (including a "when issued") basis. That is, delivery and
payment for the securities is scheduled to occur on a future settlement date but
the price, interest rate and settlement date is fixed at the time of commitment.
The Fund will not enter into a transaction with a scheduled delivery date over
one year after the commitment date. At all times the Fund maintains in a
segregated account, cash or liquid, high grade money market instruments in an
amount equal to any open commitments. However, the Fund can meet its obligations
to pay for delayed delivery securities from the sale of the securities
themselves, which may have a value greater or lesser than the Fund's payment
obligation, thus producing a realized gain or loss.
SHORT SALES AGAINST THE BOX. The Fund may 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 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. The principal purpose of making
short sales is to enable the Fund to obtain the current market price of a
security which the Fund desires to sell but which cannot be currently delivered
for settlement. For example, common stocks issuable upon conversion of a
convertible security sometimes can be sold at a better price than the
convertible security owned by the Fund. In such circumstances the Fund could
sell the common stock short "against the box" while tendering the convertible
security to the issuer for conversion. Upon receipt of the certificates for the
underlying common stock, delivery would be made to close the short sale. The
Fund may not make short sales or maintain a short position if to do so would
cause more than 25% of its total
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<PAGE> 25
assets (exclusive of proceeds from short sales) to be allocated to a segregated
account in connection with short sales.
REPURCHASE AGREEMENTS. The Fund may invest 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 and 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 may 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 which mature in more than seven days and/or
other securities which are not readily marketable.
PORTFOLIO TRANSACTIONS. The Adviser is responsible for placing orders for the
purchase and sale of portfolio securities and negotiating the price of such
transactions. Most transactions made by the Fund are with dealers acting as
principals for their own accounts without a stated commission, although the
prices of the securities usually include a profit to the dealers. Broker-dealers
are selected for their professional capability and the overall value and quality
of their execution services. Such broker-dealers may provide investment and
research information to the Adviser. The Adviser may also use information
received to manage the assets of other advisory accounts.
PORTFOLIO TURNOVER. The Fund purchases securities primarily for investment
rather than short-term trading. However, changes are made in the portfolio
whenever it appears advisable. The Fund's annual portfolio turnover rate is
shown in the table of "Financial Highlights."
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<PAGE> 26
ADDITIONAL INFORMATION
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 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 provide that shareholder meetings are
required to be held to elect directors only when required by the Investment
Company Act. Such event 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.
SHAREHOLDER INQUIRIES. Shareholders who have questions concerning (1) the Fund
may contact the Distributor; (2) their account may contact the Shareholder
Service Agent; and (3) their retirement plan may contact the Shareholder Service
Agent. The applicable addresses and telephone numbers appear on page 2.
SHAREHOLDER SERVICE AGENT. Boston Financial Data Services, Inc., P. O. Box 8500,
Boston, Massachusetts 02266-8500, serves as shareholder service and dividend
disbursing agent for the Fund. State Street Bank and Trust Company serves as
transfer agent for the Fund.
CUSTODIAN. All cash and securities of the Fund are held by the Fund's custodian,
State Street Bank and Trust Company, 225 Franklin Street, Boston, Massachusetts
02110.
LEGAL COUNSEL. O'Melveny & Myers LLP, 400 South Hope Street, Los Angeles,
California 90071, provides legal services to the Fund.
INDEPENDENT AUDITORS. Ernst & Young LLP, 515 South Flower Street, Los Angeles,
California 90071, performs annual audits of the Fund's financial statements.
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<PAGE> 27
STATEMENT OF ADDITIONAL INFORMATION
January 31, 1997
FPA NEW INCOME, INC.
This Statement of Additional Information ("Statement") supplements the current
Prospectus of FPA New Income, Inc. ("Fund") dated January 31, 1997. 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 is not itself a Prospectus, it is, in its entirety, incorporated by
reference into the Prospectus. The Fund's Prospectus may 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 from Alaska, Hawaii and Puerto Rico.
TABLE OF CONTENTS
Page
----
General Information.....................................................2
Voting Rights..................................................2
Reports to Shareholders........................................2
Investment Policies.....................................................2
Mortgage-Backed Securities ....................................2
Multiple Class Pass-Through Securities and Collateralized
Mortgage Obligations.........................................2
Securities of Foreign Issuers..................................4
Common Stocks..................................................4
Short Sales Against the Box....................................4
Repurchase Agreements..........................................4
Ratings.................................................................5
Debt Security Ratings..........................................5
Moody's........................................................5
S&P............................................................6
Commercial Paper Ratings.......................................7
Risk Factors Relating to Lower Rated Securities.........................7
Investment Restrictions.................................................8
Directors and Officers of the Fund.....................................10
Five Percent Shareholder......................................12
Investment Advisory Agreement..........................................12
Prior Performance Information..........................................13
Portfolio Transactions.................................................14
Portfolio Turnover.....................................................15
Distributor............................................................15
Purchase and Redemption of Shares......................................16
Net Asset Value...............................................16
Sales Charges.................................................16
Sales at Net Asset Value......................................16
Letter of Intent..............................................17
FPA Exchange Privilege........................................17
Redemption of Shares..........................................18
Telephone Redemption..........................................18
Tax Sheltered Retirement Plans.........................................19
Dividends, Distributions and Taxes.....................................19
Financial Statements...................................................20
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GENERAL INFORMATION
Voting Rights. Fund shares 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.
Reports to Shareholders. Shareholders receive semi-annual and annual reports
which show the portfolio of investments, major portfolio changes and other
information. Financial statements accompanied by an opinion of independent
auditors are furnished to shareholders after the Fund's fiscal year-end.
Unaudited financial statements prepared by the Fund are provided after the first
six months of the fiscal year.
INVESTMENT POLICIES
The following supplements information set forth under the captions "Investment
Objective and Policies" and "Investment Practices and Risks" in the Prospectus.
Readers must also refer to the Prospectus.
Mortgage-Backed Securities. 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 certain 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.
Multiple Class Pass-Through Securities and Collateralized Mortgage Obligations.
The Fund may also invest in multiple class securities issued by U.S. Government
agencies and instrumentalities such as FNMA or FHLMC, or by private issuers,
including collaterized mortgage obligations ("CMOs") and REMIC pass-through or
participation certificates. A REMIC is a CMO that qualifies for special tax
treatment under the Internal Revenue Code and invests in certain mortgages
principally secured by interests in real property and other permitted
investments.
CMOs and REMIC pass-through certificates ("REMIC Certificates") are types of
multiple class pass-through securities. Investors may purchase beneficial
interests in REMICs, which are known as "regular" interests or "residual"
interests. The Fund does not intent to purchase residual interests in REMICs.
The REMIC Certificates represent beneficial ownership interests in a REMIC
trust, generally consisting of mortgage loans or FNMA, FHLMC or GNMA guaranteed
mortgage pass-through certificates (the "Mortgage Assets").
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<PAGE> 29
CMOs and REMIC Certificates are issued in multiple classes. Each class of CMOs
or REMIC Certificates, often referred to as a "tranche," is issued at a specific
adjustable or fixed interest rate and must be fully retired no later than its
final distribution date. Principal prepayments on the Mortgage Loans or the
Mortgage Assets underlying the CMOs or REMIC Certificates may cause some or all
of the classes of CMOs or REMIC Certificates to be retired substantially earlier
than their final distribution dates. Generally, interest is paid or accrues on
all classes of CMOs or REMIC Certificates on a monthly basis.
The principal of and interest on the Mortgage Assets may be allocated among the
several classes of CMOs or REMIC Certificates in various ways. In certain
structures (known as "sequential pay" CMOs or REMIC Certificates), payments of
principal, including any principal prepayments, on the Mortgage Assets generally
are applied to the classes of CMOs or REMIC Certificates in the order of their
respective final distribution dates. Thus no payment of principal will be made
on any class of sequential pay CMOs or REMIC Certificates until all other
classes having an earlier final distribution date have been paid in full.
Additional structures of CMOs and REMIC Certificates include, among others,
"parallel pay" CMOs and REMIC Certificates. Parallel pay CMOs and REMIC
Certificates are those which are structured to apply principal payments and
prepayments of the Mortgage Assets to two or more classes concurrently on a
proportionate or disproportionate basis. These simultaneous payments are taken
into account in calculating the final distribution date of each class.
A wide variety of REMIC Certificates may be issued in the parallel pay or
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, and planned
amortization class ("PAC") certificates, which are parallel pay REMIC
Certificates which generally require that specified amounts of principal be
applied on each payment date to one or more classes of REMIC Certificates
(the"PAC Certificates"), even though all other principal payments and
prepayments of the Mortgage Assets are then required to be applied to one or
more other classes of the Certificates. The scheduled principal payments for the
PAC Certificates generally have the highest priority on each payment date after
interest due has been paid to all classes entitled to receive interest
currently. Shortfalls, if any, are added to the amount payable on the next
payment date. The PAC Certificate payment schedule is taken into account in
calculating the final distribution date of each class of PAC. In order to create
PAC tranches, one or more ("companion") tranches generally must be created that
absorb most of the prepayment risk or volatility in the underlying mortgage
assets. These tranches tend to have market prices and yields that are much more
volatile than the PAC classes which provide fixed principal payments within a
specified range (or "collar") of prepayment speeds on the underlying mortgages.
Targeted amortization class ("TAC") certificates are structured to provide a
targeted amount of principal prepayments on the underlying mortgages with any
excess being paid to the TAC support class certificates. TAC certificates thus
have "call protection" but are not protected against slower than expected
prepayments which extend the expected duration of the certificates.
Other CMO tranches that may be acquired include "sticky" and "non-sticky" jump
bonds. These are securities whose principal payment priorities change, depending
upon one or more trigger events. A sticky bond's principal priority would change
once, while a non-sticky bond's principal priority could change several times.
These descriptions can also be applied to some forms of accrual and companion
tranches.
The highest risk tranches in which the Fund may invest are expected to be
inverse floaters and non-sticky accrual bonds. These securities have structures
whose average lives may change significantly or the coupon interest rate paid
may be highly variable. Such investments may be utilized as an alternative to
purchasing longer-term bonds.
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<PAGE> 30
Securities of Foreign Issuers. The Fund may invest up to 10% of its net assets
in securities of foreign governments and companies. Securities of foreign
issuers may be subject to foreign government taxes which could reduce the
dividend or interest yield on such securities. Foreign investments involve
certain risks, such as political or economic instability of the issuer or of the
country of issue, the difficulty of predicting international trade patterns and
the possibility of imposition of exchange controls. Such securities may also be
subject to greater fluctuations in price than those of domestic corporations or
the United States Government. In addition, there may be less publicly available
information about a foreign company than about a domestic company. Foreign
companies generally are not subject to the uniform accounting, auditing and
financial reporting standards applicable to domestic companies. There is
generally less government regulation of stock exchanges, brokers and listed
companies abroad than in the United States. With respect to certain foreign
countries, there is a possibility of expropriation, confiscatory taxation, or
diplomatic developments affecting foreign investments. Finally, in the event of
default on any foreign debt obligation, it may be more difficult for the Fund to
obtain or enforce a judgment against the issuer.
Common Stocks. Although the Adviser does not intend to purchase common stocks,
the Fund's portfolio may include common stocks acquired upon conversion of
convertible securities. Such securities are sold when the sale does not
adversely affect the Fund's assets.
Short Sales Against the Box. In an effort to increase investment flexibility,
the Fund is authorized to make certain short sales. In a short sale, the Fund
does not immediately deliver the securities sold and does not receive the
proceeds from the sale. The Fund is said to have a short position in the
securities sold until it delivers such securities, at which time it receives the
proceeds of the sale. The Fund must pay the broker the amount of any dividend
paid on the securities while the short position is maintained. To secure its
obligation to deliver the securities sold short, the Fund deposits in escrow in
a segregated account with its custodian an equal amount of the securities sold
short or securities convertible into or exchangeable for such securities.
When the Fund expects to receive new securities in a reorganization in exchange
for securities owned by the Fund, and the new securities are traded on a "when
issued" basis, the Fund could sell in the "when issued" market and deliver the
new securities when received following the consummation of the reorganization.
If the reorganization is not consummated, all transactions in the "when issued"
market are cancelled in which event the Fund would realize no gain or loss on
the short sale, except for brokerage commissions.
The limited authority to utilize short sales as described above and in the
Prospectus would not subject the Fund to the risk of loss generally associated
with short sales. A short sale "against the box" does eliminate the potential
for gain or loss from subsequent changes in the market price of the security. It
constitutes a form of hedging under which the Fund obtains a current market
price considered attractive by the Adviser, rather than remain subject to future
fluctuations in the price of the security sold short. Such authority would be
utilized only in furtherance of the Fund's primary investment objective to seek
current income and long-term total return.
For federal income tax purposes, a short sale is not considered a completed
transaction until the Fund discharges its obligation by delivering the
securities sold. Thus, if the Fund should sell securities short "against the
box" in December and deliver the securities in January, any capital gain or loss
on the transaction would be realized in January. This principle possibly could
be utilized by the Fund to postpone recognition of capital gain or loss. Special
tax rules prevent conversion of short-term capital gains into long-term capital
gains and, in effect, long-term capital losses into short-term capital losses by
selling short "against the box."
Repurchase Agreements. The Fund pays for repurchase agreements only upon
physical delivery or evidence of book entry transfer of the underlying debt
security to a segregated account of State Street Bank and Trust Company
("Bank"), the Fund's custodian, or its agent. The Fund only enters into
repurchase agreements
4
<PAGE> 31
involving securities in which the Fund can otherwise invest. The underlying
security (normally a security of the United States Government, its agencies or
instrumentalities) may have a maturity date exceeding one year. Repurchase
agreements usually mature not more than seven days after purchase by the Fund.
It is the Fund's policy that the market value of the security collateralizing
the repurchase agreement at all times equal or exceed the amount of the
repurchase agreement. The Fund does not bear the risk of a decline in value of
the underlying security unless the seller defaults under its repurchase
obligation. In the event of bankruptcy or other default of a seller, the Fund
might experience both loss and delay in liquidating the underlying security,
including: (a) possible decline in the value of such security while the Fund
seeks to enforce its rights thereto, (b) possible lack of access to income on
such security during this period and (c) expenses of enforcing its rights.
RATINGS
Debt Security Ratings. Moody's Investor Services, Inc. ("Moody's") and Standard
& Poor's Corporation ("S&P") employ the designations set forth below to rate
debt securities.
MOODY'S
Aaa - Bonds judged to be of the best quality. They carry the smallest degree of
investment risk and are generally referred to as gilt-edge. Interest payments
are protected by a large or an exceptionally stable margin and principal is
secure. While the various protective elements are likely to change, such changes
as can be visualized are most unlikely to impair the fundamentally strong
position of such issues.
Aa - Bonds judged to be of high quality by all standards. Together with the Aaa
group they comprise what are generally known as high-grade bonds. They are rated
lower than the best bonds because margins of protection may not be as large as
in Aaa securities, fluctuation of protective elements may be of greater
amplitude, or there may be other elements present which make the long-term risks
appear somewhat larger.
A - Bonds which possess many favorable investment attributes and are to be
considered as upper medium- grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment some time in the future.
Baa - Bonds considered as medium-grade obligations (i.e., they are neither
highly protected nor poorly secured). Interest payments and principal security
appear adequate for the present but certain protective elements may be lacking
or may be characteristically unreliable over any great length of time. Such
bonds lack outstanding investment characteristics and, in fact, have speculative
characteristics as well.
Ba - Bonds judged to have speculative elements. Their future cannot be
considered as well assured. Often the protection of interest and principal
payments may be very moderate and thereby not well safeguarded during other good
and bad times over the future. Uncertainty of position characterizes bonds in
this class.
B - Bonds which generally lack characteristics of the desirable investment.
Assurance of interest and principal payments or of maintenance of other terms of
the contract over any long period of time may be small.
Caa - Bonds of poor standing. Such issues may be in default or there may be
present elements of danger with respect to principal or interest.
Ca - Bonds which represent obligations which are speculative in a high degree.
Such issues are often in default or have other marked shortcomings.
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<PAGE> 32
C - The lowest rated class of bonds and issues so rated can be regarded as
having extremely poor prospects of ever attaining any real investment standing.
Nonrated - Where no rating has been assigned or where a rating has been
suspended or withdrawn, it may be for reasons unrelated to the quality of the
issue.
Should no rating be assigned, the reason may be one of the following:
1. An application for rating was not received or accepted.
2. The issue or issuer belongs to a group of securities that are not rated
as a matter policy.
3. There is a lack of essential data pertaining to the issue or issuer.
4. The issue was privately placed, in which case the rating is not
published in Moody's publications.
Suspension or withdrawal may occur if new and material circumstances arise, the
effects of which preclude satisfactory analysis; if there is no longer available
reasonable up-to-date data to permit a judgment to be formed; if a bond is
called for redemption; or for other reasons.
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believe
possess the strongest investment attributes are designated by the symbols Aa 1,
A 1, Baa 1, Ba 1 and B 1.
S&P
AAA - Capacity to pay interest and repay principal is extremely strong.
AA - Capacity to pay interest and repay principal is very strong and these bonds
differ from AAA issues only in small degree.
A - Capacity to pay interest and repay principal is strong although they are
somewhat more susceptible to the adverse effects of changes in circumstances and
economic conditions than bonds in higher rated categories.
BBB - Capacity to pay interest and repay principal is adequate. Whereas these
bonds normally exhibit adequate protection parameters, adverse economic
conditions or changing circumstances are more likely to lead to a weakened
capacity to pay interest and repay principal than for bonds in higher rated
categories.
BB, B, CCC, CC, C - Debt rated BB, B, CCC, CC and C is regarded, on balance as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligations. BB indicates the
lowest degree of speculation and C the highest degree of speculation. While such
debt will likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major risk exposures to adverse conditions.
CI - reserved for income bonds on which no interest is being paid.
D - in default, and payment of interest and/or repayment of principal is in
arrears.
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
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<PAGE> 33
NR: Indicates that no rating has been requested, that there is insufficient
information on which to base a rating, or that Standard & Poor's does not rate a
particular type of obligation as a matter of policy.
Commercial Paper Ratings. Moody's and S&P employ the designations set forth
below to rate commercial paper.
Moody's designations, all judged to be investment grade, indicate the relative
repayment capacity of rated issuers. Issuers rated Prime-1 have a superior
capacity for repayment of short-term promissory obligations. Issuers rated
Prime-2 have a strong capacity for repayment of short-term promissory
obligations. Issuers rated Prime-3 have an acceptable capacity for repayment of
short-term promissory obligations.
S&P ratings are an assessment of the likelihood of timely payment of debt having
an original maturity of no more than 365 days. Issuers assigned the highest
rating by S&P ("A") are regarded as having the greatest capacity for timely
payment. Issuers in this category are further refined with the designations 1, 2
and 3 to indicate the relative degree of safety. A-1 indicates that the degree
of safety regarding timely payment is either overwhelming (denoted with a plus
sign) or very strong. A-2 indicates that capacity for timely payment is strong;
however, the relative degree of safety is not as high as for issuers designated
A-1. A-3 indicates a satisfactory capacity for timely payment. They are,
however, somewhat more vulnerable to the adverse effects of changes in
circumstances than obligations carrying the higher designations.
RISK FACTORS RELATING TO LOWER RATED SECURITIES
As described in the Prospectus, the Fund may invest up to 25% of its assets in
convertible securities, in debt securities which are not rated in the highest
two grades by Moody's and S&P, and in preferred stocks. Ratings of debt
securities are described above. The Prospectus discussion of the risks of
investing in lower rated high yield bonds is supplemented as follows:
1. Youth and Growth of the High Yield Bond Market. Since the high yield
bond market is relatively new, its growth has paralleled a long economic
expansion, and it has not weathered a lengthy recession in its present
size and form. An economic downturn or increase in interest rates is
likely to have a negative effect on the high yield bond market and on
the value of the high yield bonds in the Fund's portfolio, as well as on
the ability of the bonds' issuers to repay principal and interest.
2. 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, in
the case of high yield bonds structured as zero coupon or pay-in-kind
securities, their market prices are affected to a greater extent by
interest rate changes and thereby tend to be more volatile than
securities which pay interest periodically and in cash.
3. 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 may 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, may
decrease the values and liquidity of high yield bonds, especially in a
thinly
7
<PAGE> 34
traded market. To the extent the Fund owns or may acquire illiquid high
yield bonds, these securities may involve special liquidity and
valuation difficulties.
4. Legislation. New laws and proposed new laws may have a negative impact
on the market for high yield bonds. For example, recent legislation
requires federally-insured savings and loan associations to divest their
investments in high yield bonds.
5. 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.
6. 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.
INVESTMENT RESTRICTIONS
The Fund has adopted the investment restrictions set forth below, which apply at
the time securities are purchased or other relevant action is taken. These
restrictions and the Fund's investment objective cannot be changed without
approval of the holders of a majority of outstanding Fund shares. Such majority
is defined in the Investment Company Act of 1940 ("Investment Company Act") 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. Percentage limitations applicable
to investments are calculated and applied at the time of investment. These
restrictions provide that the Fund shall not:
1. Borrow money, except from a bank as a temporary measure for
extraordinary or emergency purposes (including meeting redemptions
without immediately selling securities), but not for leverage or
investment, in an amount not to exceed 10% of the value of net assets at
the time the borrowing is made; provided, however, that so long as such
borrowings exceed 5% of the value of net assets the Fund will not make
any new investments;
2. Mortgage, pledge or hypothecate assets, except to an extent not greater
than 10% of total assets to secure borrowings made in accordance with
restriction 1 above;
3. Invest more than 5% of its total assets (excluding cash and cash items)
in the securities of any one issuer, except the United States
Government, its agencies and instrumentalities. Investments in one or
more domestic commercial banks are excluded from this 5% limitation with
respect to 25% of the Fund's total assets;
4. Invest more than 25% of the Fund's total assets in the securities of
issuers (other than domestic banks and the U.S. Government, its agencies
and instrumentalities) in the same industry. Electric, natural gas
distribution, natural gas pipeline, combined electric and natural gas
and telephone utilities are
8
<PAGE> 35
considered separate industries for purposes of this restriction and
finance companies as a group shall not be considered within a single
industry;
5. Make time deposits (excluding negotiable certificates of deposit) of
more than seven days. Time deposits with maturity occurring on the
Fund's next business day or within up to seven calendar days may not
exceed 10% of the Fund's total assets;
6. Make loans to others, except through the purchase of various kinds of
publicly distributed debt obligations, investments in variable amount
master demand notes and repurchase agreement transactions in which the
Fund is permitted to invest;
7. Purchase or sell real estate; however, the Fund may purchase marketable
securities issued by companies which invest in real estate or interests
therein;
8. Purchase securities on margin or sell short, 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;
9. Purchase or sell commodities or commodity futures contracts, or
interests in oil, gas or mineral exploration or development programs;
10. Underwrite securities of other issuers;
11. Acquire more than 10% of any class of securities of an issuer. For this
purpose, all outstanding bonds and other evidences of indebtedness shall
be deemed within a single class regardless of maturities, priorities,
coupon rates, series, designations, conversion rights, security or other
differences;
12. Purchase securities (other than under repurchase agreements of not more
than one week's duration considering only the remaining days to maturity
of each existing repurchase agreement) for which there exists no readily
available market or for which there are legal or contractual
restrictions on resale (except securities which are subject to such
resale restrictions but which, in the judgment of the Fund's investment
adviser, are readily redeemable on demand), if, as a result of any such
purchase, more than 10% of the Fund's net assets would be invested in
such securities;
13. Purchase warrants or write, purchase or sell puts, calls, straddles,
spreads or combinations thereof;
14. Purchase securities of other investment companies except in connection
with a merger, consolidation, acquisition or reorganization;
15. Purchase securities of any issuer for the purpose of exercising control
of management;
16. Invest more than 5% of total assets in securities of any issuer which,
together with predecessors, has been in continuous operation less than
three years; and
17. Purchase or retain the securities of an issuer if those officers or
directors of the Fund or the Fund's investment adviser who are also
officers or directors of the issuer and who each own beneficially more
than 0.5% of the securities of that issuer, together own more than 5% of
the securities of such issuer.
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<PAGE> 36
The Fund has also undertaken with one State that so long as its shares
are registered for sale in that State it will not invest in real estate
limited partnerships or in oil, gas or other mineral leases.
DIRECTORS AND OFFICERS OF THE FUND
All directors and officers of the Fund are also directors and/or officers of one
or more of the 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 Capital Fund, Inc. ("Capital"), FPA
Paramount Fund, Inc. ("Paramount"), FPA Perennial Fund, Inc. ("Perennial") and
Source Capital, Inc. ("Source") (collectively, the "FPA Fund Complex").
The directors and officers of the Fund and their principal occupations during
the past five years follow. Their address is 11400 West Olympic Boulevard, Suite
1200, Los Angeles, California 90064.
Donald E. Cantlay, Director
General Partner of Cee'n'Tee Co. (commercial real estate) for more than the past
five years. Director of Capital, of Transamerica Income Shares, Inc. ("Income
Shares"), a closed-end investment company, of California Trucking Association
and of Western Highway Institute. Member of the Board of Regents of Loyola
Marymount University.
DeWayne W. Moore, Director
Former Director, Senior Vice President and Chief Financial Officer of Guy F.
Atkinson Company of California (construction). Director of Capital and of Income
Shares.
Lawrence J. Sheehan, Director (1)
Of counsel to, and partner (1969 to 1994) of, the law firm of O'Melveny & Myers
LLP, legal counsel to the Fund. Director of Source, of Perennial and of Capital.
Director of TCW Convertible Securities Fund, Inc., a closed-end investment
company.
Kenneth L. Trefftzs, Director
Private investor. Former Professor of Finance and Chairman of the Department of
Finance and Business Economics, University of Southern California Graduate
School of Business. Director of Source, of Perennial and of Capital.
Robert L. Rodriguez, President & Chief Investment Officer
Director, Principal and Chief Investment Officer of the Adviser since March
1996; President and Chief Investment Officer of New Income for more than the
past five years; and Director and Senior Vice President of Source since March
1996. Director of the Distributor since March 1996. Executive Vice President
from January 1996 to March 1996, Senior Vice President from February 1993 to
January 1996, and Vice President from November 1983 to February 1993, of the
Adviser.
Julio J. de Puzo, Jr., Executive Vice President
Director (since October 1995), Principal (since March 1996) and Chief Executive
Officer (since March 1996) of the Adviser; Director and President since March
1996 of Source; Director and Executive Vice President since April 1996 of
Paramount and of Perennial; and Executive Vice President since August 1996 of
Capital. President (since January 1997), Chief Executive Officer (since January
1997), Chief Financial Officer and Director for more than the past five years of
the Distributor. 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, Senior
Vice President from February 1993 to October 1995, and First Vice President from
April 1985 to February 1993, of the
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<PAGE> 37
Adviser. Treasurer from July 1984 to August 1996 of the Fund and of Capital;
from June 1981 to August 1996 of Paramount; from May 1982 to August 1996 of
Source; and from September 1983 to August 1996 of Perennial. Executive Vice
President (or Senior Vice President or First Vice President) from October 1991
to January 1997 of the Distributor.
Eric S. Ende, Vice President
Senior Vice President (or Vice President) of the Adviser and of Source for more
than the past five years; President and Chief Investment Officer of Perennial
since September 1995; and Vice President of Capital and of Paramount for more
than the past five years. Executive Vice President of Perennial from August 1995
to September 1995, and Vice President of Perennial from May 1985 to August 1995.
J. Richard Atwood, Treasurer
Senior Vice President, Chief Financial Officer and Treasurer of the Adviser, and
Senior Vice President and Treasurer of the Distributor. Treasurer of Capital, of
Paramount, of Source and of Perennial 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 the Adviser from 1988 to January 1995, and Assistant Treasurer of
Fund Distributors from May 1991 to January 1995. Assistant Treasurer of the
Fund, of Capital, of Paramount, of Source and of Perennial from 1988 to 1995.
Sherry Sasaki, Secretary
Assistant Vice President and Secretary of the Adviser, and Secretary of Source,
of Capital, of Paramount, of Perennial and of the Distributor for more than the
past five years.
Christopher H. Thomas, Assistant Treasurer
Vice President and Controller of the Adviser and of the Distributor since March
1995, and Assistant Treasurer of Capital, of Paramount, of Source and of
Perennial since April 1995. Staff Accountant with the Office of Inspection of
the Securities and Exchange Commission from 1994 to March 1995. School
Administrator of the Calvary Road Christian Academy from 1988 to 1993.
- -----------------------
(1) 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.
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 $21,000 in
Directors' fees. Such Directors are also reimbursed for certain travel expenses
by the Fund. The following information relates to Director compensation. The
Fund does not pay any salaries to its officers, all of whom are compensated by
the Adviser.
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<PAGE> 38
TOTAL COMPENSATION*
AGGREGATE COMPENSATION* FROM THE FPA FUND COMPLEX
NAME OF DIRECTORS FROM THE FUND INCLUDING THE FUND
- --------------------------------------------------------------------------------
Donald E. Cantlay $5,250 $10,500**
DeWayne W. Moore $5,250 $10,500**
Lawrence J. Sheehan $5,250 $31,500***
Kenneth L. Trefftzs $5,250 $31,500***
* No pension or retirement benefits are provided to Directors by the Fund or
the FPA Fund Complex.
** Includes compensation from the Fund and one other open-end investment
company.
*** Includes compensation from the Fund, two other open-end investment
companies, and one closed-end investment company.
Currently, the personnel of the Adviser consists of six persons engaged full
time in portfolio management or investment research in addition to 23 persons
engaged full time in trading, administrative, financial or clerical activities.
The Adviser is registered as an investment adviser with the Securities and
Exchange Commission, which does not imply supervision by said Commission of the
Adviser's activities. The Adviser's parent company, UAM, is a publicly held
corporation. No person is known by UAM to own or hold with power to vote 25% or
more of its outstanding shares of common stock.
Five Percent Shareholder. As of December 31, 1996, no person was known by the
Fund to own of record or beneficially 5% or more of the outstanding Fund shares,
except Donaldson, Lufkin & Jenrette Securities Corp., P.O. Box 2052, Jersey
City, New Jersey 07303-2052, which was the holder of record of 3,772,187 shares
(11.2%); Divtex & Co., for the benefit of Pritchard Hubble & Herr, Client
Support Mutual Fund Unit, P.O. Box 200547, Houston, Texas 77216-0547, which held
3,016,247 shares (8.9%); Charles Schwab & Co., Inc., for the benefit of
customers, 101 Montgomery Street, San Francisco, California 94104-4122, which
held 2,584,763 shares (7.7%); and National Financial Services Corp., for the
exclusive use of its customers, Attention: Mutual Funds, 5th Floor, 200 Liberty
Street- 1 WFC, New York, New York 10281-1003, which held 1,752,269 shares
(5.2%). The foregoing broker-dealers and/or investment advisory firms advise
that the shares are held for the benefit of their customers.
INVESTMENT ADVISORY AGREEMENT
The Fund has entered into an investment advisory agreement dated December 27,
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 compensates all officers and other personnel of the Fund,
all of whom are employed by the Adviser.
Other than the expenses the Adviser specifically assumes under the Advisory
Agreement, the Fund bears all costs incurred in 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
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<PAGE> 39
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; and
postage.
For services rendered, facilities furnished and expenses assumed, the Adviser is
paid an investment management fee. Such fee is payable monthly at the annual
rate of 0.50% of the Fund's average daily net assets.
The Adviser pays the Fund the amount by which certain defined operating expenses
of the Fund for any fiscal year exceed 1.50% of the first $15 million of average
net assets plus 1% of the remaining average net assets. Such reimbursement is
calculated at the close of business on the last business day of each calendar
month. Any required reduction or refund is paid monthly. Such operating expenses
include the advisory fee but exclude interest, taxes and brokerage commissions.
The Advisory Agreement provides that the Adviser shall not be liable for any
error of judgment, any mistake of law, any loss arising out of any investment,
or any act or omission in the management of the Fund, except willful
misfeasance, bad faith or negligence in the Adviser's performance of its duties
or the reckless disregard of its obligations and duties under the Advisory
Agreement.
The Advisory Agreement is renewable annually if such renewal is specifically
approved each year (a) by the Fund's Board of Directors or by the vote of a
majority 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. The continuation of the Advisory Agreement to December 31, 1997, 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 September 30, 1994, 1995 and 1996, the Adviser
received gross advisory fees of $579,841, $755,915 and 1,283,864, 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:
P(1 + T)n = 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).
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<PAGE> 40
Under the foregoing formula, the time periods used in advertising are 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. 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.
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 bond index such as the
Lehman Brothers Government/Corporate Bond 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 is
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
September 30, 1996 was 2.19%, 8.16%, and 9.45%, respectively. The Fund's average
annual total return (determined pursuant to the alternative computation which
does not include the maximum initial sales charge of 4.5% of the offering price)
for the same periods was 7.00%, 9.16%, and 9.95%, 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 level of interest rates,
and general economic and other market conditions.
PORTFOLIO TRANSACTIONS
The Adviser is responsible for decisions to buy and sell securities for the Fund
and for the placement of its portfolio business and the negotiation of any
commissions paid on such transactions. Since most transactions the Fund makes
are principal transactions at net prices, the Fund incurs little or no brokerage
costs. Portfolio securities are normally purchased directly from the issuer or
from an underwriter or market maker for the securities. Purchases of portfolio
securities from underwriters include a commission or concession the issuer pays
to the underwriter. Purchases from dealers serving as market makers include the
spread between the bid and asked price. Sales to dealers are effected at bid
prices.
The Adviser is responsible for placing portfolio transactions and does so in a
manner deemed fair and reasonable to the Fund and not according to any formula.
The primary consideration in all portfolio transactions is prompt execution of
orders in an effective manner at the most favorable price. 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 price to the Fund in any transaction may be less
favorable than that available from
14
<PAGE> 41
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
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.
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 the 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 opinions of the persons responsible for recommending the
investments.
Brokerage commissions paid by the Fund on a portfolio transaction(s) for the
fiscal years ended September 30, 1994, 1995 and 1996 totaled $1,860, $1,800 and
$3,747, respectively. During the last fiscal year, all commissions were paid on
transactions having a total value of $1,629,280 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.
DISTRIBUTOR
FPA Fund Distributors, Inc., a wholly owned subsidiary of the Adviser, acts as
the principal underwriter of Fund shares pursuant to the distribution agreement
dated December 27, 1994 ("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 its own overhead and general administrative expenses, the cost
of printing and distributing prospectuses used in connection with this offering,
except for those furnished to existing shareholders, and the cost of advertising
and sales literature. The Fund pays expenses attributable to the registration of
Fund shares under federal and state laws and the compensation and expenses of
the Fund's transfer agent.
15
<PAGE> 42
The Distribution Agreement is renewable annually if such renewal is 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, 1997, 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 Investement 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.
During the fiscal years ended September 30, 1994, 1995 and 1996, total
underwriting commissions on sales of Fund shares were $940,155, $1,760,140 and
$1,735,400, respectively, of which $106,947, $188,788 and $183,468,
respectively, were retained by the Distributor after reallowances to other
dealers.
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, 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, President's Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day. Such computation is made by valuing (a)
securities listed or traded on a national securities exchange or on the NASDAQ
National Market System at the last sale price or, if there has been no sale that
day, at the last bid price, (b) unlisted securities and securities listed on a
national securities exchange for which the over-the-counter market more
accurately reflects the securities value in the judgment of the Fund's officers,
at the most recent bid price or other ascertainable market value, (c) at cost
money market instruments with maturities of 60 days or less (in the case of
instruments originally purchased with maturities over 60 days, market value on
the 61st day prior to maturity is used rather than cost), plus or minus any
discount or premium ratably amortized until maturity and (d) all other portfolio
securities and assets at fair value as determined in good faith by the Fund's
Board of Directors.
Sales Charges. The maximum sales charge is 4.5%, 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 86%
to 100%, 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.
Sales at Net Asset Value. Full-time employees of the Adviser may 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.
16
<PAGE> 43
Letter of Intent. To be eligible, 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 such initial purchase. The
investor thereby becomes eligible for a reduced sales charge based on the total
amount of the specified intended investment ("LOI Goal"), provided such 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 may 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 reduced sales charge applicable. In
addition, during the Period, the shareholder may 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
in the premises 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 to, or as directed by, the shareholder.
FPA Exchange Privilege. The procedures for exchanging shares between FPA Funds
are set forth under "Purchase of Shares - FPA Exchange Privilege" 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 "Redemption of Shares" in the Fund's Prospectus.
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
17
<PAGE> 44
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 shall 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 prior to the time 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 Shareholder Service 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 in the manner
described above.
Redemption of Shares. Redemptions are not made on days during which the NYSE is
closed, including those holidays listed under "Purchase and Redemption of Shares
- - Net Asset Value." The right of redemption may 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.
Telephone Redemption. Redemptions may be made by telephone once the shareholder
has properly completed and returned to the Shareholder Service 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
"Redemption of Shares" in the Fund's Prospectus. The optional shareholder
services form is available from authorized securities 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 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.
The shareholder may cancel the telephone redemption authorization upon written
notice. If the shareholder has authorized telephone redemptions, neither the
Fund nor the Shareholder Service 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
18
<PAGE> 45
purchased by check, the Shareholder Service Agent can delay transmitting the
proceeds until the purchasing check has cleared.
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. The investor
should be aware that a penalty tax applies, in general, to distributions made
before age 59-1/2, excess contributions and failure to commence distribution of
the account at age 70-1/2. Borrowing from or against the account may 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
these 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 such 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 establishment of 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 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.
19
<PAGE> 46
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 from year to year, a small portion of
the dividends paid to shareholders from the Fund's net investment income may
qualify 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.
FINANCIAL STATEMENTS
DETERMINATION OF NET ASSET VALUE, REDEMPTION PRICE AND OFFERING PRICE PER
SHARE - September 30, 1996
Net asset value and redemption price per share
(net assets divided by shares outstanding)..................... $10.97
Offering price per share
(100/95.5 of per share net asset value).......................... $11.49
The offering price is reduced on purchases of $10,000 or more; see "Purchase and
Redemption of Shares - Sales Charge" herein and "Purchase of Shares - Table of
Sales Charges" in the Prospectus.
20
<PAGE> 47
PORTFOLIO OF INVESTMENTS
September 30, 1996
<TABLE>
<CAPTION>
Principal
BONDS & DEBENTURES Amount Cost Value
- ------------------------------------------------------------- --------------- -------------- ---------------
<S> <C> <C> <C>
U.S. GOVERNMENT & AGENCIES
MORTGAGE-BACKED SECURITIES -- 46.6%
Federal Home Loan Bank (Indexed Amortization Notes)
--6.55% 2003................................. $6,500,000 $6,437,505 $6,437,031
Federal Home Loan Mortgage Corporation (CMO)
--7% 2020 ................................................... 16,060,00 15,681,625 15,713,706
--8% 2010 ................................................... 668,073 671,414 666,820
--8 1/2% 2024 ............................................... 5,000,000 5,031,250 5,046,875
Federal Home Loan Mortgage Corporation (PAC-REMIC)
--7% 2008 ................................................... 7,700,000 7,658,563 7,482,375
Federal Home Loan Mortgage Corporation (PAC-IO-CMO)
--6 1/2% 2020 ............................................... 4,171,384 673,134 659,600
--7% 2020 ................................................... 8,000,000 1,935,995 2,200,000
Federal Home Loan Mortgage Corporation (PAC-IO-REMIC)
--6 1/2% 2007 ............................................... 16,722,123 2,941,808 2,947,274
--6 1/2% 2023 ............................................... 11,856,023 1,683,533 1,719,123
Federal Home Loan Mortgage Corporation (REMIC)
--6 1/2% 2018 ............................................... 1,500,000 1,527,188 1,449,375
--7% 2003 ................................................... 2,600,000 2,652,000 2,577,250
--7% 2007 ................................................... 6,248,912 6,174,706 6,073,161
--7% 2008 ................................................... 13,221,089 13,096,827 12,752,205
--7% 2023 ................................................... 5,000,000 4,487,500 4,515,625
--7 1/2% 2026 ............................................... 7,492,789 6,639,960 6,734,144
--10.15% 2006 ............................................... 102,880 179,606 103,909
Federal National Mortgage Association (PAC-REMIC)
--7% 2007 ................................................... 2,467,245 2,439,489 2,397,854
--7 3/4% 2023 ............................................... 3,500,000 3,215,625 3,430,000
--8% 2023 ................................................... 6,590,000 6,540,575 6,631,188
--8 1/2% 2024 ............................................... 1,687,000 1,708,615 1,693,326
--8 1/2% 2025 ............................................... 11,000,000 11,056,250 11,048,125
Federal National Mortgage Association (PAC-IO-REMIC)
--6 1/2% 2009 ............................................... 11,976,597 1,757,544 1,800,232
--6 1/2% 2020 ............................................... 6,000,000 1,376,741 1,381,875
--7% 2004 ................................................... 1,796,601 325,691 336,301
--7% 2017 ................................................... 9,914,724 1,097,357 1,363,275
Federal National Mortgage Association (REMIC)
--7% 2008 ................................................... 5,734,854 5,684,351 5,518,819
--7% 2023 ................................................... 6,406,075 6,213,893 6,065,752
--7% 2024 ................................................... 9,351,511 7,271,755 7,659,472
--7 1/2% 2024 ............................................... 7,972,287 7,213,911 7,199,972
--8% 2011 ................................................... 2,000,000 2,010,000 2,011,250
</TABLE>
21
<PAGE> 48
PORTFOLIO OF INVESTMENTS
Continued
<TABLE>
<CAPTION>
Principal
BONDS & DEBENTURES Amount Cost Value
- ------------------------------------------------------------- --------------- -------------- ---------------
<S> <C> <C> <C>
Government National Mortgage Association
--7 1/2% 2023 ............................................... 844,652 807,698 833,830
Government National Mortgage Association (GPM)
--14% 2014 .................................................. 77,054 77,569 85,048
Government National Mortgage Association (MH)
--7 1/2% 2002 ............................................... 293,771 307,725 295,240
--8 1/4% 2006-7 ............................................. 818,924 859,559 840,933
--8 3/4% 2006 ............................................... 1,473,411 1,523,861 1,528,664
--8 3/4% 2011 ............................................... 1,693,162 1,750,306 1,755,597
--9% 2010-11 ................................................ 3,480,634 3,654,622 3,637,262
--9 1/4% 2010-11 ............................................ 1,504,234 1,584,333 1,579,446
--9 3/4% 2005-6 ............................................. 3,819,294 4,074,029 4,048,452
--9 3/4% 2012-13 ............................................ 1,512,584 1,629,336 1,603,339
--10 1/4% 2003-5 ............................................ 634,114 645,446 676,124
--10 3/4% 1999-2001 ......................................... 743,718 782,921 799,497
Government National Mortgage Association (PL)
--10 1/4% 2017 .............................................. 945,163 1,025,502 1,001,873
Government National Mortgage Association (REMIC)
--7.99125% 2010 ............................................. 3,442,118 3,442,118 3,452,875
------------ ------------
$157,549,436 $157,754,094
U.S. TREASURY -- 4.3%
U.S. Treasury Notes--8 1/4% 2005............................... $1,800,000 $ 1,706,250 $ 1,886,625
U.S. Treasury Notes Strip--0% 2009 ............................ 31,000,000 11,195,403 12,730,150
------------ ------------
$ 12,901,653 $ 14,616,775
------------ ------------
U.S. AGENCIES -- 1.2%
Tennessee Valley Authority --8 3/8% 1999....................... $3,400,000 $3,222,781 $ 3,551,937
U.S. Small Business Administration --9.8% 1998 ............... 287,915 289,648 295,293
------------ ------------
$ 3,512,429 $ 3,847,230
------------ ------------
TOTAL U.S. GOVERNMENT & AGENCIES -- 52.1% $173,963,518 $176,218,099
------------ ------------
OTHER U.S. GOVERNMENT-BACKED -- 1.5%
Republic of Turkey Trust Certificates--0% 1998................. $ 3,000,000 $ 2,473,078 $ 2,631,600
State of Israel Trust Certificates--0% 1998 ................... 2,785,000 2,320,502 2,443,002
------------ ------------
$ 4,793,580 $ 5,074,602
------------ ------------
</TABLE>
22
<PAGE> 49
PORTFOLIO OF INVESTMENTS
Continued
<TABLE>
<CAPTION>
Principal
BONDS & DEBENTURES Amount Cost Value
- ------------------------------------------------------------- --------------- -------------- ---------------
<S> <C> <C> <C>
MORTGAGE BONDS
ASSET BACKED -- 3.1%
Green Tree Financial Corporation (CMO)
--6.9% 2004................................................... $6,306,481 $ 6,243,899 $ 6,209,913
Merrill Lynch Mortgage Investors, Inc. Class A
(backed by Manufactured Housing First Mortgages)
--8.3% 2012 .................................................. 4,100,000 4,105,516 4,182,000
--9.2% 2011 .................................................. 183,069 182,210 186,044
--9.7% 2008 .................................................. 51,227 51,989 51,707
------------ ------------
$10,583,614 $10,629,664
------------ ------------
MORTGAGE BACKED -- 0.9%
Drexel Burnham Lambert (CMO) Trust Series B Class B-3
--8.9% 2016 (backed by Federal National
Mortgage Association Bonds)................................... $ 195,228 $ 191,323 $ 195,228
Home Mac Mortgage Securities Corporation (CMO)
--9.15% 2019 (backed by U.S. Government
Agency Bonds) ................................................ 490,992 412,433 500,812
Kidder Peabody Mortgage Assets (CMO) Series 5 Class G
--8.45% 2018 (backed by U.S. Government
Agency Bonds) .............................................. 2,162,794 2,151,980 2,162,794
------------ ------------
$ 2,755,736 $ 2,858,834
------------ ------------
TOTAL MORTGAGE BONDS -- 4.0% ................................. $ 13,339,350 $ 13,488,498
------------ ------------
CORPORATE BONDS & DEBENTURES
Aztar Corporation--11% 2002....................$ ............. $ 500,000 $ 500,000 $ 510,000
Busse Broadcasting Corporation --11 5/8% 2000.. 3,250,000 .... 3,176,600 3,282,500
Genesco Inc. --10 3/8% 2003 .................................. 1,000,000 980,000 1,002,500
Oregon Steel Mills, Inc. --11% 2003 .......................... 1,000,000 1,000,000 1,056,250
Plantronics, Inc. --10% 2001 ................................. 3,248,000 3,299,575 3,353,560
RJR Nabisco Incorporated --8 5/8% 2002 ....................... 500,000 467,750 501,875
Trump Atlantic City Associates--11 1/4% 2006 ................. 6,000,000 5,945,625 5,880,000
------------ ------------
TOTAL CORPORATE BONDS
& DEBENTURES -- 4.6% ........................................ $ 15,369,550 $ 15,586,685
------------ ------------
TOTAL NON-CONVERTIBLE
BONDS & DEBENTURES -- 62.2% ................................. $207,465,998 $210,367,884
------------ ------------
CONVERTIBLE SECURITIES
CONVERTIBLE BONDS & DEBENTURES -- 3.8%
Alexander Haagen Properties Inc. (Class "A")--7 1/2% 2001 $1,065,000 $ 923,888 $ 963,825
Alexander Haagen Properties Inc. (Class "B")--7 1/2% 2001 1,400,000 1,221,500 1,274,000
</TABLE>
23
<PAGE> 50
PORTFOLIO OF INVESTMENTS
Continued
<TABLE>
<CAPTION>
Shares or
Principal
CONVERTIBLE SECURITIES -- CONTINUED Amount Cost Value
- ----------------------------------------------------- -------------- -------------- --------------
<S> <C> <C> <C>
Charming Shoppes, Inc.--7 1/2% 2006 .................. 3,000,000 3,000,000 3,150,000
Diagnostic/Retrieval Systems, Inc.--8 1/2% 1998 ...... 852,000 615,979 856,260
Diagnostic/Retrieval Systems, Inc.--9% 2003 .......... 2,000,000 2,000,000 2,620,000
Fabri-Centers of America, Inc.--6 1/4% 2002 .......... 3,631,000 2,762,010 3,068,195
Quantum Health Resources, Inc.--4 3/4% 2000 .......... 1,000,000 776,250 912,500
------------ ------------
$ 11,299,627 $ 12,844,780
------------ ------------
CONVERTIBLE PREFERRED STOCKS -- 0.8%
Integon Corporation .................................. 30,000 $ 1,500,000 $ 1,680,000
Network Imaging Corporation .......................... 75,000 1,400,000 1,087,500
------------ ------------
$ 2,900,000 $ 2,767,500
------------ ------------
TOTAL CONVERTIBLE SECURITIES -- 4.6% ................. $ 14,199,627 $ 15,612,280
------------ ------------
LIMITED PARTNERSHIP -- 0.0%
Jewel Recovery L.P. .................................. 18,594 $ 9,297 $ 9,297
------------ ------------
SHORT-TERM INVESTMENTS -- 3.7%
U.S. Treasury Notes--7 1/4% 11/30/96.................. $3,000,000 $ 2,990,156 $ 3,008,438
U.S. Treasury Notes--6 7/8% 4/30/97 .................. 9,500,000 9,650,234 9,568,281
------------ ------------
$ 12,640,390 $ 12,576,719
------------ ------------
TOTAL INVESTMENT SECURITIES -- 70.5% ................. $234,315,312 $238,566,180
============ ------------
OTHER SHORT-TERM INVESTMENTS -- 28.4%
Short-term Corporate Notes:
Exxon Asset Management Company--5 1/4% 10/1/96...... $16,000,000 $ 16,000,000
Ford Motor Credit Company--5.16% 10/3/96............ 11,600,000 11,596,674
General Electric Capital Services, Inc.--5.34% 10/3/96. 2,300,000 2,299,318
American General Finance Corporation --5.31% 10/7/96. 14,000,000 13,987,610
General Motors Acceptance Corporation--5.35% 10/7/96. 16,600,000 16,585,198
Hertz Corporation--5.36% 10/8/96............. 16,600,000 16,582,699
American Express Credit Corporation--5.28% 10/10/96. 8,650,000 8,638,582
General Electric Capital Services, Inc.--5.32% 10/10/96. 8,650,000 8,638,496
State Street Bank Repurchase Agreement--4 3/4% 10/1/96
(Collateralized by U.S. Treasury Notes--5 7/8% 1997,
market value $1,601,922)..................... 1,566,000 1,566,207
$ 95,894,784
------------
TOTAL INVESTMENTS -- 98.9%..................... $334,460,964
Other assets less liabilities-- 1.1%........... 3,835,963
------------
TOTAL NET ASSETS -- 100%....................... $338,296,927
============
</TABLE>
See notes to financial statements.
24
<PAGE> 51
STATEMENT OF ASSETS AND LIABILITIES
September 30, 1996
<TABLE>
<CAPTION>
<S> <C> <C>
ASSETS
Investments at value:
Investment securities -- at market value
(identified cost $234,315,312)................... $238,566,180
Short-term investments -- at cost plus interest
earned (maturities of 60 days or less).......... 95,894,784 $334,460,964
------------
Cash................................................. 316
Receivable for:
Interest........................................... $2,886,217
Capital Stock sold................................. 1,414,419 4,300,636
------------ ------------
$338,761,916
LIABILITIES
Payable for:
Capital Stock repurchased.......................... $ 219,811
Advisory fees...................................... 136,228
Accrued expenses and other liabilities............. 108,950 464,989
------------ ------------
NET ASSETS -- equivalent to $10.97 per share on 30,829,948
shares of Capital Stock outstanding.................. $338,296,927
============
SUMMARY OF SHAREHOLDERS' EQUITY
Capital Stock -- par value $0.01 per share; authorized
100,000,000 shares; outstanding 30,829,948 shares.. $ 308,299
Additional Paid-in Capital........................... 326,740,364
Undistributed net realized gains on investments...... 1,653,523
Undistributed net investment income.................. 5,343,873
Unrealized appreciation of investments............... 4,250,868
------------
Net assets at September 30, 1996..................... $338,296,927
============
</TABLE>
See notes to financial statements.
25
<PAGE> 52
STATEMENT OF OPERATIONS
For the Year Ended September 30, 1996
<TABLE>
<CAPTION>
<S> <C> <C>
INVESTMENT INCOME
Interest........................................... $18,240,477
Dividends.......................................... 319,298
-----------
$18,559,775
EXPENSES
Advisory fees...................................... $1,283,864
Transfer agent fees and expenses................... 111,491
Registration fees.................................. 97,924
Custodian fees and expenses........................ 45,234
Audit fees......................................... 23,040
Postage............................................ 22,615
Directors' fees and expenses....................... 21,556
Insurance.......................................... 13,736
Reports to shareholders............................ 13,113
Legal fees......................................... 8,717
Taxes, other than federal income tax............... 800
Other expenses..................................... 9,861 1,651,951
------------ ------------
Net investment income...................... $16,907,824
------------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS
Net realized gain on investments:
Proceeds from sales of investment securities (excluding
short-term investments with maturities of 60 days or less). $52,256,522
Cost of investment securities sold................. 50,306,075
------------
Net realized gain on investments............... $1,950,447
Unrealized appreciation of investments:
Unrealized appreciation at beginning of year....... $5,407,459
Unrealized appreciation at end of year............. 4,250,868
------------
Decrease in unrealized appreciation of investments. (1,156,591)
------------
Net realized and unrealized gain on investments. $ 793,856
------------
NET INCREASE IN NET ASSETS RESULTING
FROM OPERATIONS...................................... $17,701,680
============
</TABLE>
See notes to financial statements.
26
<PAGE> 53
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
For the Year Ended September 30,
--------------------------------
1996 1995
----------------------------- ----------------------------
<S> <C> <C> <C> <C>
INCREASE IN NET ASSETS
Operations:
Net investment income........... $16,907,824 $ 10,111,535
Net realized gain on investments. 1,950,447 3,080,818
Increase (decrease) in unrealized
appreciation of investments.... (1,156,591) 4,526,158
------------- -------------
Increase in net assets resulting
from operations................. $17,701,680 $ 17,718,511
Distributions to shareholders:
From net investment income...... $(14,518,692) $ (9,257,545)
From net realized capital gains. (3,355,550) (17,874,242) -- (9,257,545)
------------- -------------
Capital Stock transactions:
Proceeds from Capital Stock sold. $157,921,206 $ 100,118,255
Proceeds from shares issued to
shareholders upon reinvestment
of dividends and distributions. 12,754,692 7,265,944
Cost of Capital Stock repurchased. (39,224,350) 131,451,548 (31,535,316) 75,848,883
------------- ------------- ------------- -------------
Total increase in net assets...... $131,278,986 $ 84,309,849
NET ASSETS
Beginning of year, including
undistributed net investment income
of $2,954,741 and $2,100,751.... 207,017,941 122,708,092
------------- -------------
End of year, including
undistributed net investment income
of $5,343,873 and $2,954,741.... $338,296,927 $ 207,017,941
============= =============
CHANGE IN CAPITAL STOCK
OUTSTANDING
Shares of Capital Stock sold...... 14,518,767 9,332,648
Shares issued to shareholders
upon reinvestment of dividends
and distributions............... 1,178,442 693,811
Shares of Capital Stock repurchased. (3,608,711) (2,947,243)
------------- -------------
Increase in Capital Stock
outstanding..................... 12,088,498 7,079,216
============= =============
</TABLE>
See notes to financial statements.
27
<PAGE> 54
NOTES TO FINANCIAL STATEMENTS
September 30, 1996
NOTE 1 -- SIGNIFICANT ACCOUNTING POLICIES
The Fund is registered under the Investment Company Act of 1940 as a
diversified, open-end,management investment company. 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 and securities listed on a national
securities exchange for which the over-the-counter market more accurately
reflects the securities' value in the judgment of the Fund's officers, are
valued at the most recent bid price or other ascertainable market value.
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.
NOTE 2 -- PURCHASES OF INVESTMENT SECURITIES
Cost of purchases of investment securities (excluding short-term
investments with maturities of 60 days or less) aggregated $106,698,464 for the
year ended September 30, 1996. Realized gains or losses are based on the
specific-certificate identification method. Cost of investment securities owned
at September 30, 1996 was the same for federal income tax and financial
reporting purposes.
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 0.5% of the average daily net assets of the Fund. The Agreement
obligates the Adviser to reduce its fee to the extent necessary to 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 $15 million and 1% of the
remaining average net assets of the Fund for the year.
For the year ended September 30, 1996, the Fund paid aggregate fees of
$21,000 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.
28
<PAGE> 55
NOTE 4 -- DISTRIBUTOR
For the year ended September 30, 1996, FPA Fund Distributors, Inc.
("Distributor"), a wholly owned subsidiary of the Adviser, received $183,468 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 -- DISTRIBUTION TO SHAREHOLDERS
On September 30, 1996, the Board of Directors declared a dividend from
net investment income of $0.17 per share payable October 15, 1996 to
shareholders of record on September 30, 1996. For financial statement purposes,
this dividend and distribution was recorded on the ex-dividend date, October 1,
1996.
29
<PAGE> 56
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
TO THE BOARD OF DIRECTORS AND
SHAREHOLDERS OF FPA NEW INCOME, INC.
We have audited the accompanying statement of assets and liabilities of FPA New
Income, Inc., including the portfolio of investments, as of September 30,
1996, and 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 4 of the Prospectus for each of the
ten 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. Our procedures included confirmation of securities
owned as of September 30, 1996, 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
New Income, Inc. at September 30, 1996, 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 4 of the Prospectus,
for each of the ten years in the period then ended in conformity with generally
accepted accounting principles.
/s/ ERNST & YOUNG LLP
ERNST & YOUNG LLP
Los Angeles, California
November 1, 1996
30
<PAGE> 57
PART C. OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Financial Statements (all included in Part B)
Report of Independent Auditors
Portfolio of Investments, September 30, 1996
Statement of Assets and Liabilities, September 30, 1996
Statement of Operations
Year ended September 30, 1996
Statement of Changes in Net Assets
Year ended September 30, 1995
Year ended September 30, 1996
All other financial statements and schedules are inapplicable.
(b) Exhibits
1. Articles of Incorporation was filed as Exhibit 1 to
Post-Effective Amendment No. 35 of Registrant's Registration
Statement on Form N-1A and is incorporated herein by
reference.
2. By-Laws was filed as Exhibit 2 to Post-Effective Amendment No.
35 of Registrant's Registration Statement on Form N-1A and is
incorporated herein by reference.
4. Specimen common stock certificate was filed as Exhibit 4 to
Post-Effective Amendment No. 35 of Registrant's Registration
Statement on Form N-1A and is incorporated herein by
reference.
5. Investment Advisory Agreement, dated December 27, 1994,
between Registrant and First Pacific Advisors, Inc. was filed
as Exhibit 5 to Post-Effective Amendment No. 35 of
Registrant's Registration Statement on Form N-1A and is
incorporated herein by reference.
6. Distribution Agreement, dated December 27, 1994, between
Registrant and FPA Fund Distributors, Inc. was filed as
Exhibit 6 to Post-Effective Amendment No. 35 of Registrant's
Registration Statement on Form N-1A and is incorporated herein
by reference.
6.1 Specimen Selling Group Agreement was filed as Exhibit 6.1 to
Post-Effective Amendment No. 32 of Registrant's Registration
Statement on Form N-1A and is incorporated herein by
reference.
8. Custodian Contract between Registrant and State Street Bank
and Trust Company was filed as Exhibit 8 to Post-Effective
Amendment No. 25 of Registrant's Registration Statement on
Form N-1A and is incorporated herein by reference.
8.1 Amendment to the Custodian Contract was filed as Exhibit 8 to
Post-Effective Amendment No. 28 of Registrant's Registration
Statement on Form N-1A and is incorporated herein by
reference.
8.2 Custodian Fee Schedule Addendum for GNMA Securities Traded
through Participants Trust Company was filed as Exhibit 8 to
Post-Effective
C-1
<PAGE> 58
Amendment No. 31 of Registrant's Registration Statement on
Form N-1A and is incorporated herein by reference.
8.3 Amendment to the Custodian Contract was filed as Exhibit 8.3
to Post-Effective Amendment No. 34 of Registrant's
Registration Statement on Form N-1A and is incorporated herein
by reference.
8.4 Amendment to the Custodian Contract.
9. Agreement and Articles of Merger, dated February 14, 1994, was
filed as Exhibit 9 to Post-Effective Amendment No. 35 of
Registrant's Registration Statement on Form N-1A and is
incorporated herein by reference.
11. Consent of Independent Auditors (filed as page C-7).
14. State Street Bank and Trust Company Individual Retirement
Custodial Account and Disclosure Statement was filed as
Exhibit 14 to Post-Effective Amendment No. 34 of Registrant's
Registration Statement on Form N-1A and is incorporated herein
by reference.
16. Schedule of computations of performance quotations.
17. Financial Data Schedule.
ITEM 25. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT.
None.
ITEM 26. NUMBER OF HOLDERS OF SECURITIES.
As of September 30, 1996:
<TABLE>
<CAPTION>
(1) (2)
Title of Class Number of Record Holders
-------------- ------------------------
<S> <C>
Common Stock, $0.01 par value 5,367
</TABLE>
ITEM 27. INDEMNIFICATION.
Registrant's Articles of Incorporation provide that the Corporation shall
indemnify (i) its directors and officers, whether serving the Corporation or at
its request any other entity, to the full extent required or permitted by the
General Laws of the State of Maryland now or hereafter in force, including the
advance of expenses under the procedures and to the full extent permitted by
law, and (ii) other employees and agents to such extent as shall be authorized
by the Board of Directors or the By-Laws and as permitted by law. Nothing
contained herein shall be construed to protect any director or officer of the
Corporation against any liability to the Corporation or to any holders of
securities of the Corporation to which he would otherwise be subject by reason
of willful misfeasance, bad faith, gross negligence, or reckless disregard of
the duties involved in the conduct of his office. The foregoing rights of
indemnification shall not be exclusive of any other rights to which those
seeking indemnification may be entitled. The Board of Directors may take such
action as is necessary to carry out these indemnification provisions and is
expressly empowered to adopt, approve and amend from time to time such by-laws,
resolutions or contracts
C-2
<PAGE> 59
implementing such provisions or such further indemnification arrangements as
may be permitted by law. No amendment of the charter of the Corporation or
repeal of any of its provisions shall limit or eliminate the right of
indemnification provided hereunder with respect to acts or omissions occurring
prior to such amendment or repeal.
ITEM 28. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER.
During the last two fiscal years, First Pacific Advisors, Inc., the investment
adviser to Registrant ("Adviser"), has not engaged in any other business of a
substantial nature except as investment adviser to Source Capital, Inc.
("Source"), a registered closed-end investment company; as investment adviser to
FPA Capital Fund, Inc. ("Capital"), FPA Paramount Fund, Inc. ("Paramount"), FPA
Perennial Fund, Inc. ("Perennial"), and FPA Crescent Portfolio ("Crescent"),
each a registered open-end investment company; and as investment adviser to
institutional accounts. During the last two fiscal years, no director or officer
of the Adviser has engaged for his own account or in the capacity of director,
officer, employee, partner or trustee, in any other business, profession,
vocation or employment of a substantial nature except as described under the
caption "Directors and Officers of the Fund" in Part B hereof as set forth
below.
<TABLE>
<CAPTION>
Name and Position
with Adviser Other Affiliations (1)
------------------ ------------------
<S> <C>
Julio J. de Puzo, Jr., (2)
Director, Principal
& Chief Executive Officer
Robert L. Rodriguez, (2)
Director, Principal
& Chief Investment Officer
William M. Sams, Officer of Paramount.
Director & Principal
J. Richard Atwood, (2)
Senior Vice President,
Chief Financial Officer
& Treasurer
Eric S. Ende, (2)
Senior Vice President
Steven T. Romick, Officer of Source
Senior Vice President and of Crescent.
Daryl A. Weber, ---
Senior Vice President
</TABLE>
C-3
<PAGE> 60
Christopher H. Thomas, (2)
Vice President & Controller
Dennis M. Bryan, Officer of Capital.
Vice President
Steven R. Geist, Officer of Source and
Vice President of Perennial.
Janet M. Pitman, Officer of Paramount, of
Vice President Perennial and of Source.
Mary S. Thomas, ---
Vice President
Sherry Sasaki, (2)
Assistant Vice President
& Secretary
Marie McAvenia, ---
Assistant Vice President
(1) The address of each company named is 11400 West Olympic Boulevard, Suite
1200, Los Angeles, California 90064.
(2) A description of such person's other affiliations is given under the
caption "Directors and Officers of the Fund" in Part B hereof.
ITEM 29. PRINCIPAL UNDERWRITERS.
(a) FPA Fund Distributors, Inc., the principal underwriter for Registrant, acts
as a principal underwriter for Capital, Paramount and Perennial but does not
act as depositor or investment adviser for any investment company.
(b) The following information is furnished with respect to each director and
officer of FPA Fund Distributors, Inc.
<TABLE>
<CAPTION>
Name and Principal Positions & Offices Positions and Offices
Business Address with Principal Underwriter with Registrant
- ---------------- -------------------------- ---------------
<S> <C> <C>
Julio J. de Puzo, Jr. (1) President, Chief Executive Executive Vice President
Officer, Chief Financial
Officer & Director
Robert L. Rodriguez (1) Director President &
Chief Investment Officer
William M. Sams (1) Director ---
J. Richard Atwood (1) Senior Vice President Treasurer
& Treasurer
</TABLE>
C-4
<PAGE> 61
<TABLE>
<S> <C> <C>
Daryl A. Weber (1) Senior Vice President ---
Christopher H. Thomas (1) Vice President Assistant Treasurer
& Controller
Sherry Sasaki (1) Secretary Secretary
</TABLE>
(1) 11400 West Olympic Boulevard, Suite 1200, Los Angeles, California
90064
(c) Commissions and other compensation received by each principal underwriter
who is not an affiliated person of Registrant or an affiliated person of such
an affiliated person, directly or indirectly, from Registrant during
Registrant's last fiscal year.
Inapplicable.
ITEM 30. LOCATION OF BOOKS AND RECORDS.
The accounts, books and other documents required to be maintained by Section
31(a) of the Investment Company Act of 1940 and the Rules promulgated
thereunder are maintained in the physical possession of Mr. Julio J. de Puzo,
Jr., Treasurer of Registrant*, except as otherwise stated below:
Subparagraph of Physical Possession
Rule 31a-1 of Required Records
-------------- -------------------
(b)(2)(iv) Boston Financial Data Services, Inc.,
Shareholder Service Agent for
Registrant**
(b)(4) Sherry Sasaki,
Secretary of Registrant*
(f) First Pacific Advisors, Inc.,
Investment Adviser to Registrant*
____________
* 11400 West Olympic Boulevard, Suite 1200, Los Angeles, California 90064
** P.O. Box 8500, Boston, Massachusetts 02266-8500
ITEM 31. MANAGEMENT SERVICES.
There is no management-related service contract under which services are
provided to Registrant which is not discussed in Parts A or B hereof.
ITEM 32. UNDERTAKINGS.
Inapplicable.
C-5
<PAGE> 62
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the Investment
Company Act of 1940, the Registrant certifies that it meets all of the
requirements for effectiveness of this Post-Effective Amendment to Registration
Statement pursuant to Rule 485(b) under the Securities Act of 1933 and has duly
caused this Post-Effective Amendment to Registration Statement to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of Los
Angeles, State of California, on the 28th day of January, 1997.
FPA NEW INCOME, INC.
By: /s/ ROBERT L. RODRIGUEZ
-----------------------------
Robert L. Rodriguez
President
Pursuant to the requirements of the Securities Act of 1933, this Post-Effective
Amendment to Registration Statement has been signed below by the following
persons in the capacities and on the dates indicated:
Signature Title Date
/s/ ROBERT L. RODRIGUEZ
- ---------------------------- President (Principal January 28, 1997
Robert L. Rodriguez Executive Officer)
/s/ J. RICHARD ATWOOD
- ---------------------------- Treasurer (Principal January 28, 1997
J. Richard Atwood Financial Officer and
Principal Accounting
Officer)
DONALD E. CANTLAY* Director January 28, 1997
- ----------------------------
Donald E. Cantlay
DEWAYNE W. MOORE* Director January 28, 1997
- ----------------------------
DeWayne W. Moore
LAWRENCE J. SHEEHAN* Director January 28, 1997
- ----------------------------
Lawrence J. Sheehan
KENNETH L. TREFFTZS* Director January 28, 1997
- ----------------------------
Kenneth L. Trefftzs
*By: /s/ ROBERT L. RODRIGUEZ
- ----------------------------
Robert L. Rodriguez
Attorney-in-Fact pursuant to Power-of-Attorney included as page C-7
in Registrant's Post-Effective Amendment No. 35 to the Registration
Statement which was filed on October 28, 1994.
C-6
<PAGE> 63
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the reference to our firm under the captions "Financial
Highlights" and "Additional Information" and to the use of our report dated
November 1, 1996, in Post-Effective Amendment No. 38 to the Registration
Statement on Form N-1A dated January 31, 1997 and related Statement of
Additional Information of FPA New Income, Inc.
/s/ERNST & YOUNG LLP
ERNST & YOUNG LLP
Los Angeles, California
January 28, 1997
C-7
<PAGE> 64
EXHIBIT INDEX
EXHIBIT
8.4 Amendment to the Custodian Agreement.
11 Consent of Independent Auditors (filed as page C-7).
16. Schedule of computations of performance quotations.
27. Financial Data Schedule.
All other applicable exhibits are incorporated herein by reference.
<PAGE> 1
AMENDMENT TO CUSTODIAN AGREEMENT
Agreement made by and between State Street Bank and Trust Company (the
"Custodian") and FPA New Income, Inc. (the "Fund").
WHEREAS, the Custodian and the Fund are parties to a Custodian
Agreement dated August 20, 1984 as amended on October 27, 1988 and July 20,
1993 (the "Custodian Agreement") governing the terms and conditions under which
the Custodian maintains custody of the securities and other assets of the Fund;
and
WHEREAS, the Custodian and the Fund desire to amend the terms and
conditions under which the Custodian maintains the Fund's securities and other
non-cash property in the custody of certain foreign sub-custodians in
conformity with the requirements of Rule 17f-5 under the Investment Company Act
of 1940, as amended;
NOW THEREFORE, in consideration of the premises and covenants
contained herein, the Custodian and the Fund hereby amend the Custodian
Agreement by the addition of the following terms and provisions;
1. Notwithstanding any provisions to the contrary set forth in
the Custodian Agreement, the Custodian may hold securities and other non-cash
property for all of its customers, including the Fund, with a foreign
sub-custodian in a single account that is identified as belonging to the
Custodian for the benefit of its customers, provided however, that (i) the
records of the Custodian with respect to securities and other non-cash property
of the Fund which are maintained in such account shall identify by book-entry
those securities and other non-cash property belonging to the Fund and (ii) the
Custodian shall require that securities and other non-cash property so held by
the foreign sub- custodian be held separately from any assets of the foreign
sub-custodian or of others.
2. Except as specifically superseded or modified herein, the
terms and provisions of the Custodian Agreement shall continue to apply with
full force and effect.
IN WITNESS WHEREOF, each of the parties has caused this instrument
to be executed as a sealed instrument in its name and behalf by its duly
authorized representative this 5th day of February, 1996.
FPA NEW INCOME, INC.
By: /s/JULIO J. DE PUZO, JR.
---------------------------------
Title: TREASURER
------------------------------
STATE STREET BANK AND TRUST COMPANY
By: /s/CAROL C. AYOTTE
---------------------------------
Title: VICE PRESIDENT
------------------------------
EXHIBIT 8.4
<PAGE> 1
Calculation of Total Return
The Fund calculates its average annual total return quotations for the 1, 5,
and 10 year periods ended on the date of the most recent balance sheet included
in the registration statement, by finding the average annual compounded rates
of return over the 1, 5, and 10 year periods that would equate the initial
amount invested to the ending redeemable value, according to the following
formula:
P(1 + T)n =ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000
payment made at the beginning of the 1, 5, or 10
year periods at the end of 1, 5, or 10 year
periods (or fractional portion thereof).
These calculations incorporate the following assumptions:
1. The maximum sales load (or other charges deducted from payments)
is deducted from the initial $1000 payment.
2. All dividends and distributions by the Fund are reinvested at the
price stated in the prospectus on the reinvestment dates during
the period, i.e., any sales load charged upon reinvestment of
dividends would be reflected.
3. All recurring fees, if any, charged to all shareholder accounts
are included.
4. The ending redeemable value assumes a complete redemption at the
end of the 1, 5, or 10 year periods and the deduction of all
nonrecurring charges deducted at the end of each period.
EXHIBIT 16
<PAGE> 2
One Year Calculation
P = 1000
n = 1
ERV = $1,021.90
P(1+T)n= ERV
1000(1+T)= $1,021.90
T = 2.19%
Five Year Calculation
P = 1000
n = 5
ERV = $1,480.24
P(1+T)n= ERV
1000(1+T)5= $1,480.24
T = 8.16%
Ten Year Calculation
P = 1000
n = 10
ERV = $2,466.93
P(1+T)n= ERV
1000(1+T)10= $2,466.93
T = 9.45%
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<NAME> FIRSTPACAD
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