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FPA New Income, Inc.
PROSPECTUS
FPA New Income, Inc. seeks current
income and long-term total return. The
Fund's investment adviser, First Pacific
Advisors, Inc., invests the Fund's assets
primarily in fixed-income securities, with
emphasis on obligations issued or
guaranteed by the United States
Government and its agencies and instrumentalities.
THE SECURITIES AND EXCHANGE
COMMISSION HAS NOT APPROVED OR
DISAPPROVED THESE SECURITIES OR
PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
[Logo]
DISTRIBUTOR:
FPA FUND DISTRIBUTORS, INC.
11400 West Olympic Boulevard, Suite 1200
Los Angeles, California 90064
FEBRUARY 1, 2000
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FPA NEW INCOME, INC.
11400 West Olympic Boulevard, Suite 1200
Los Angeles, California 90064
(310) 473-0225
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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, CA 90064
(310) 473-0225
(800) 982-4372 except
Alaska, Hawaii and Puerto Rico
SHAREHOLDER Boston Financial Data
SERVICE AGENT: Services, Inc.
P.O. Box 8115
Boston, Massachusetts 02266-8115
(617) 483-5000
(800) 638-3060 except
Alaska, Hawaii, Massachusetts and
Puerto Rico
CUSTODIAN AND State Street Bank and
TRANSFER AGENT: Trust Company
225 Franklin Street
Boston, Massachusetts 02110
</TABLE>
INQUIRIES CONCERNING TRANSFER OF REGISTRATION, DISTRIBUTIONS, REDEMPTIONS AND
SHAREHOLDER SERVICE SHOULD BE DIRECTED TO THE SHAREHOLDER SERVICE AGENT.
INQUIRIES CONCERNING SALES SHOULD BE DIRECTED TO FPA FUND DISTRIBUTORS, INC.
TABLE OF CONTENTS
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PAGE
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Risk/Return Summary......................................... 3
Investment Results.......................................... 5
Fees and Expenses of the Fund............................... 6
Investment Objectives, Principal Investment Strategies, and
Principal Risks........................................... 7
Management and Organization................................. 10
Purchase, Pricing and Sale of Shares........................ 11
Exchange of Shares and Shareholder Services................. 15
Dividends, Distributions and Taxes.......................... 17
Financial Highlights........................................ 19
</TABLE>
2
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RISK/RETURN SUMMARY
INVESTMENT OBJECTIVES. The Fund's primary investment objectives are current
income and long-term total return.
WHO MAY WANT TO INVEST IN THE FUND?
- - Investors seeking current income and long-term total return
- - Investors willing to own shares over the course of a market cycle or longer
PRINCIPAL INVESTMENT STRATEGIES. The Adviser purchases primarily fixed-income
securities, with an emphasis on obligations issued or guaranteed by the United
States Government and its agencies and instrumentalities. The Fund can also
invest in corporate debt securities, preferred stocks and convertible
securities.
PRINCIPAL INVESTMENTS. At least 65% of the Fund's assets are invested in income
producing securities. The Adviser generally invests a significant portion (50%
or more) of the Fund's assets in debt obligations issued or guaranteed by the
United States Government and its agencies and instrumentalities, including
mortgage-backed securities.
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:
- - securities issued or guaranteed by the United States Government, and its
agencies and instrumentalities;
- - 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);
- - 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
- - repurchase agreements with a member bank of the Federal Reserve System or a
U.S. securities dealer.
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. Up to 30% of the Fund's 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 Fund may
invest up to 10% of its net assets in securities of foreign issuers.
3
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PRINCIPAL INVESTMENT RISKS. Even though the Adviser attempts to lessen price
risk, you can lose money by investing in the Fund if any of the following
occurs:
- - If interest rates rise, the market price of fixed-income securities held by
the Fund will fall.
- - Investments in fixed-income securities with longer maturities generally
produce higher yields but are subject to greater market fluctuation.
- - To the extent that convertible debt securities or other debt securities
acquired by the Fund are rated lower than investment grade or are not rated,
there is greater risk as to the timely repayment of principal and interest.
- - The prices of derivatives, such as interest only and principal only stripped
mortgage securities, Z-Bonds and inverse floaters, are likely to be more
volatile in reaction to actual or expected changes in interest rates or in
mortgage prepayment rates.
- - Prices of the Fund's foreign securities go down because of unfavorable changes
in foreign currency exchange rates, foreign government actions or political
instability.
- - The Adviser's judgments about the attractiveness, value and potential
appreciation of particular securities prove to be incorrect.
An investment in the Fund is not a bank deposit and is not insured or guaranteed
by the Federal Deposit Insurance Company or any other government agency, entity
or person.
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INVESTMENT RESULTS
The bar chart and table below provide an indication of the risk of investing in
the Fund by showing changes in the Fund's performance from year to year and by
showing how the Fund's average annual returns for 1, 5 and 10 years compare with
those of a broad measure of market performance. The bar chart shows the Fund's
performance for the last ten calendar years. The table shows how the Fund's
average annual returns for one calendar year, five calendar years and ten
calendar years compared with those of the Lehman Brothers Government/Corporate
Bond Index and the Lipper Corporate Debt--"A" Rated Funds Average. The Lehman
Index is considered a measure of bond performance and is included as a
broad-based comparison to the capitalization characteristics of the Fund's
portfolio. The Lipper Average provides an additional comparison of how the Fund
performed in relation to other mutual funds with similar objectives. Keep in
mind that the Fund's past performance does not indicate how it will perform in
the future.
- --------------------------------------------------------------------------------
Here are the Fund's results calculated without a sales charge on a calendar year
basis. (If a sales charge were included, results would be lower.)
- --------------------------------------------------------------------------------
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
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1990 8.38%
1991 18.80%
1992 11.12%
1993 10.17%
1994 1.46%
1995 14.36%
1996 7.12%
1997 8.31%
1998 3.56%
1999 3.39%
</TABLE>
The Fund's highest/lowest QUARTERLY results during this time period were:
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<S> <C> <C>
HIGHEST 6.25% (Quarter ended 12/31/90)
LOWEST (0.84)% (Quarter ended 9/30/90)
</TABLE>
FOR THE PERIODS ENDED DECEMBER 31, 1999:
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<CAPTION>
FUND WITH LEHMAN BROTHERS LIPPER CORPORATE
MAXIMUM GOVERNMENT/ DEBT--"A" RATED
AVERAGE ANNUAL SALES CHARGE CORPORATE FUNDS
TOTAL RETURN DEDUCTED BOND INDEX AVERAGE
- ------------ -------- ----------------- -----------------
<S> <C> <C> <C>
One Year................................. (1.26)% (2.15)% (2.61)%
Five Years............................... 6.35% 7.61% 6.91%
Ten Years................................ 8.08% 7.66% 7.31%
</TABLE>
5
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FEES AND EXPENSES OF THE FUND
THE FOLLOWING DESCRIBES THE FEES AND EXPENSES THAT YOU MIGHT PAY IF YOU BUY AND
HOLD SHARES OF THE FUND.
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SHAREHOLDER FEES
(fees paid directly from your investment)
Maximum Sales Load Imposed on Purchases (as a
percentage of offering price)....................... 4.50%
Maximum Deferred Sales Load (as a percentage of
original sales price or redemption proceeds, as
applicable)......................................... *
Redemption Fee (as a percentage of amount
redeemed)........................................... None**
Exchange Fee........................................ $5.00
ANNUAL FUND OPERATING EXPENSES
(expenses that are deducted from Fund assets)
Management Fees..................................... 0.50%
Distribution (12b-1) Fees........................... None
Other Expenses...................................... 0.10%
-------
Total Annual Fund Operating Expenses................ 0.60%
</TABLE>
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* An account management fee is charged by unaffiliated investment advisers or
broker-dealers to certain accounts entitled to purchase shares without sales
charge.
** Redemptions by wire are subject to a $3.50 charge per wire.
EXAMPLE
This Example is intended to help you compare the cost of investing in the Fund
with the cost of investing in other mutual funds.
The Example assumes you invest $10,000 in the Fund for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Example also assumes that your investment has a 5% return each year and that the
Fund's operating expenses remain the same. Although your actual costs may be
higher or lower, based on these assumptions your costs would be:
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One year........................... $ 509
Three years........................ $ 634
Five years......................... $ 770
Ten years.......................... $1,166
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6
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INVESTMENT OBJECTIVES, PRINCIPAL INVESTMENT STRATEGIES, AND PRINCIPAL RISKS
INVESTMENT OBJECTIVES.
The Fund's primary investment objectives are current income and long-term total
return.
PRINCIPAL INVESTMENT STRATEGIES. At least 65% of the Fund's 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.
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, 1999 was 3.7 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 "Debt Security 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. A repurchase agreement is a short-term investment.
The Fund acquires a debt security that the seller agrees to repurchase at a
future time and set price. If the seller declares bankruptcy or defaults,
the Fund may incur delays and expenses liquidating the security. Such
security may also decline in value and fail to provide income. The Fund will
not invest more than 10% of its total assets in repurchase agreements that
mature in more than seven days and/or other securities that are not readily
marketable.
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. 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.
The Fund
7
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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.
A Convertible Security is a bond, debenture, or note that may be exchanged for
particular common stocks in the future at a predetermined 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. Prior
to redemption, Convertible Securities provide benefits similar to
non-convertible debt securities in that they generally provide a stable income
stream with higher yields than those of comparable common stocks. Convertible
Securities entail less risk than the corporation's common stocks. The extent to
which the risk is reduced, however, largely depends on whether the Convertible
Security can sell near its value as a fixed-income security.
Convertible Securities are generally not investment grade. This means that S&P
and Moody's do not rate Convertible Securities within the four highest
categories. The risks against repayment of the principal and interest increase
when debt securities are rated lower than investment grade or are not rated. The
Fund may purchase Convertible Securities and other debt securities rated BB or
lower by S&P or Ba or lower by Moody's. The rating agencies give these ratings
when the issuer's continuing ability to make principal and interest payments is
speculative. Debt securities rated BB or lower by S&P or Ba or lower by Moody's
are, thus, commonly referred to as junk bonds. The Adviser decides to purchase
and sell these securities based on their investment potential and not on the
ratings assigned by credit agencies.
The Fund may sometimes invest in debt securities even though the issuing
companies are financially troubled. These securities are called Deep Discount
Securities and are deeply discounted from their face value. Deep Discount
Securities may be rated C, CI or D by S&P or C by Moody's or may be unrated. The
Fund will invest in Deep Discount Securities when the Adviser believes that the
issuer's financial conditions are likely to improve. A debt instrument purchased
at a deep discount, but prior to default, may pay a very high effective yield.
If the issuer's financial condition improves, the underlying value of the
securities may increase and result in a capital gain. If the issuer cannot meet
its debt obligations, however, the Deep Discount Securities may stop generating
income and lose its value or become worthless. The Adviser will balance the
benefits of Deep Discount Securities with their risks. A diversified portfolio
may reduce the overall impact of a Deep Discount Security in default or reduced
in value, but the risk cannot be eliminated.
Both interest-only Stripped Mortgage Securities and inverse floaters are highly
sensitive to changes in interest and prepayment rates. As a result, such
securities are extremely volatile. The Adviser, however, believes that the
volatility of the individual security value is tempered when the securities are
combined. Together, interest-only Stripped Mortgage Securities and inverse
floaters could produce higher yields than more traditional securities while
maintaining a relatively low degree of volatility. This is because factors
affecting the value of these securities may or generally balance each other out.
The value of inverse floaters fall as interest rates rise but the value of
interest-only Stripped Mortgage-Backed Securities rise and vice versa. The
accuracy of this technique, of course, is dependent on the Adviser's ability to
forecast interest rates and to allocate the investments accordingly.
Adjustable Rate Mortgages (ARMs) contain maximum and minimum rates beyond which
the mortgage interest rate may not vary over the lifetime of the security. Some
ARMs restrict the maximum amount of adjustment for the mortgage interest rate
during any single adjustment period. Alternatively, certain
8
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ARMs also limits any changes in the required monthly payment. If a monthly
payment is not sufficient to pay the interest accruing on an ARM, excess
interest is added to the principal balance of the mortgage loan. The
insufficient amount is, then, repaid through future monthly payments. The
adjustable interest rate feature of the mortgages underlying ARMs generally
buffers the ARMs' market value against sharp responses to normal interest rate
fluctuations. Since the interest rates on the mortgages are reset periodically,
the securities' yields will gradually align themselves to reflect the changes in
market rates.
PRINCIPAL RISKS. Your investment in the Fund is subject to a number of risks
related to principal investment strategies, including:
- - the market price of fixed-income securities held by the Fund will fall as
rates rise;
- - investments in fixed-income securities with longer maturities generally
produce higher yields but are subject to greater market fluctuation;
- - to the extent that convertible securities or other debt securities acquired by
the Fund are rated lower than investment grade or are not rated, there is a
greater risk as to the timely repayment of principal and interest. Decisions
to purchase and sell these securities are based on the Adviser's evaluation of
their investment potential and not on the ratings assigned by credit agencies.
Because investment in lower-rated securities involves greater investment risk,
achievement of the Fund's investment objective is more dependent on the
Adviser's credit analysis than with respect to the Fund's investments in
higher-rated securities. Lower-rated securities may be more susceptible to
real or perceived adverse economic and competitive industry conditions than
investment grade securities. A projection of an economic downturn, for
example, could cause a decline in the prices of lower-rated securities because
the advent of a recession could lessen the ability of a highly leveraged
company to make principal and interest payments on its debt securities. New
laws and proposed new laws could negatively impact the market for high-yield
bonds. In addition, the secondary trading market for lower-rated securities
may be less liquid than the market for higher-rated securities;
- - the price of debt securities held by the Fund can be affected by changing
interest rates, effective maturities and credit ratings;
- - the Adviser's emphasis on a value-oriented investment approach could result in
a portfolio that does not reflect the national economy, differs significantly
from broad market indices and consists of securities considered by the average
investor to be unpopular or unfamiliar;
- - although the Fund may not invest more than 5% of its total assets in the
securities of any one issuer (except the U.S. Government) at the time of
purchase, changes in market prices and the assets of the Fund may from time to
time cause more than 5% or even 10% of the Fund's assets to be invested in
securities of a single company. Such relative concentration is likely to
increase the volatility of the Fund's net asset value per share;
- - Fund shares could decline in value in response to certain events, such as
changes in markets or economies;
- - factors that affect mortgage-backed securities' value include: (1) the types
and amounts of insurance carried by the mortgagor, (2) the amount of time the
mortgage loan has been outstanding, (3) the loan-to-value ratio of each
mortgage and the amount of overcollateralization of a mortgage pool;
9
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- - mortgage-backed securities reflect an interest on monthly payments made by the
borrowers who take out the underlying mortgage loans. Even though the
underlying mortgage loans are for specified periods of time, the borrowers can
often pay them off sooner. The mortgage-backed security, thus, will be
prepaid. Given the higher cost of delaying payment, a borrower is more likely
to prepay a mortgage with a higher interest rate. The likelihood of prepayment
will have several consequences. Some higher yielding securities might be
converted to cash in times of declining interest rates, so the Fund would be
forced to accept lower interest rates when that cash is used to purchase
additional securities. The increase in prepayment also limits market price
appreciation of mortgage-backed securities when interest rates decline. In
addition, a mortgage-backed security may be subject to redemption at the
option of the issuer;
- - during periods of extreme fluctuations in interest rates, the resulting
fluctuations of ARM rates could affect the ARMs' market value. Most ARMs
generally have annual reset limits or "caps" of 100 to 200 basis points.
Fluctuations in interest rates above these levels, thus, could cause the
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 and result in lower yields.
Because of this feature, the value of ARMs will likely not rise during periods
of declining interest rates to the same extent as fixed-rate instruments;
- - special tax considerations are associated with investing in high yield bonds
structured as zero coupon or pay-in-kind securities. The Fund does not receive
any cash interest on such bonds until the bond matures, but the interest on
these securities are accrued as income. Similarly, the inflation accretion
income recorded on inflation-indexed notes is not received until maturity. The
Internal Revenue Code requires the Fund to distribute such income to its
shareholders. Thus, the Fund may have to dispose of securities when it might
not want to in order to provide the cash necessary to make distributions to
those shareholders who do not reinvest dividends;
- - the prices of equity securities held by the Fund can be affected by events
specifically involving the issuers of these securities; and
- - investing outside the U.S. can also involve additional risks, such as currency
fluctuations or political, social and economic instability.
MANAGEMENT AND ORGANIZATION
INVESTMENT ADVISER
First Pacific Advisors, Inc. is the Fund's investment adviser. The Adviser,
together with its predecessors, has been in the investment advisory business
since 1954 and has served as the Fund's investment adviser since July 11, 1984.
The Adviser manages assets of approximately $3.1 billion for six investment
companies, including one closed-end investment company, and 21 institutional
accounts. First Pacific Advisors, Inc. is headquartered at 11400 West Olympic
Boulevard, Suite 1200, Los Angeles, California 90064. The Adviser selects
investments for the Fund, provides administrative services and manages the
Fund's business. The total management fee paid by the Fund, as a percentage of
average net assets, for the previous fiscal year was 0.50%.
10
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PORTFOLIO MANAGER
Robert L. Rodriguez, President of the Fund, and Principal, Chief Investment
Officer and director of the Adviser, is primarily responsible for the day-to-day
management of the Fund's portfolio. Mr. Rodriguez has been the Chief Investment
Officer of the Fund for over fifteen years.
PURCHASE, PRICING AND SALE OF SHARES
PURCHASE AND INVESTMENT MINIMUMS. You can purchase shares by contacting any
investment dealer authorized to sell the Fund's shares. You can use the account
information form for initial purchases. The minimum initial investment is
$1,500, and each subsequent investment must be at least $100. All purchases made
by check should be in U.S. dollars and made payable to the FPA Funds or State
Street Bank and Trust Company. Third party checks will not be accepted. A charge
may be imposed if a check does not clear.
SHARE PRICE. The Fund calculates its share price, also called net asset value,
as of 4:00 p.m. New York time, which is the normal close of trading on the New
York Stock Exchange ("NYSE"), every day the NYSE is open. Share price is not
calculated on days when the NYSE is not open. Share price is rounded to the
nearest cent per share and equals the market value of all portfolio securities
plus other assets, less all liabilities, divided by the number of Fund shares
outstanding. Orders received by dealers before the NYSE closes on any business
day are priced based on the share price for that day if Boston Financial Data
Services, Inc. receives the order prior to its close of business. Orders
received by Boston Financial Data Services, Inc. after such time generally are
priced based on the share price for the next business day. However, orders
received by certain retirement plans and certain other financial intermediaries
before the NYSE closes and communicated to Boston Financial Data Services, Inc.
by 9:30 a.m., Eastern time, on the following business day are priced at the
share price for the prior business day. Share prices for sales (redemptions) of
Fund shares is the first share price determined after Boston Financial Data
Services, Inc. receives a properly completed request, except that sale orders
received by an authorized dealer, certain retirement plans and certain other
financial intermediaries before the NYSE closes are priced at the closing price
for that day if communicated to Boston Financial Data Services, Inc. within the
times specified above.
SALES CHARGES. The offering price is the share price plus any applicable sales
charge. A sales charge may apply to your purchase. As indicated in the table
below, your sales charge can be reduced for larger purchases. You, your spouse
and the following related people (and their spouses) can combine your investment
to reduce your sales charge: grandparents, parents, siblings, children or
grandchildren; or
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by the individual, his or her spouse and a trustee or other fiduciary purchasing
securities for related trusts, estates or fiduciary accounts, including employee
benefit plans.
<TABLE>
<CAPTION>
SALES SALES REALLOWED
SIZE OF INVESTMENT CHARGE(1) CHARGE(2) TO DEALERS(2)
- ------------------ --------- --------- -------------
<S> <C> <C> <C>
Less than $10,000.......................................... 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.
REDUCING YOUR SALES CHARGE
INVESTMENTS IN OTHER FPA FUNDS. To determine the sales charge, you can add the
current value, at offering price, of all presently held shares of the FPA Funds,
which are:
- - FPA Capital Fund, Inc. (which is currently closed to new investors)
- - FPA New Income, Inc. (this Fund)
- - FPA Paramount Fund, Inc.
- - FPA Perennial Fund, Inc.
If your holdings of other FPA Funds qualify you for a reduced sales charge, you
must provide information to verify your holdings.
LETTER OF INTENT. A letter of intent will allow you to obtain a reduced sales
charge by aggregating investments made during a thirteen-month period. The value
of all presently held shares of the FPA Funds (see above list) can also be used
to determine the applicable sales charge. The account information form contains
the Letter of Intent that must be signed at the time of initial purchase, or
within 30 days. Each investment made under a Letter of Intent during the period
receives the sales charge for the total investment goal. IF YOU DO NOT REACH
YOUR INVESTMENT GOAL, YOU MUST PAY THE DIFFERENCE BETWEEN THE SALES CHARGES
APPLICABLE TO THE AMOUNT PURCHASED MINUS THOSE ACTUALLY PAID.
PURCHASES NOT SUBJECT TO SALES CHARGE. You and your spouse (and your immediate
relatives) can purchase shares without a sales charge, if you fall into one of
the following categories and you represent that the shares you purchase are for
investment and will not be resold except through redemption or repurchase by the
Fund. Immediate relatives include grandparents, parents, siblings, children and
grandchildren of a qualified investor, and the spouse of any immediate relative.
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(a) current and former directors, officers and employees of the Adviser, United
Asset Management Corporation (the Adviser and FPA Fund Distributors, Inc.
are indirect wholly owned subsidiaries of United Asset Management
Corporation) and its affiliates;
(b) current and former directors, officers and employees of Angeles Corporation
(the former parent of the Adviser) and its affiliates;
(c) current and former directors of, and partners and employees of legal counsel
to, the investment companies advised by the Adviser;
(d) investment advisory clients of the Adviser and pension consultants to such
clients and their directors, officers and employees; (e) employees
(including registered representatives) of a dealer that has a selling group
agreement with FPA Fund Distributors, Inc. and consents to the purchases;
(f) any employee benefit plan maintained for the benefit of such qualified
investors; and
(g) directors, officers and employees of a company whose employee benefit plan
holds shares of one or more of the FPA Funds.
Because FPA Fund Distributors, Inc. anticipates that certain purchases will
result in economies of scale in the sales effort and related expenses compared
to sales made through normal distribution channels, upon satisfaction of certain
conditions the following persons can purchase without a sales charge:
(a) trustees or other fiduciaries purchasing shares for employee benefit plans
of employers with 20 or more employees;
(b) trust companies, bank trust departments and registered investment advisers
purchasing for accounts over which they exercise investment authority and
which are held in a fiduciary, agency, advisory, custodial or similar
capacity, provided that the amount collectively invested or to be invested
by such accounts during the subsequent 13-month period in the Fund or other
FPA Funds totals at least $1,000,000;
(c) tax-exempt organizations enumerated in Section 501(c) (3), (9), or (13) of
the Internal Revenue Code; and
(d) accounts upon which an investment adviser, financial planner or
broker-dealer charges an account management or consulting fee, provided it
has entered into an agreement with FPA Fund Distributors, Inc. regarding
those accounts or purchases Fund shares for such accounts or for its own
accounts through an omnibus account maintained by a broker-dealer that has
entered into such an agreement with the Fund or FPA Fund Distributors, Inc.
If you qualify, you must submit a special application form available from FPA
Fund Distributors, Inc. with your initial purchase, and you must notify FPA Fund
Distributors, Inc. of your eligibility when you place the order. If you place
the order through a broker, the broker may charge you a service fee. No such fee
is charged if you purchase directly from FPA Fund Distributors, Inc. or the
Fund.
SELLING (REDEEMING) YOUR SHARES
You can sell (redeem) for cash without charge any or all of your Fund shares at
any time by sending a written request to Boston Financial Data Services, Inc.
Faxes are not acceptable. You can also place redemption requests through
dealers, but they may charge a fee. If you are selling Fund shares from a
13
<PAGE>
retirement plan, you should consult the plan documentation concerning federal
tax consequences and consult your plan custodian about procedures.
A check will be mailed to you within seven days after Boston Financial Data
Services, Inc. receives a properly completed request. If Fund shares sold were
recently purchased by check, payment of the redemption proceeds will be delayed
until confirmation that the purchase check has cleared, which may take up to 15
days.
WRITTEN REQUESTS. Requests must be signed by the registered shareholder(s). If
you hold a stock certificate, it must be included with your written request. A
signature guarantee is required if the redemption is:
- - Over $10,000;
- - Made payable to someone other than the registered shareholder or to somewhere
other than the registered address; or
- - If the shareholder is a corporation, partnership, trust or fiduciary.
A signature guarantee can be obtained from a bank or trust company; a broker or
dealer; a credit union; a national securities exchange, registered securities
association or clearing agency; or a savings and loan association. Additional
documents are required for sales by corporations, partnerships, trusts,
fiduciaries, executors or administrators.
TELEPHONE TRANSACTIONS. You must elect the option on the account information
form to have the right to sell your shares by telephone. If you wish to make an
election to have the right to sell your shares via telephone or to change such
an election after opening an account, you will need to complete a request with a
signature guarantee. Sales via telephone are not available for shares held in a
Fund-sponsored retirement account or in certificate form.
When you obtain the right to sell your Fund shares by telephone, you designate a
bank account to which the proceeds of such redemptions are sent. Telephone
redemptions of $5,000 or more are wired unless the designated bank cannot
receive Federal Reserve wires. Telephone redemptions under $5,000 are mailed
unless you request otherwise. There is a $3.50 charge per wire.
Boston Financial Data Services, Inc. uses procedures it considers reasonable to
confirm redemption instructions via telephone, including requiring account
registration verification from the caller and recording telephone instructions.
Neither Boston Financial Data Services, Inc. nor the Fund is liable for losses
due to unauthorized or fraudulent instructions if there is a reasonable belief
in the authenticity of received instructions and reasonable procedures are
employed; otherwise, they may be liable. During periods of significant economic
or market changes, it may be difficult to sell your shares by telephone.
The Fund can change or discontinue telephone redemption privileges without
notice.
REINVESTING IN THE FUND WITH PROCEEDS FROM REDEMPTION OF SHARES. If you
reinvest in the Fund within 30 days you do not have to pay a sales charge. Your
reinvestment is made at the first share price determined after Boston Financial
Data Services, Inc. receives your order. You can only do this once for each Fund
investment, and you must provide sufficient information to verify your
reinvestment when you make your purchase. A sale and reinvestment is a taxable
transaction, but losses on the sale are not deductible for federal income tax
purposes.
14
<PAGE>
AUTOMATIC REDEMPTION (SALE) OF YOUR SHARES. If as a result of a redemption your
account value is less than $500, the Fund can direct Boston Financial Data
Services, Inc. to sell your remaining Fund shares. In such case, you will be
notified in writing that your account value is insufficient and be given up to
60 days to increase it to $500.
EXCHANGE OF SHARES AND SHAREHOLDER SERVICES
EXCHANGING YOUR FUND SHARES
EXCHANGING YOUR SHARES FOR SHARES OF OTHER FPA FUNDS. You can exchange your
shares of the Fund for shares of other FPA Funds, except that only existing
shareholders of FPA Capital Fund, Inc., may exchange into that Fund.
You can increase an existing account or start a new account in the selected FPA
Fund. Shares of the Fund acquired must be registered for sale in your state.
A $5.00 service fee applies to each exchange. In addition, a sales charge
applies unless:
- - you paid a sales charge on the exchanged shares equivalent to that applicable
to the acquired shares;
- - you are otherwise entitled to purchase shares without a sales charge (as noted
under "Purchases Not Subject to Sales Charge"); or
- - the shares you are exchanging were acquired by reinvestment.
EXCHANGING YOUR SHARES FOR SHARES OF A MONEY MARKET FUND. FPA Fund
Distributors, Inc. has made arrangements to allow you to exchange your shares
for shares of the money market portfolio of the Cash Equivalent Fund, a no-load
diversified money market mutual fund. Shares of the money market fund you
acquire through exchange plus any shares acquired by reinvestment of dividends
and distributions may be re-exchanged for shares of any FPA Fund without a sales
charge. However, in the case of FPA Capital Fund, Inc., you must have maintained
your account in FPA Capital Fund, Inc. in order to re-exchange your shares in
the money market fund for shares in FPA Capital Fund, Inc.
If your shares are held in a Fund-sponsored individual retirement account, you
cannot exchange them into shares of the money market fund.
The $5.00 exchange fee is paid by FPA Fund Distributors, Inc., which receives a
fee from Kemper Financial Services, the administrator of the money market fund,
of 0.15 of 1% per year or more of the average daily net asset value of shares of
the money market fund acquired through this exchange program.
The money market fund is not an FPA Fund and is separately managed. The fact
that you have the ability to exchange your shares for shares of the money market
fund is not a Fund recommendation of the money market fund.
HOW TO EXCHANGE YOUR SHARES. You can exercise your exchange privileges either
by written instructions or telephone (telephone exchange privileges are
available unless you specifically decline them on the account information form).
Exchanges are subject to the following restrictions:
- - You are limited to four exchanges in one account during any calendar year; if
we give you notice you have exceeded this limit, any further exchanges will be
null and void;
15
<PAGE>
- - Shares must be owned 15 days before exchanging, and cannot be in certificate
form unless you deliver the certificate when you request the exchange;
- - An exchange requires the purchase of shares with a value of at least $1,000;
and
- - Exchanges are subject to the same signature and signature guarantee
requirements applicable to the redemption of shares.
Exchanges and purchases are at the share price next determined after receipt of
a proper request by Boston Financial Data Services, Inc. In the case of
exchanges into the money market fund, dividends generally start on the following
business day.
For federal and state income tax purposes, an exchange is treated as a sale and
could result in a capital gain or loss. If the shares exchanged have been held
less than 91 days, the sales charge paid on them is not included in the tax
basis of the exchanged shares, but is carried over and included in the tax basis
of the shares acquired. See the Statement of Additional Information for further
information.
DISCONTINUATION OF THE EXCHANGE PROGRAMS. The Fund and FPA Fund Distributors,
Inc. can change or discontinue the rights to exchange Fund shares into other FPA
Funds or the money market fund upon 60 days' notice. If you have exchanged your
shares into shares of the money market fund, you will have at least 60 days
after being given notice of the end of the exchange program to reacquire Fund
shares without a sales charge.
FOR MORE INFORMATION OR FOR PROSPECTUSES FOR OTHER FPA FUNDS AND/OR THE MONEY
MARKET FUND, PLEASE CONTACT A DEALER OR FPA FUND DISTRIBUTORS, INC. YOU SHOULD
READ THE PROSPECTUSES OF THESE OTHER FUNDS AND CONSIDER DIFFERENCES IN
OBJECTIVES AND POLICIES BEFORE MAKING ANY EXCHANGE.
OTHER SHAREHOLDER SERVICES
INVESTMENT ACCOUNT. Each shareholder has an investment account in which Boston
Financial Data Services, Inc. holds Fund shares. You will receive a statement
showing account activity after each transaction. Unless you make a written
request, stock certificates will not be issued. Stock certificates are only
issued for full shares.
PRE-AUTHORIZED INVESTMENT PLAN. To make automatic monthly investments of at
least $100, you must complete the account information form available from
dealers or FPA Fund Distributors, Inc. Boston Financial Data Services, Inc. will
withdraw funds from your bank account monthly for $100 or more as specified
through the Automated Clearing House.
RETIREMENT PLANS. If you are eligible, you can establish an IRA (individual
retirement account) and/or other retirement plan with a $100 minimum initial
investment and an expressed intention to increase the investment to $1,500
within 12 months. Each subsequent investment must be at least $100. Neither the
Fund nor FPA Fund Distributors, Inc. imposes additional fees for these plans,
but the plan custodian does.
You should consult your tax adviser about the implications of establishing a
retirement plan with Fund shares. Persons with earned income ineligible for
deductible contributions generally may make non-deductible contributions into an
IRA. The earnings on shares held in an IRA are generally tax-deferred. In
addition, the Taxpayer Relief Act of 1997 expanded opportunities for certain
investors to make deductible
16
<PAGE>
contributions to IRAs and also created two new tax-favored accounts, the Roth
IRA and the Education IRA, in which earnings (subject to certain restrictions)
are not taxed even on withdrawal. Tax matters are complicated; you should
consult your tax adviser. FPA Fund Distributors, Inc. and dealers have
applicable forms and information regarding plan administration, custodial fees
and other plan documents.
SYSTEMATIC WITHDRAWAL PLAN. If you have an account with a value of $10,000 or
more, you can make monthly, quarterly, semi-annual or annual withdrawals of $50
or more by electing this option on the account information form. Under this
arrangement, sufficient Fund shares will be sold to cover the withdrawals and
the proceeds will be forwarded to you as directed on the account information
form. Dividends and capital gains distributions are automatically reinvested in
the Fund at net asset value. If withdrawals continuously exceed reinvestments,
your account will be reduced and ultimately exhausted. PLEASE NOTE THAT
CONCURRENT WITHDRAWALS AND PURCHASES ARE ORDINARILY NOT IN YOUR BEST INTEREST
BECAUSE OF ADDITIONAL SALES CHARGES, AND YOU WILL RECOGNIZE ANY TAXABLE GAINS OR
LOSSES ON THE AUTOMATIC WITHDRAWALS.
DIVIDENDS, DISTRIBUTIONS AND TAXES
DIVIDENDS AND DISTRIBUTIONS
The Fund's investment income consists principally of dividends and interest
earned on its portfolio securities. This income, after payment of expenses, will
be distributed to you quarterly. Net capital gains realized from the sale of
securities are distributed at least annually. Dividends and capital gain
distributions are automatically reinvested in the Fund at the share price
determined at the close of business the day after the record date, unless before
the record date for receipt of the dividend or capital gain distribution you
request cash payment of dividends and capital gains distributions. You can use
the account information form to request a cash payment.
TAX CONSEQUENCES
Dividends and capital gains are generally taxable whether they are reinvested or
received in cash -- unless you are exempt from taxation or entitled to tax
deferral. Dividends and distributions are taxed at ordinary rates while capital
gains may be taxed at a different rate. Furthermore, capital gains may be taxed
at different rates depending on the length of time the Fund holds its assets.
Redemptions from a retirement plan account and an ordinary shareholder account
could have different tax treatment.
You must provide the Fund with a certified correct taxpayer identification
number (generally your social security number) and certify that you are not
subject to backup withholding. You can use the account information form for this
purpose. If you fail to do so, the IRS can require the Fund to withhold 31% of
your taxable distributions and redemptions. Federal law also requires the Fund
to withhold 30% or the applicable tax treaty rate from dividends paid to certain
nonresident aliens, non-U.S. partnership and non-U.S. corporation shareholder
accounts.
Federal tax law generally requires that a holder (such as the Fund) of a debt
security purchased at a discount (including a zero coupon security) accrue a
portion of the discount at which the security was purchased as income each year
even though the holder receives no interest payment in cash on the security
during the year. Periodic adjustments for inflation in the principal value of
inflation-indexed
17
<PAGE>
bonds also may give rise to original issue discount which is includable in the
Fund's gross income on a current basis. Similarly, the Fund generally must
recognize as income interest accrued on accrual bonds and other debt securities
even though not paid in cash. As an investment company, the Fund must pay
dividends equal to substantially all of its net investment income each year.
Since most shareholders reinvest dividends declared by the Fund, it is not
expected that cash dividend payments would exceed the total amount of cash
interest the Fund actually receives. Cash distributions are made from the cash
assets of the Fund or by liquidation of portfolio securities, if necessary. If
the principal value of an inflation-indexed bond is adjusted downward in any
period as a result of deflation, the reduction may be treated as a loss to the
extent the reduction exceeds coupon payments received in that period; in that
case, the amount distributable by the Fund may be reduced and amounts
distributed previously in the taxable year may be characterized in some
circumstances as return of capital.
Please see the Statement of Additional Information and consult with your tax
adviser.
18
<PAGE>
FINANCIAL HIGHLIGHTS
The financial highlights table is intended to help you understand the Fund's
financial performance for the past five (5) years. Certain information reflects
financial results for a single Fund share. The total returns in the table
represent the rate that an investor would have earned or lost on an investment
in the Fund purchased at net asset value and assuming reinvestment of all
dividends and distributions. This information has been audited by Ernst & Young
LLP, whose report, along with the Fund's financial statements, are included in
the Statement of Additional Information, which is available upon request.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED SEPTEMBER 30,
----------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Per share operating performance:
Net asset value at beginning of year.............. $ 11.13 $ 11.24 $ 10.97 $ 11.05 $ 10.52
------- ------- ------- ------- -------
Income from investment operations:
Net investment income........................... $ .71 $ .67 $ .68 $ .68 $ .67
Net realized and unrealized gain (loss) on
investment securities......................... (.30) (.10) .32 .06 .55
------- ------- ------- ------- -------
Total from investment operations.................. $ .41 $ .57 $ 1.00 $ .74 $ 1.22
------- ------- ------- ------- -------
Less distributions:
Dividends from net investment income............ $ (.71) $ (.66) $ (.68) $ (.66) $ (.69)
Distributions from net realized capital gains... (.06) (.02) (.05) (.16) --
------- ------- ------- ------- -------
Total distributions............................... $ (.77) $ (.68) $ (.73) $ (.82) $ (.69)
------- ------- ------- ------- -------
Net asset value at end of year.................... $ 10.77 $ 11.13 $ 11.24 $ 10.97 $ 11.05
======= ======= ======= ======= =======
Total investment return*.......................... 3.87% 5.24% 9.54% 7.00% 12.14%
Ratios/supplemental data:
Net assets at end of year (in $000's)............. 531,133 615,746 529,574 338,297 207,018
Ratio of expenses to average net assets........... 0.60% 0.59% 0.59% 0.63% 0.68%
Ratio of net investment income to average net
assets.......................................... 6.43% 6.06% 6.37% 6.44% 6.50%
Portfolio turnover rate........................... 24% 47% 29% 16% 31%
</TABLE>
- ------------
* Return is based on net asset value per share, adjusted for reinvestment of
distributions, and does not reflect deduction of the sales charge.
19
<PAGE>
FOR SHAREHOLDER SERVICES CALL
BOSTON FINANCIAL DATA
SERVICES, INC.
(617) 483-5000 or
(800) 638-3060 except Alaska
Hawaii, Massachusetts and
Puerto Rico
FOR RETIREMENT PLAN SERVICES
CALL YOUR EMPLOYER OR PLAN
ADMINISTRATOR
FOR 24-HOUR iNFORMATION GO TO
FUNDMASTER MARKETING GROUP
INTERNET WEB SITE
http://www.fundmaster.com
FOR DEALER SERVICES CALL
FPA FUND DISTRIBUTORS, INC.
(310) 473-0225 or
(800) 982-4372 except
Alaska, Hawaii and
Puerto Rico
Telephone conversations may be recorded or monitored for verification,
record keeping and quality assurance purposes.
MULTIPLE TRANSLATIONS
This Prospectus may be translated into other languages. If there are any
inconsistencies or ambiguities, the English text will prevail.
OTHER FUND INFORMATION
ANNUAL/SEMI-ANNUAL REPORT TO SHAREHOLDERS
Additional information about the Fund's investments is available in the
Fund's annual and semi-annual reports to shareholders. In the Fund's annual
report, you will find a discussion of the market conditions and investment
strategies that significantly affected the Fund's performance during its
last fiscal year.
STATEMENT OF ADDITIONAL INFORMATION (SAI)
The SAI contains more detailed information on all aspects of the Fund,
including the Fund's financial statements.
A current SAI has been filed with the Securities and Exchange Commission
("SEC") and is incorporated by reference into this Prospectus. The SAI and
other related materials about the Fund are available for review or to be copied
at the SEC's Public Reference Room in Washington, D.C. (1-800-SEC-0330) or on
the SEC's Internet Web Site at http://www.sec.gov and copies of this
information may be obtained, upon payment of a duplicating fee, by writing the
Reference Section of the SEC, Washington, D.C. 20549-6009.
FOR MORE INFORMATION OR TO REQUEST A FREE COPY OF ANY OF THE DOCUMENTS ABOVE
CONTACT FPA FUND DISTRIBUTORS, INC. AT 11400 WEST OLYMPIC BOULEVARD, SUITE
1200, LOS ANGELES, CALIFORNIA 90064, AT (800) 982-4372, EXCEPT FROM ALASKA,
HAWAII AND PUERTO RICO (WHERE YOU MAY CALL COLLECT (310) 473-0225).
Investment Company Act No. 811-1735
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
FPA NEW INCOME, INC.
February 1, 2000
This Statement of Additional Information supplements the current Prospectus of
FPA New Income, Inc. ("Fund") dated February 1, 2000. This Statement does not
present a complete picture of the various topics discussed and should be read in
conjunction with the Fund's Prospectus. Although this Statement of Additional
Information is not itself a Prospectus, it is, in its entirety, incorporated by
reference into the Prospectus. The Fund's Prospectus can be obtained by
contacting your securities dealer or the Fund's principal underwriter, FPA Fund
Distributors, Inc. ("Distributor"), at 11400 West Olympic Boulevard, Suite 1200,
Los Angeles, California 90064; telephone (310) 473-0225 or (800) 982-4372,
except Alaska, Hawaii and Puerto Rico.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C>
Investment Objectives, Strategies and Policies..................................................................1
Description of Certain Securities and Investment Techniques.....................................................2
Fixed-Income Securities ................................................................................2
U.S. Government Securities .............................................................................2
Inflation-Indexed Bonds ................................................................................3
Zero Coupon Securities .................................................................................3
Mortgage-Backed Securities..............................................................................4
Guaranteed Mortgage Pass-Through Securities.............................................................4
Collateralized Mortgage Obligations, Multiclass Pass-Through Securities
and Accrual Certificates (Z-Bonds).................................................................5
Private Mortgage Pass-Through Securities................................................................7
Stripped Mortgage Securities............................................................................7
Inverse Floaters........................................................................................8
Risks of Mortgage-Backed Securities.....................................................................8
Asset-Backed Securities................................................................................10
Convertible Securities and Lower Rated Debt Securities ................................................10
Risk Factors Relating to Lower Rated Securities .......................................................11
Securities of Foreign Issuers..........................................................................12
Delayed Delivery.......................................................................................13
Short Sales Against the Box............................................................................13
Repurchase Agreements..................................................................................13
Common Stocks..........................................................................................14
Debt Security Ratings..................................................................................14
Moody's...........................................................................................14
S&P...............................................................................................15
Commercial Paper Ratings..........................................................................15
Investment Restrictions........................................................................................16
Fund Organization..............................................................................................18
Directors and Officers of the Fund.............................................................................18
Five Percent Shareholders......................................................................................23
-i-
<PAGE>
Management.....................................................................................................23
Investment Adviser.....................................................................................23
Investment Advisory and Service Agreement..............................................................24
Principal Underwriter..................................................................................25
Portfolio Transactions and Brokerage...........................................................................25
Portfolio Turnover.............................................................................................26
Capital Stock..................................................................................................26
Common Stock...........................................................................................26
Voting Rights..........................................................................................26
Purchase and Redemption of Shares..............................................................................26
Net Asset Value........................................................................................26
Sales Charges..........................................................................................26
Authorized Financial Intermediaries....................................................................27
Sales at Net Asset Value...............................................................................27
Letter of Intent.......................................................................................27
FPA Exchange Privilege.................................................................................28
Redemption of Shares...................................................................................28
Telephone Redemption...................................................................................28
Tax Sheltered Retirement Plans.................................................................................29
Dividends, Distributions and Taxes.............................................................................30
Distributor....................................................................................................31
Prior Performance Information..................................................................................31
Financial Statements...........................................................................................33
</TABLE>
ii
<PAGE>
INVESTMENT OBJECTIVES, STRATEGIES AND POLICIES
The following limitations and guidelines are considered at the time of purchase,
under normal market conditions, and are based on a percentage of FPA New Income,
Inc.'s (the "Fund") net assets unless otherwise noted. This summary is not
intended to reflect all of the Fund's investment limitations.
INVESTMENT OBJECTIVE AND STRATEGIES
- - The Fund's primary investment objective is current income and long-term
return.
- - At least 65% of the Fund's assets are invested in income producing
securities. The Fund generally invests 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.
- - 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
"Repurchase Agreements").
- - Up to 25% of the Fund's net assets can be invested in non-convertible
debt securities which are not rated in the highest two grades by
Moody's or S&P; convertible debt securities and preferred stocks in an
amount not exceeding 5% of the Fund's assets. Such debt securities may
include so-called junk bonds.
- - Up to 30% of the Fund's net assets can be invested, or committed for
investment, in securities offered on a delayed delivery basis.
- - The Fund can invest in inflation-indexed bonds which are fixed-income
securities whose principal value is periodically adjusted to reflect
the rate of inflation.
- - The Fund can invest in mortgage-backed securities which represent an
interest in a pool of mortgage loans. Collateralized mortgage
obligations are a type of bond secured by an underlying pool of
mortgages or mortgage pass-through certificates that are structured to
direct payments on underlying collateral to different series or classes
of the obligations. A variety of CMO certificates may be issued in
sequential pay structures. These securities include accrual
certificates (also known as "Z-bonds") which only accrue interest at a
specified rate until all other certificates having an earlier final
distribution date have been retired and are converted thereafter to an
interest-paying security. Up to 15% of the Fund's assets can be
invested in interest-only and principal-only classes of stripped
mortgage securities, Z-bonds, and inverse floaters.
1
<PAGE>
- - The Fund can invest up to 10% of its net assets in securities of
foreign issuers.
At September 30, 1999, 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 & Agencies................... 76%
AAA/AA........................................ 1
BBB........................................... 3
BB/Ba......................................... 5*
B/B........................................... 12*
Nonrated...................................... 1**
Preferred Stock............................... 1
Cash and Equivalents.......................... 1
------
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.
DESCRIPTION OF CERTAIN SECURITIES AND INVESTMENT TECHNIQUES
FIXED-INCOME SECURITIES -- The Fund will invest primarily in fixed-income
securities, including convertible securities. Bonds and other fixed-income
securities are used by issuers to borrow money. Issuers pay investors interest
and generally must repay the amount borrowed at maturity. Some fixed-income
securities, such as zero coupon bonds, do not pay current interest but are
purchased at a discount from their face value. The market price of fixed-income
securities held by the Fund can be expected to vary inversely to changes in
prevailing interest rates and can also be affected by the financial conditions
of the issuers. Investments in fixed-income securities with longer maturities
generally produce higher yields but are subject to greater market fluctuation.
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 ("Federal Agencies") such as the Government National Mortgage
Association ("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
("FNMA"), 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 ("FHLMC"), are supported only by the credit of
the instrumentality. The guaranteed mortgage pass-through securities in which
the Fund may invest include those issued or guaranteed by GNMA, FNMA and FHLMC.
FNMA and FHLMC are federally chartered, privately owned corporations which are
instrumentalities of the United States. 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.
2
<PAGE>
INFLATION-INDEXED BONDS -- The Fund can invest in inflation-indexed bonds which
are fixed-income securities whose principal value is periodically adjusted to
reflect the rate of inflation. Such bonds generally are issued at an interest
rate lower than comparable non-indexed bonds, but are expected to retain their
principal value over time. The interest rate on these bonds is fixed at
issuance, but over the life of the bond this interest may be paid on an
increasing principal value, which has been adjusted for inflation.
Inflation-indexed bonds issued by the U.S. Treasury have maturities of five,
ten, and thirty years, although it is anticipated that securities with other
maturities will be issued in the future. If the periodic adjustment rate
measuring inflation falls, the principal value of inflation-indexed bonds will
be adjusted downward, and consequently the interest payable on these securities
(calculated with respect to a smaller principal amount) will be reduced.
Repayment of the original bond principal upon maturity (as adjusted for
inflation) is guaranteed in the case of U.S. Treasury inflation-indexed bonds,
even during a period of deflation. However, the current market value of the
bonds is not guaranteed, and will fluctuate. Any increase in the principal
amount of an inflation-indexed bond is considered taxable ordinary income, even
though investors do not receive their principal until maturity. See also
"Dividends, Distributions and Taxes in the Prospectus."
Inflation-indexed bonds issued by the U.S. Treasury pay interest on a
semi-annual basis, equal to a fixed percentage of the inflation-adjusted
principal amount. For example, if a Fund purchased an inflation-indexed bond
with a par value of $1,000 and a 3% real rate of return coupon (payable 1.5%
semi-annually), and inflation over the first six months were 1%, the mid-year
par value of the bond would be $1,010 and the first semi-annual interest payment
would be $15.15 ($1,010 times 1.5%). If inflation continued during the second
half of the year and reached 3% by year end, the end-of-year par value of the
bond would be $1,030 and the second semi-annual interest payment would be $15.45
($1,030 times 1.5%).
The value of inflation-indexed bonds is expected to change in response to
changes in real interest rates. Real interest rates in turn are tied to the
relationship between nominal interest rates and the rate of inflation.
Therefore, if inflation were to rise at a faster rate than nominal interest
rates, real interest rates might decline, leading to an increase in the value of
inflation-indexed bonds. In contrast, if nominal interest rates increased at a
faster rate than inflation, real interest rates might rise, leading to a
decrease in the value of inflation-indexed bonds.
While these securities are expected to be protected from long-term inflationary
trends, short-term increases in inflation may lead to a decline in value. If
interest rates rise due to reasons other than inflation (for example, due to
changes in currency exchange rates), investors in these securities may not be
protected to the extent that the increase is not reflected in the bond's
inflation measure.
The periodic adjustment of U.S. inflation-indexed bonds is tied to the Consumer
Price Index for Urban Consumers ("CPI-U"), which is calculated monthly by the
U.S. Bureau of Labor Statistics. The CPI-U is a measurement of changes in the
cost of living, made up of components such as housing, food, transportation and
energy. There can be no assurance that the CPI-U will accurately measure the
real rate of inflation in the prices of goods and services.
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
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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 in the Prospectus."
MORTGAGE-BACKED SECURITIES -- The Fund may invest in mortgage-backed securities
which include (a) obligations issued or guaranteed by Federal Agencies, such as
GNMA, FNMA and FHLMC; (b) collateralized mortgage obligations ("CMOs"),
including real estate mortgage investment conduits, issued by domestic or
foreign private issuers that represent an interest in or are collateralized by
mortgage-backed securities issued or guaranteed by Federal Agencies; and (c)
obligations issued by domestic 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.
The mortgage-backed securities in which the Fund may invest may include those
backed by the full faith and credit of the United States. 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 FNMA and
FHLMC. Pass-through securities issued by FNMA are guaranteed as to timely
payment of principal and interest by FNMA. Participation certificates
representing interests in mortgages from FHLMC's national portfolio are
guaranteed as to the timely payment of interest and ultimate collection of
principal by FHLMC. The Fund may also invest in mortgage-backed securities
issued by private non-governmental corporations, such as financial institutions.
The average maturity of pass-through pools of mortgage-backed securities varies
with the maturities of the underlying mortgage instruments. In addition, a
pool's stated maturity may be shortened by unscheduled payments on the
underlying mortgages. Factors affecting mortgage prepayments include the level
of interest rates, general economic and social conditions, the location of the
mortgaged property and the age of the mortgage. Because prepayment rates of
individual mortgage pools vary widely, it is not possible to accurately predict
the average life of a particular pool. Common industry practice, for example, is
to assume that prepayments will result in a 7-to-9 year average life for pools
of fixed-rate 30-year mortgages. Pools of mortgages with other maturities of
different characteristics will have varying average life assumptions.
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
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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.
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 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 in some respects 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
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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.
The Fund may 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 intend 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").
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
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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.
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 domestic and foreign private issuers
such as originators of and investors in Mortgage Assets, 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 Assets.
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 these securities.
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 Assets. 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
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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. Inverse floaters may
be used alone or in tandem with interest-only Stripped Mortgage Securities.
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
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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 the Fund's net
asset value. The liquidity of mortgage-backed securities varies by type of
security; at certain times the 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 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
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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 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
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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.
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
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.
RISK FACTORS RELATING TO LOWER RATED SECURITIES
1. SENSITIVITY TO INTEREST RATE AND ECONOMIC CHANGES. The economy and
interest rates affect high yield securities differently from other
securities. The prices of high yield bonds have been found to be less
sensitive to interest rate changes than higher rated investments, but more
sensitive to adverse economic changes or individual issuer developments.
During an economic downturn or substantial
11
<PAGE>
period of rising interest rates, highly leveraged issuers are likely to
experience financial stress which would adversely affect their ability to
service their principal and interest payment obligations, to meet
projected business goals, and to obtain additional financing. If the
issuer of a bond owned by the Fund defaults, the Fund may incur additional
expenses to seek recovery. In addition, periods of economic uncertainty
and changes can be expected to result in increased volatility of market
prices of high yield bonds and the Fund's asset value. Furthermore, the
market prices of high yield bonds structured as zero coupon or pay-in-kind
securities are affected to a greater extent by interest rate changes and
thereby tend to be more volatile than securities that pay interest
periodically and in cash.
2. LIQUIDITY AND VALUATION. To the extent that there is no established retail
secondary market, there may be thin trading of high yield bonds, and there
could be a negative impact on the Fund's Board of Directors' ability to
accurately value high yield bonds and the Fund's assets and on the Fund's
ability to dispose of the bonds. Adverse publicity and investor
perceptions, whether or not based on fundamental analysis, can decrease
the values and liquidity of high yield bonds, especially in a thinly
traded market. To the extent the Fund owns or may acquire illiquid high
yield bonds, these securities may involve special liquidity and valuation
difficulties.
3. LEGISLATION. New laws and proposed new laws could have a negative impact
on the market for high yield bonds. For example, several years ago
legislation required federally-insured savings and loan associations to
divest their investments in high yield bonds.
4. TAXATION. Special tax considerations are associated with investing in high
yield bonds structured as zero coupon or pay-in-kind securities. The Fund
accrues the interest on these securities as income even though it receives
no cash interest until the security's maturity or payment date. The Fund
is required to distribute such income to its shareholders in order to
maintain its qualification for pass-through treatment under the Internal
Revenue Code. Thus, the Fund may have to dispose of portfolio securities
at a time it otherwise might not want to do so in order to provide the
cash necessary to make distributions to those shareholders who do not
reinvest dividends.
5. CREDIT RATINGS. Certain risks are associated with applying credit ratings
as a method of evaluating high yield bonds. Credit ratings evaluate the
safety of principal and interest payments, not market value risk of high
yield bonds. Since credit rating agencies may fail to timely change the
credit ratings to reflect subsequent events, the Adviser monitors the
issuers of high yield bonds in the Fund's portfolio to determine if the
issuers appear to have sufficient cash flow to meet required principal and
interest payments. The Fund may retain a portfolio security whose rating
has been changed.
SECURITIES OF FOREIGN ISSUERS -- The Fund can invest up to 10% of its net assets
in securities of foreign governments and companies. 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.
12
<PAGE>
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.
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 can make short sales of securities or
maintain a short position if the Fund contemporaneously owns or has the right to
obtain at no added cost 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 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 which 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.
13
<PAGE>
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.
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 both 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.
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.
14
<PAGE>
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 of 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.
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
15
<PAGE>
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.
INVESTMENT RESTRICTIONS
The Fund has adopted investment restrictions stated below. They apply at the
time securities are purchased or other relevant action is taken. These
restrictions and the Fund's investment objectives cannot be changed without
approval of the holders of a majority of outstanding Fund shares. The Investment
Company Act defines this majority as the lesser of (a) 67% or more of the voting
securities present in person or represented by proxy at a meeting, if the
holders of more than 50% of the outstanding voting securities are present or
represented by proxy; or (b) more than 50% of the outstanding voting securities.
In addition to those described in the Prospectus, these restrictions provide
that the Fund will not:
1. Borrow 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 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
16
<PAGE>
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.
17
<PAGE>
FUND ORGANIZATION
The Fund is a Maryland corporation and a diversified, open-end management
investment company, generally called a mutual fund, which was organized in 1966.
A mutual fund provides the investor a practical and convenient way to invest in
a diversified portfolio of securities by combining resources with others who
have similar investment goals.
A board of five directors is responsible for overseeing the Fund's affairs.
DIRECTORS AND OFFICERS OF THE FUND
All directors and officers of the Fund are also directors and/or officers of one
or more of four other investment companies advised by the Adviser, which is an
indirect wholly owned subsidiary of United Asset Management Corporation ("UAM").
These investment companies are FPA Capital Fund, Inc., FPA Paramount Fund, Inc.,
FPA Perennial Fund, Inc. and Source Capital, Inc. (collectively, the "FPA Fund
Complex").
The directors and officers of the Fund, their ages on the date hereof and their
principal occupations during the past five years follow. Their address is 11400
West Olympic Boulevard, Suite 1200, Los Angeles, California 90064.
18
<PAGE>
FUND DIRECTORS AND OFFICERS
DIRECTORS
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------
POSITION HELD WITH
NAME/AGE FUND PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Willard H. Altman, 64 Director Former Partner of Ernst & Young LLP,
independent auditors for the Fund. Director of
Source Capital, Inc., of FPA Capital Fund, Inc.
and of FPA Perennial Fund, Inc. Director of
Current Income Shares, Inc., a closed-end
investment company. Vice President of Evangelical
Council for Financial Accountability, an
accreditation organization for Christian
non-profit entities.
- ------------------------------------------------------------------------------------------------------------
Donald E. Cantlay, 77 Director (Until 5/99)
- ------------------------------------------------------------------------------------------------------------
DeWayne W. Moore, 85 Director Former Director, Senior Vice President and Chief
Financial Officer of Guy F. Atkinson Company of
California (construction). Director of FPA
Capital Fund, Inc.
- ------------------------------------------------------------------------------------------------------------
<CAPTION>
- ------------------------------------------------------------------------------------------------------------
AGGREGATE
AGGREGATE COMPENSATION (1)
COMPENSATION (1) FROM THE FPA TOTAL NUMBER OF
FROM THE FUND FUND COMPLEX BOARDS OF FUNDS
DURING THE FISCAL DURING THE FISCAL MANAGED BY THE
YEAR ENDED YEAR ENDED ADVISER ON WHICH
NAME/AGE 9/30/99 9/30/99 DIRECTOR SERVED
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Willard H. Altman, 64 $10,000 $41,500 4
- ------------------------------------------------------------------------------------------------------------
Donald E. Cantlay, 77 $ 5,584 $11,168 2
- ------------------------------------------------------------------------------------------------------------
DeWayne W. Moore, 85 $10,000 $20,000 2
- ------------------------------------------------------------------------------------------------------------
</TABLE>
19
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------
POSITION HELD WITH
NAME/AGE FUND PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Julio J. de Puzo, Jr., 45* Director (Elected Director (since October 1995), Principal and
12/20/99) Chief Executive Officer (since March 1996) of
& Executive Vice First Pacific Advisors, Inc.; Director and
President President (since March 1996) of Source
Capital, Inc.; Director and Executive Vice
President (since April 1996) of FPA Paramount
Fund, Inc. and of FPA Perennial Fund, Inc.;
Director (since December 1999) and Executive
Vice President (since August 1996) of FPA
Capital Fund, Inc. President and Chief
Executive Officer (since January 1997), and
Director for more than the past five years of
FPA Fund Distributors, Inc. Executive Vice
President from October 1995 to March 1996,
Chief Administrative Officer from October
1995 to March 1996, Chief Financial Officer
from June 1991 to March 1996, Treasurer from
June 1991 to March 1996, and Senior Vice
President from February 1993 to October 1995,
of First Pacific Advisors, Inc. Treasurer
from July 1984 to August 1996 of the Fund and
of FPA Capital Fund, Inc.; from June 1981 to
August 1996 of FPA Paramount Fund, Inc.; from
May 1982 to August 1996 of Source Capital,
Inc.; and from September 1983 to August 1996
of FPA Perennial Fund, Inc. Chief Financial
Officer from October 1991 to March 1998, and
Executive Vice President (or Senior Vice
President or First Vice President) from
October 1991 to January 1997 of FPA Fund
Distributors, Inc.
- ------------------------------------------------------------------------------------------------------------
<CAPTION>
- ------------------------------------------------------------------------------------------------------------
AGGREGATE
AGGREGATE COMPENSATION (1)
COMPENSATION FROM THE FPA TOTAL NUMBER OF
(1) FROM THE FUND COMPLEX BOARDS OF FUNDS
FUND DURING DURING THE FISCAL MANAGED BY THE
THE FISCAL YEAR YEAR ENDED ADVISER ON WHICH
NAME/AGE ENDED 9/30/99 9/30/99 DIRECTOR SERVED
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Julio J. de Puzo, Jr., 45* $ -0- $ -0- 5
- ------------------------------------------------------------------------------------------------------------
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
POSITION HELD WITH
NAME/AGE FUND PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Alfred E. Osborne, Jr., 55 Director (Elected Director of the Harold Price Center for
12/20/99) Entrepreneurial Studies and Associate
Professor of Business Economics at The John
E. Anderson Graduate School of Management at
UCLA. Dr. Osborne has been at UCLA since
1972. Director of FPA Capital Fund, Inc., of
the Times Mirror Company, of K2 Inc., of
Nordstrom, Inc., and of E+ Capital
Corporation, a privately held company, which
operates a venture capital fund and owns
Wedbush Morgan Securities, Inc., a
broker-dealer. Independent general partner of
Technology Funding Venture Partners V L.P., a
business development company. Trustee of the
WM Group of Funds, a mutual fund complex.
- ----------------------------------------------------------------------------------------------------------
Lawrence J. Sheehan, 67* Director 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
Capital, Inc., of FPA Perennial Fund, Inc.
and of FPA Capital Fund, Inc. Director of TCW
Convertible Securities Fund, Inc., a
closed-end investment company.
- ----------------------------------------------------------------------------------------------------------
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
AGGREGATE
AGGREGATE COMPENSATION (1)
COMPENSATION FROM THE FPA TOTAL NUMBER OF
(1) FROM THE FUND COMPLEX BOARDS OF FUNDS
FUND DURING DURING THE FISCAL MANAGED BY THE
THE FISCAL YEAR YEAR ENDED ADVISER ON WHICH
NAME/AGE ENDED 9/30/99 9/30/99 DIRECTOR SERVED
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Alfred E. Osborne, Jr., 55 $ -0- $ -0- 2
- ----------------------------------------------------------------------------------------------------------
Lawrence J. Sheehan, 67* $10,000 $42,000 4
- ----------------------------------------------------------------------------------------------------------
</TABLE>
- --------------------------------
(1) No pension or retirement benefits are provided to directors by the
Fund or the FPA Fund Complex.
* Director who is an interested person, as defined in the Investment
Company Act, by virtue of his affiliation with First Pacific Advisors,
Inc. in the case of Mr. de Puzo and by virtue of his affiliation with
legal counsel to the Fund in the case of Mr. Sheehan.
21
<PAGE>
OFFICERS
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
NAME/AGE POSITION HELD WITH FUND PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Robert L. Rodriguez, 51 President & Chief Director, Principal and Chief Investment Officer of
Investment Officer First Pacific Advisors, Inc. since March 1996;
President and Chief Investment Officer of FPA
Capital Fund, Inc. for more than the past five
years; and Director of Source Capital, Inc. since
March 1996. Director of FPA Fund Distributors,
Inc. since March 1996. Executive Vice President
from January 1996 to March 1996 and Senior Vice
President from February 1993 to January 1996, of
First Pacific Advisors, Inc.
- --------------------------------------------------------------------------------------------------------------
Eric S. Ende, 55 Vice President Senior Vice President of First Pacific Advisors,
Inc. for more than the past five years; President
(since September 1995) and Portfolio Manager
(since August 1999) of FPA Perennial Fund, Inc.;
Chief Investment Officer since May 1997 and
Senior Vice President for more than the past five
years of Source Capital, Inc.; and Vice President of
FPA Capital Fund, Inc. and of FPA Paramount
Fund, Inc. for more than the past five years. Chief
Investment Officer from September 1995 to August
1999, Executive Vice President from August 1995
to September 1995, and Vice President from May
1985 to August 1995 of FPA Perennial Fund, Inc.
- --------------------------------------------------------------------------------------------------------------
J. Richard Atwood, 39 Treasurer Senior Vice President, Chief Financial Officer and
Treasurer of First Pacific Advisors, Inc. since
January 1997; and Chief Financial Officer since
March 1998, Senior Vice President and Treasurer
of FPA Fund Distributors, Inc. since January
1997. Treasurer of Source Capital, Inc., of FPA
Paramount Fund, Inc., of FPA Perennial Fund,
Inc., and of FPA Capital Fund, Inc. since January
1997. Vice President and Chief Financial Officer
of Transamerica Investment Services, Inc. from
January 1995 to January 1997. Vice President (or
Assistant Vice President) and Controller of First
Pacific Advisors, Inc. from August 1988 to January
1995, and Assistant Treasurer of FPA Fund
Distributors, Inc. from May 1991 to January 1995.
Assistant Treasurer of the Fund, of FPA Capital
FundNew Income, Inc., of FPA Paramount Fund,
Inc., of FPA Perennial Fund, Inc., and of Source
Capital, Inc. from August 1988 to January 1995.
- --------------------------------------------------------------------------------------------------------------
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
NAME/AGE POSITION HELD WITH FUND PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Sherry Sasaki, 44 Secretary Assistant Vice President and Secretary for more
than the past five years of First Pacific Advisors,
Inc.; and Secretary of Source Capital, Inc., of
FPA Capital Fund, Inc., of FPA Paramount Fund,
Inc., of FPA Perennial Fund, Inc., and of FPA
Fund Distributors, Inc. for more than the past five
years.
- --------------------------------------------------------------------------------------------------------------
Christopher H. Thomas, 42 Assistant Treasurer Vice President and Controller of First Pacific
Advisors, Inc. and of FPA Fund Distributors, Inc.
since March 1995, and Assistant Treasurer of FPA
Perennial Fund, Inc., of FPA Capital Fund, Inc.,
of Source Capital, Inc., and of FPA Paramount
Fund, Inc. 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.
- --------------------------------------------------------------------------------------------------------------
</TABLE>
All officers of the Fund are also officers of the Adviser. The Directors and
officers of the Fund as a group own less than 1% of the outstanding Fund shares.
During the last fiscal year, the Directors then in office received as a group
$35,584 in Directors' fees. Such Directors were also reimbursed for certain
travel expenses by the Fund.
FIVE PERCENT SHAREHOLDERS
As of December 31, 1999, no person was known by the Fund to own of record or
beneficially 5% or more of the outstanding Fund shares, except Charles Schwab &
Co., Inc., for the benefit of customers, 101 Montgomery Street, San Francisco,
California 94104-4122, which held 8,260,462 shares (16.5%), 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 4,898,396 shares (9.8%). The foregoing broker-dealers
and/or investment advisory firms advise that the shares are held for the benefit
of their customers.
MANAGEMENT
INVESTMENT ADVISER. First Pacific Advisors, Inc., together with its
predecessors, has been in the investment advisory business since 1954, serving
as investment adviser to the Fund since July 11, 1984. Presently, the investment
adviser manages assets of approximately $3.1 billion for six investment
companies, including one closed-end investment company, and 21 institutional
accounts. Currently, the personnel of First Pacific Advisors, Inc. consists of
nine persons engaged full time in portfolio management or investment research in
addition to 27 persons engaged full time in trading, administrative, financial
or clerical activities. FPA Fund Distributors, Inc. is a wholly owned subsidiary
of First Pacific Advisors, Inc., which is itself a wholly owned subsidiary of
United Asset Management Holdings, Inc. United Asset Management Holdings, Inc. is
a wholly owned subsidiary of UAM, a New York Stock Exchange listed holding
company principally engaged, through affiliated firms, in providing
institutional investment management and acquiring institutional investment
management firms. No person is known by UAM to own or hold with power to vote
25% or more of its outstanding shares of common stock.
23
<PAGE>
INVESTMENT ADVISORY AND SERVICE 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 of its operation. These costs include the
charges and expenses of any custodian or depository appointed by the Fund for
the safekeeping of its cash, portfolio securities and other property; the
charges and expenses of auditors; the charges and expenses of any stock transfer
or dividend agent or agents appointed by the Fund; brokers' commissions
chargeable to the Fund in connection with portfolio securities transactions to
which the Fund is a party; all taxes, including issuance and transfer taxes, and
corporate fees payable by the Fund to federal, state or other governmental
agencies; the cost of stock certificates representing Fund shares; fees involved
in registering and maintaining registrations of the Fund and of Fund shares with
the Securities and Exchange Commission ("SEC") and various states and other
jurisdictions; all expenses of shareholders' and Directors' meetings and of
preparing, printing and mailing proxy statements and semi-annual and annual
reports to shareholders except as set forth in the Distribution Agreement
between the Fund and the Distributor; fees and travel expenses of Directors not
affiliated with the Adviser; the expense of furnishing, or causing to be
furnished, to all shareholders a statement of account after every transaction
affecting their account, including the expense of mailing; charges and expenses
of legal counsel in connection with matters relating to the Fund, including,
without limitation, legal services rendered in connection with the Fund's
corporate and financial structure and relations with its shareholders, issuance
of Fund shares, and registrations and qualifications of securities under
federal, state and other laws; association dues; interest payable on Fund
borrowings; 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 computed and paid monthly.
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 under the Advisory Agreement.
The Advisory Agreement is renewable annually if specifically approved each year
(a) by the Fund's Board of Directors or by the vote of a majority (as defined in
the Investment Company Act) of the Fund's outstanding voting securities and (b)
by the vote of a majority of the Fund's directors who are not parties to the
Advisory Agreement or interested persons (as defined in the Investment Company
Act) of any such party, by votes cast in person at a meeting called for the
purpose of voting on such approval. The continuation of the Advisory Agreement
to December 31, 2000, has been approved by the Board of Directors and a majority
of the Fund's directors who are not parties to the Advisory Agreement or
interested persons of any such party (as defined in the Investment Company Act).
The Advisory Agreement may be terminated without penalty upon 60 days' written
notice at the option of either party or by the vote of the Fund's shareholders.
The Advisory Agreement automatically terminates in the event
24
<PAGE>
of its assignment.
For the fiscal years ended September 30, 1997, 1998 and 1999, the Adviser
received gross advisory fees of $2,124,391, $2,958,785 and $2,846,976,
respectively.
PRINCIPAL UNDERWRITER. FPA Fund Distributors, Inc. (the "Distributor"), located
at 11400 West Olympic Boulevard, Suite 1200, Los Angeles, California 90064, acts
as principal underwriter of Fund shares pursuant to a Distribution Agreement
dated December 27, 1994 (the "Distribution Agreement"). Please see "Distributor"
for more information.
PORTFOLIO TRANSACTIONS AND BROKERAGE
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 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
25
<PAGE>
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, 1997 and 1998 totaled $330 and $12,
respectively. During the last fiscal year, the Fund did not pay any brokerage
commissions.
PORTFOLIO TURNOVER
The portfolio turnover rate is calculated by dividing the lesser of purchases or
sales of portfolio securities for a fiscal year by the average monthly value of
the portfolio securities during such fiscal year. Securities maturing in one
year or less at the time of acquisition are not included in this computation.
The turnover rate for prior periods is shown in the Prospectus under the caption
"Financial Highlights." This rate may vary greatly from year to year as well as
within a year.
CAPITAL STOCK
COMMON STOCK. Each Fund share outstanding participates equally in dividends,
distributions and liquidation of the Fund's net assets. Fund shares are
transferable, fully paid and non-assessable, and do not have any preemptive,
preferential, subscription or conversion rights. The Fund has authorized 100
million shares of $0.01 par value Common Stock.
VOTING RIGHTS. The By-Laws of the Fund require shareholder meetings to elect
directors only when required by the Investment Company Act which is likely to
occur infrequently. In addition, a special meeting of the shareholders will be
called, if requested by the holders of ten percent of the Fund's outstanding
shares, for the purposes, and to act upon the matters, specified in the request
(which may include election or removal of directors). When matters are submitted
for a shareholder vote, each shareholder is entitled to one vote for each share
owned. Shares of the Fund do not have cumulative voting rights, which means
holders of more than 50% of Fund shares voting for the election of directors can
elect 100% of the directors if they so choose. In such event, holders of the
remaining Fund shares are not able to elect any person or persons to the Fund's
Board of Directors.
PURCHASE AND REDEMPTION OF SHARES
NET ASSET VALUE. The net asset value is computed as of the close of the New York
Stock Exchange ("NYSE") on each business day during which the NYSE is open. Net
asset value, rounded to the nearest cent per share, is the total market value of
all the Fund's portfolio securities plus other assets (including any accrued
reimbursement of expenses), less all liabilities, divided by the total number of
Fund shares outstanding. The NYSE is closed not only on weekends but also on
customary holidays, which currently are New Year's Day, Martin Luther King, Jr.
Day, President's Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day. Computation is made by valuing (a)
securities listed or traded on a national securities exchange or on the National
Association of Securities Dealers Automated Quotations NASDAQ National Market
System ("NASDAQ") at the last sale price or, if there has been no sale that day,
at the last bid price, (b) unlisted securities for which quotations are readily
available at the last representative bid price as supplied by the NASDAQ or by
dealers, and (c) securities for which there are no readily available market
quotations and all other assets at fair value in such manner as determined in
good faith by the Fund's Board of Directors.
SALES CHARGES. The maximum sales charge is 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
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<PAGE>
in amounts ranging from 80% to 89%, depending on the size of the investment.
During special promotions, the Distributor may reallow up to 100% of the sales
charge to dealers. At such times dealers may be deemed to be underwriters for
purposes of the Securities Act of 1933. Discounts are alike to all dealers.
AUTHORIZED FINANCIAL INTERMEDIARIES. The Fund has authorized certain financial
intermediaries including one or more brokers to accept on its behalf purchase
and redemption orders. These brokers are authorized to designate other
intermediaries to accept purchase and redemption orders on the Fund's behalf.
The Fund is deemed to have received a purchase or redemption order when an
authorized financial intermediary including an authorized broker or if
applicable a broker's authorized designee accepts the order. Customer orders are
priced at the Fund's net asset value next computed after they are accepted by an
authorized financial intermediary, including an authorized broker or the
broker's authorized designee.
SALES AT NET ASSET VALUE. Full-time employees of the Adviser can purchase Fund
shares at net asset value via payroll deduction, provided the minimum initial
investment is $250. Each subsequent investment must be at least $50.
LETTER OF INTENT. To be eligible for reduced sales charges, the investor must
sign at the time of initial purchase, or within 30 days, a Letter of Intent
("LOI") covering investments to be made within a period of 13 months ("Period")
from the initial purchase. The investor then becomes eligible for a reduced
sales charge based on the total amount of the specified intended investment
("LOI Goal"), provided the amount is not less than $10,000. A minimum initial
purchase of $1,500 and minimum subsequent purchases of $100 each are required.
Fund shares can also be purchased to fulfill a letter of intent entered into
with respect to shares of the other FPA Funds. The account information form,
which should be used to establish an LOI, is available from dealers or the
Distributor.
All transactions under an LOI must be indicated as such and must be placed by
the dealer (in the case of an initial purchase) or the shareholder (in the case
of any subsequent purchase) directly through Boston Financial Data Services,
Inc. ("Shareholder Service Agent"). Shareholders should review for accuracy all
confirmations of transactions, especially purchases made pursuant to an LOI.
If the LOI Goal is completed before the end of the Period, any subsequent
purchases within the Period receive the applicable reduced sales charge. In
addition, during the Period, the shareholder can increase his or her LOI Goal,
and all subsequent purchases are treated as a new LOI (including escrow of
additional Fund shares) except as to the Period, which does not change.
Signing an LOI does not bind the shareholder to complete his or her LOI Goal,
but the LOI Goal must be completed to obtain the reduced sales charge. The LOI
is binding on the Fund and the Distributor. However, the Distributor may
withdraw a shareholder's LOI privileges for future purchases upon receiving
information that the shareholder has resold or transferred his or her Fund
shares within the Period.
The LOI requires the Shareholder Service Agent, as escrow agent, to hold 5% of
the LOI Goal in escrow until completion of the LOI Goal within the Period. The
escrowed Fund shares are taken from the first purchase and, if necessary, from
each successive purchase. If the LOI Goal is completed within the Period, the
escrowed Fund shares are promptly delivered to, or as directed by, the
shareholder.
If the LOI Goal is not completed within the Period, the shareholder must pay the
Distributor an amount equal to the sales charge applicable to a single purchase
in the total amount of the purchases made under the LOI minus the sales charges
actually paid. If the Distributor does not receive such unpaid sales charge
within 20 days after requesting payment in writing, the Distributor instructs
the Shareholder Service Agent to redeem escrowed Fund shares sufficient to cover
the unpaid sales charge. Under the LOI, the
27
<PAGE>
shareholder irrevocably appoints the Shareholder Service Agent as his or her
attorney with full power of substitution to surrender for redemption any or all
escrowed Fund shares. If the redemption proceeds are inadequate, the shareholder
is liable to the Distributor for the difference. The Shareholder Service Agent
delivers to, or as directed by, the shareholder all Fund shares remaining after
such redemption, together with any excess cash proceeds.
Any income dividends and capital gains distributions on the escrowed Fund shares
are paid or reinvested as directed by, the shareholder.
FPA EXCHANGE PRIVILEGE. The procedures for exchanging shares between FPA Funds
are described under "Exchanging Your Fund Shares" in the Fund's Prospectus. If
the account registration information for the two FPA Fund accounts involved in
the exchange are different in any respect, the exchange instructions must be in
writing and must contain a signature guarantee as described under "Selling
(Redeeming) Your Shares" in the Fund's Prospectus.
By use of the exchange privilege, the investor authorizes the Shareholder
Service Agent ("Agent") to act on telephonic, telegraphic or written exchange
instructions from any person representing himself to be the investor or the
agent of the investor and believed by the Agent to be genuine. The Agent's
records of such instructions are binding.
For purposes of determining the sales charge rate previously paid, all sales
charges paid on the exchanged security and on any security previously exchanged
for such security or for any of its predecessors will be included. If the
exchanged security was acquired through reinvestment, that security may be
exchanged without a sales charge. If a shareholder exchanges less than all of
his securities, the security requiring no or the lowest incremental sales charge
is deemed exchanged first.
Exchange requests received on a business day before shares of the Funds involved
in the request are priced, are processed on the date of receipt by the
Shareholder Service Agent. "Processing" a request means that shares in the Fund
from which the shareholder is withdrawing an investment will be redeemed at the
net asset value per share next determined after receipt. Shares of the new Fund
into which the shareholder is investing will also normally be purchased at the
net asset value per share, plus any applicable sales charge, next determined
after receipt by the Agent. Exchange requests received on a business day after
the time shares of the Funds involved in the request are priced, are processed
on the next business day as described above.
Boston Financial Data Services, Inc. uses procedures it considers reasonable to
confirm exchange instructions via telephone, including requiring account
registration verification from the caller and recording telephone instructions.
Neither Boston Financial Data Services, Inc. nor the Fund is liable for losses
due to unauthorized or fraudulent instructions if there is a reasonable belief
in the authenticity of received instructions and reasonable procedures are
employed; otherwise, they may be liable.
REDEMPTION OF SHARES. Redemptions are not made on days when the NYSE is closed,
including those holidays listed under "Purchase and Redemption of Shares - Net
Asset Value." The right of redemption can be suspended and the payment therefore
may be postponed for more than seven days during any period when (a) the NYSE is
closed for other than customary weekends or holidays; (b) trading on the NYSE is
restricted; (c) an emergency exists as a result of which disposal by the Fund of
securities it owns is not reasonably practicable or it is not reasonably
practicable 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 can be made by telephone once the shareholder
has properly completed and returned to the Agent the account information form,
including the designation of
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<PAGE>
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 account information form.
Existing shareholders who wish to establish the telephone redemption
privilege or change the Designated Bank should either enter the new
information on an account information form, marking it for "change of
information" purposes, or send a letter identifying the Fund account and
specifying the exact information to be changed. The letter must be signed
exactly as the shareholder's name(s) appear on the account. All signatures
require a guarantee as described under "Selling (Redeeming) Your Shares" in
the Fund's Prospectus. The account information form is available from
authorized security dealers or the Distributor.
Shareholders who want to use a savings and loan ("S&L") as their Designated Bank
are advised that if the S&L is not a participant in the Federal Reserve System,
redemption proceeds must be wired through a commercial bank which is a
correspondent of the S&L. As this may delay receipt by the shareholder's
account, it is suggested that shareholders who wish to use an S&L discuss wire
procedures with their S&L and submit any special wire transfer information with
the telephone redemption authorization. If appropriate wire information is not
supplied, redemption proceeds will be mailed to such Designated Bank.
A shareholder can cancel the telephone redemption authorization upon written
notice. If the shareholder has authorized telephone redemptions, neither the
Fund nor the Agent is responsible for any unauthorized telephone redemptions. If
the Fund shares to be redeemed by telephone (technically a repurchase by
agreement between the Fund and the shareholder) were recently purchased by
check, the Agent can delay transmitting the proceeds until the purchasing check
has cleared but no more than 15 days from purchase.
Boston Financial Data Services, Inc. uses procedures it considers reasonable to
confirm redemption instructions via telephone, including requiring account
registration verification from the caller and recording telephone instructions.
Neither Boston Financial Data Services, Inc. nor the Fund is liable for losses
due to unauthorized or fraudulent instructions if there is a reasonable belief
in the authenticity of received instructions and reasonable procedures are
employed; otherwise, they may be liable.
TAX SHELTERED RETIREMENT PLANS
Through the Distributor, prototype retirement plans are available for purchase
of Fund shares. These include plans for self-employed individuals and plans for
individuals buying shares under an Individual Retirement Account. A penalty tax
applies, in general, to distributions made before age 59-1/2, excess
contributions and failure to start distribution of the account at age 70-1/2.
Borrowing from or against the account could also result in plan
disqualification. Distributions from these retirement plans generally are
taxable as ordinary income when received.
State Street Bank and Trust Company ("Bank") presently acts as custodian for
retirement plans and imposes fees for administering them. Purchases of Fund
shares for a retirement plan must be made by direct remittance to the Bank.
When contributions for any tax-qualified plan are invested in Fund shares, all
dividends and capital gains distributions paid on those Fund shares are retained
in the plan and automatically reinvested in additional Fund shares at net asset
value. All earnings accumulate tax-free until distribution.
The investor should consult his or her own tax adviser concerning the tax
ramifications of establishing, and distributions from, a retirement plan.
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<PAGE>
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.
Prior to purchasing Fund shares, the impact of dividends or capital gains
distributions should be carefully considered. Any such payments made to a
shareholder shortly after purchasing Fund shares reduce the net asset value of
such Fund shares to that extent and unnecessarily increase sales charges. All or
a portion of such dividends or distributions, although in effect a return of
capital, is subject to taxes, possibly at ordinary income tax rates.
Dividends and distributions declared payable to shareholders of record after
September 30 of any year and paid before February 1 of the following year are
considered taxable income to shareholders on the record date even though paid in
the next year. To the extent determined each year, a portion of the dividends
paid to shareholders from the Fund's net investment income qualifies for the 70%
dividends received deduction for corporations.
Some shareholders may be subject to 31% withholding on reportable dividends,
capital gains distributions and redemption payments ("backup withholding").
Generally, shareholders subject to backup withholding are those for whom a
taxpayer identification number is not on file with the Fund or who, to the
Fund's knowledge, furnished an incorrect number. When establishing an account,
an investor must certify under penalty of perjury that such number is correct
and that he or she is not subject to backup withholding.
Under existing provisions of the Code, dividends paid to shareholders who are
nonresident aliens may be subject to a 30% federal withholding tax applicable to
foreign individuals and entities unless a reduced rate of withholding or a
withholding exemption is provided under applicable treaty law. Nonresident
shareholders are urged to consult their own tax advisers concerning the
applicability of the federal withholding tax.
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<PAGE>
The foregoing is a general and abbreviated summary of the applicable provisions
of the Code and Treasury Regulations presently in effect. For the complete
provisions, reference should be made to the pertinent Code sections and Treasury
Regulations. The Code and these Treasury Regulations are subject to change by
legislative or administrative action either prospectively or retroactively.
Each investor should consult his or her own tax adviser as to federal tax laws
and the effect of state and local tax laws which may differ from federal tax
laws.
DISTRIBUTOR
The Distributor acts as principal underwriter of Fund shares pursuant to the
Distribution Agreement. The offering of Fund shares is a continuous offering.
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 Fund 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 registering Fund shares under federal and state laws
and the compensation and expenses of the Fund's transfer agent.
The Distribution Agreement is renewable annually if specifically approved each
year (a) by the Fund's Board of Directors or by a vote of a majority (as defined
in the Investment Company Act) of the Fund's outstanding voting securities and
(b) by a majority of the Fund's directors who are not parties to the
Distribution Agreement or interested persons (as defined in the Investment
Company Act) of any such party, by votes cast in person at a meeting called for
such purpose. The continuation of the Distribution Agreement to September 3,
2000 has been approved by the Board of Directors and a majority of the Fund's
directors who are not parties to the Distribution Agreement or interested
persons of any such party (as defined in the Investment Company Act). The
Distribution Agreement terminates if assigned (as defined in the Investment
Company Act) and may be terminated at any time on 60 days' written notice,
without penalty, by the Fund's Board of Directors, the vote of a majority of the
Fund's outstanding voting securities or the Distributor.
The Distributor's obligation under the Distribution Agreement is an agency or
best efforts arrangement pursuant to which the Distributor is required to take
and pay for only those Fund shares sold to the public.
The Distributor is not obligated to sell any stated number of Fund shares.
For the fiscal years ended September 30, 1997, 1998 and 1999, total underwriting
commissions on the sale of Fund shares were $1,121,144, $1,013,895 and $541,675,
respectively, of which $163,881, $129,635 and $70,027, respectively, were
retained by the Distributor after reallowances to other dealers.
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)
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ERV = ending redeemable value of a hypothetical
$1,000 payment, made at the beginning of the 1, 5 or
10 year period, at the end of such period (or
fractional portion thereof).
Under the foregoing formula, the time periods used in advertising will be based
on rolling calendar quarters, updated to the last day of the most recent quarter
prior to submission of the advertising for publication, and cover 1, 5 and
10-year periods of a fund's existence or such shorter period dating from the
effectiveness of a fund's registration statement. In calculating the ending
redeemable value, the maximum sales load is deducted from the initial $1,000
payment and all dividends and distributions by a fund are assumed to have been
reinvested at net asset value as described in the Prospectus on the reinvestment
dates during the period. Total return, or "T" in the formula above, is computed
by finding the average annual compounded rates of return over the 1, 5 and
10-year periods (or fractional portion thereof) that would equate the initial
amount invested to the ending redeemable value.
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 will be
given no greater prominence in such advertising than the information prescribed
under SEC regulations.
The Fund's average annual total return (calculated in accordance with the SEC
regulations described above) for the one, five and ten-year periods ended
September 30, 1999 was (0.80)%, 6.53% and 8.33%, 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 3.87%, 7.52% and 8.83%, 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.
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PORTFOLIO OF INVESTMENTS
September 30, 1999
<TABLE>
<CAPTION>
Principal
BONDS & DEBENTURES Amount Value
- ------------------------------------------------------------ ------------- -------------
<S> <C> <C>
U.S. GOVERNMENT & AGENCIES
MORTGAGE-BACKED SECURITIES -- 33.3%
Federal Home Loan Mortgage Corporation
--5.85% 2017 ............................................. $ 9,110,870 $ 9,056,774
--6% 2008 ................................................ 26,642,721 25,762,273
--6% 2009 ................................................ 22,316,000 21,318,754
--7% 2008 ................................................ 2,453,541 2,430,539
--7% 2023 ................................................ 5,000,000 4,800,000
--7 1/2% 2021 ............................................ 1,149,739 1,158,721
--8 1/2% 2026 ............................................ 7,929,853 8,237,135
--10.15% 2006 ............................................ 13,456 13,473
Federal Home Loan Mortgage Corporation (IO)
--6 1/2% 2007 ............................................ 8,044,424 685,345
--6 1/2% 2020 ............................................ 1,764,835 113,198
--6 1/2% 2023 ............................................ 4,437,568 503,211
--7% 2020 ................................................ 8,000,000 920,000
Federal Home Loan Mortgage Corporation (Z)
--6 1/2% 2029 ............................................ 5,333,082 4,399,792
--7% 2029 ................................................ 4,915,019 4,483,419
--7 1/2% 2026 ............................................ 7,168,831 7,108,344
Federal National Mortgage Association
--5.16% 2022 ............................................. 18,500,000 17,667,500
--6 1/2% 2008 ............................................ 2,867,198 2,833,149
Federal National Mortgage Association (IO)
--6% 2027 ................................................ 38,536,034 10,933,559
--6% 2028 ................................................ 23,765,747 6,657,760
--6 1/2% 2009 ............................................ 4,159,415 646,985
--6 1/2% 2020 ............................................ 4,976,693 466,371
--7% 2004 ................................................ 862,420 111,306
--7% 2017 ................................................ 2,343,119 59,126
Federal National Mortgage Association (Z)
--7% 2019 ................................................ 13,111,641 12,275,774
--7% 2024 ................................................ 11,529,717 10,448,807
--7 1/2% 2024 ............................................ 1,658,816 1,599,722
</TABLE>
33
<PAGE>
PORTFOLIO OF INVESTMENTS
September 30, 1999
<TABLE>
<CAPTION>
Principal
BONDS & DEBENTURES--CONTINUED Amount Value
- ------------------------------------------------------------------------- -------------- -------------
<S> <C> <C>
Government National Mortgage Association
--7% 2028 ............................................................ $ 9,825,724 $ 9,610,786
--7 1/2% 2023 ........................................................ 457,560 459,275
Government National Mortgage Association II --8% 2027 ................... 3,875,107 3,950,187
Government National Mortgage Association (MH)
--8 1/4% 2006-7 ...................................................... 348,339 355,306
--8 3/4% 2006 ........................................................ 782,738 810,623
--8 3/4% 2011 ........................................................ 839,414 858,824
--9% 2010 ............................................................ 497,004 512,225
--9% 2011 ............................................................ 1,204,111 1,240,987
--9 1/4% 2010-11 ..................................................... 873,492 905,156
--9 3/4% 2005-6 ...................................................... 1,777,391 1,849,041
--9 3/4% 2012-13 ..................................................... 762,704 793,451
Government National Mortgage Association (PL)
--10 1/4% 2017 ....................................................... 898,441 923,149
--------------
$ 176,960,047
--------------
OTHER U.S. GOVERNMENT & AGENCIES --42.7%
Tennessee Valley Authority --8 3/8% 1999 ................................ $ 3,400,000 $ 3,400,000
U.S. Treasury Inflation-Indexed Notes --3 3/8% 2007 ..................... 214,620,240 204,895,260
U.S. Treasury Notes --8 1/4% 2005 ....................................... 1,800,000 1,829,813
U.S. Treasury Notes Strip --0% 2009 ..................................... 31,000,000 16,691,950
--------------
$ 226,817,023
--------------
TOTAL U.S. GOVERNMENT & AGENCIES --76.0% ................................ $ 403,777,070
--------------
MORTGAGE BONDS
ASSET BACKED --3.4%
Green Tree Financial Corporation
--7 1/4% 2005 ........................................................ $ 9,716,854 $ 9,388,909
--7 3/4% 2029 ........................................................ 1,000,000 805,000
--7.77% 2029 ......................................................... 5,500,000 4,840,000
--8% 2028 ............................................................ 3,048,511 2,876,081
--------------
$ 17,909,990
--------------
</TABLE>
34
<PAGE>
PORTFOLIO OF INVESTMENTS
September 30, 1999
<TABLE>
<CAPTION>
Principal
BONDS & DEBENTURES--CONTINUED Amount Value
- ---------------------------------------------------------------------------------------- -------------- --------------
<S> <C> <C>
MORTGAGE BACKED --1.6%
DLJ Mortgage Acceptance Corp. (Series 1997-E Class B)
--7.5481% 2026* .............................................................. $ 4,959,717 $ 3,655,078
First Financial Mortgage Trust (Series 9 Class A4)
--5.8% 2008 .................................................................. 1,000,000 977,500
Norwest Asset Securities Corp. (Series 1999-13 Class A"Z")
--6 3/4% 2029 ................................................................ 1,316,355 1,115,611
Prudential Home Mortgage Securities Corp. (Series 1993-F Class 1B1)
--6.65995% 2000* ............................................................. 2,942,698 2,932,582
------------
$ 8,680,771
------------
TOTAL MORTGAGE BONDS --5.0% ................................................... $ 26,590,761
------------
CORPORATE BONDS & DEBENTURES --7.3%
Advanta Corporation
--5.6075% 2000 (Floating Rate) ............................................... $ 1,600,000 $ 1,582,000
--6.65% 2000 ................................................................. 2,400,000 2,384,714
--6.658% 1999 ................................................................ 3,400,000 3,396,600
Advantica Restaurant Group, Inc. --11 1/4% 2008 ................................ 10,928,038 10,053,795
Oregon Steel Mills, Inc. --11% 2003 ............................................ 13,350,000 13,817,250
Trump Atlantic City Associates --11 1/4% 2006 .................................. 9,000,000 7,650,000
------------
$ 38,884,359
------------
TOTAL NON-CONVERTIBLE BONDS & DEBENTURES --88.3% ............................... $469,252,190
------------
CONVERTIBLE SECURITIES CONVERTIBLE BONDS & DEBENTURES --10.5%
Centertrust Retail Properties, Inc. ............................................
--7 1/2% 2001 (Class A) ...................................................... $ 4,858,000 $ 4,627,245
--7 1/2% 2001 (Class B) ...................................................... 5,800,000 5,365,000
Charming Shoppes, Inc. --7 1/2% 2006 ........................................... 7,000,000 6,370,000
CKE Restaurants, Inc. --4 1/4% 2004 ............................................ 12,000,000 7,680,000
DRS Technologies, Inc. --9% 2003 ............................................... 2,000,000 2,240,000
HomeBase, Inc. --5 1/4% 2004 ................................................... 8,302,000 5,728,380
Michaels Stores, Inc. --6 3/4% 2003 ............................................ 17,250,000 16,775,625
Offshore Logistics, Inc. --6% 2003 ............................................. 2,000,000 1,675,000
Quantum Health Resources, Inc. --4 3/4% 2000 ................................... 1,000,000 915,000
Read-Rite Corporation --6 1/2% 2004 ............................................ 10,055,000 4,273,375
------------
$ 55,649,625
------------
</TABLE>
35
<PAGE>
PORTFOLIO OF INVESTMENTS
September 30, 1999
<TABLE>
<CAPTION>
Shares or
Principal
CONVERTIBLE SECURITIES--CONTINUED Amount Value
- -------------------------------------------------------------------------- -------------- ------------
<S> <C> <C>
CONVERTIBLE PREFERRED STOCK --0.1%
Treev Inc. (Series A) ..................................................... 66,000 $ 449,625
------------
TOTAL CONVERTIBLE SECURITIES --10.6% ...................................... $ 56,099,250
------------
OTHER PREFERRED STOCK --0.6%
Crown American Realty Trust ............................................... 78,500 $ 3,238,125
------------
TOTAL INVESTMENT SECURITIES --99.5% (Cost $542,907,348) ................... $528,589,565
------------
SHORT-TERM INVESTMENT --0.2%
State Street Bank Repurchase Agreement --4 1/4% 10/1/99
(Collateralized by U.S. Treasury Notes --8 1/8% 2021
market value $783,544, Cost $767,091) ................................. $ 767,000 $ 767,091
------------
TOTAL INVESTMENTS --99.7% (Cost $543,674,439) ............................. $529,356,656
Other assets and liabilities, net --0.3% .................................. 1,776,829
------------
TOTAL NET ASSETS --100% ................................................... $531,133,485
------------
------------
</TABLE>
* Restricted securities purchased without registration under the Securities Act
of 1933 pursuant to Rule 144A, which generally may be resold only to certain
institutional investors prior to registration. DLJ Mortgage Acceptance Corp.
was purchased on September 8, 1997 and Prudential Home Mortgage Securities
Corp. was purchased on May 20, 1998. These restricted securities constituted
1.2% of total net assets at September 30, 1999.
See notes to financial statements.
36
<PAGE>
STATEMENT OF ASSETS AND LIABILITIES
September 30, 1999
<TABLE>
<CAPTION>
ASSETS
<S> <C> <C>
Investments at value:
Investment securities --at market value
(identified cost $542,907,348) .................................... $ 528,589,565
Short-term investments --at cost plus interest earned
(maturities of 60 days or less) ................................... 767,091 $ 529,356,656
-------------
Cash .................................................................. 503
Receivable for:
Interest ............................................................ $ 5,515,399
Capital Stock sold .................................................. 725,922
Investment securities sold .......................................... 66,311 6,307,632
------------- -------------
$ 535,664,791
LIABILITIES
Payable for:
Capital Stock repurchased ........................................... $ 4,175,174
Advisory fees ....................................................... 225,947
Accrued expenses and other liabilities .............................. 130,185 4,531,306
------------- -------------
NET ASSETS .............................................................. $ 531,133,485
-------------
-------------
SUMMARY OF SHAREHOLDERS' EQUITY
Capital Stock -- par value $0.01 per share; authorized
100,000,000 shares; outstanding 49,324,340 shares ................... $ 493,243
Additional Paid-in Capital ............................................ 531,442,176
Undistributed net realized gains on investments ....................... 4,252,881
Undistributed net investment income ................................... 9,262,968
Unrealized depreciation of investments ................................ (14,317,783)
-------------
Net assets at September 30, 1999 ...................................... $ 531,133,485
-------------
-------------
NET ASSET VALUE, REDEMPTION PRICE AND MAXIMUM
OFFERING PRICE PER SHARE
Net asset value and redemption price per share
(net assets divided by shares outstanding) ........................... $ 10.77
-------------
-------------
Maximum offering price per share
(100/95.5 of per share net asset value) .............................. $ 11.28
-------------
-------------
</TABLE>
See notes to financial statements.
37
<PAGE>
STATEMENT OF OPERATIONS
For the Year Ended September 30, 1999
<TABLE>
<CAPTION>
INVESTMENT INCOME
<S> <C> <C>
Interest .................................................................. $ 39,220,123
Dividends ................................................................. 479,000
-------------
$ 39,699,123
EXPENSES
Advisory fees ............................................................. $ 2,846,976
Transfer agent fees and expenses .......................................... 253,280
Custodian fees and expenses ............................................... 57,813
Registration fees ......................................................... 50,685
Directors' fees and expenses .............................................. 36,150
Insurance ................................................................. 31,067
Audit fees ................................................................ 24,920
Postage ................................................................... 22,523
Reports to shareholders ................................................... 22,319
Legal fees ................................................................ 3,611
Other expenses ............................................................ 16,979 3,366,323
------------- -------------
Net investment income ............................................. $ 36,332,800
-------------
NET REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
Net realized gain on investments:
Proceeds from sales of investment securities (excluding
short-term investments with maturities of 60 days or less) .............. $ 176,943,008
Cost of investment securities sold ........................................ 172,179,484
-------------
Net realized gain on investments ...................................... $ 4,763,524
Unrealized appreciation (depreciation) of investments:
Unrealized appreciation at beginning of year .............................. $ 5,317,224
Unrealized depreciation at end of year .................................... (14,317,783)
-------------
Decrease in unrealized appreciation of investments .................... (19,635,007)
-------------
Net realized and unrealized loss on investments ................... $ (14,871,483)
-------------
NET INCREASE IN NET ASSETS RESULTING
FROM OPERATIONS ............................................................. $ 21,461,317
-------------
-------------
</TABLE>
See notes to financial statements.
38
<PAGE>
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
For the Year Ended September 30,
----------------------------------------------------------------------------
1999 1998
----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
Operations:
Net investment income ........................ $ 36,332,800 $ 35,993,477
Net realized gain on investments ............. 4,763,524 2,862,505
Decrease in unrealized
appreciation of investments ................ (19,635,007) (9,176,172)
------------- -------------
Increase in net assets resulting
from operations .............................. $ 21,461,317 $ 29,679,810
Distributions to shareholders from:
Net investment income ........................ $ (37,467,415) $ (33,893,211)
Net realized capital gains ................... (3,215,415) (40,682,830) (1,183,945) (35,077,156)
------------- -------------
Capital Stock transactions:
Proceeds from Capital Stock sold ............. $ 127,033,525 $ 236,277,210
Proceeds from shares issued to
shareholders upon reinvestment
of dividends and distributions ............. 35,025,699 30,352,091
Cost of Capital Stock repurchased ............ (227,450,554) (65,391,330) (175,059,444) 91,569,857
------------- ------------- ------------ -------------
Total increase (decrease) in net assets ........ $ (84,612,843) $ 86,172,511
NET ASSETS
Beginning of year, including
undistributed net investment income
of $10,397,583 and $8,297,317 ................ 615,746,328 529,573,817
------------- -------------
End of year, including
undistributed net investment income
of $9,262,968 and $10,397,583 ................ $ 531,133,485 $ 615,746,328
------------- -------------
------------- -------------
CHANGE IN CAPITAL STOCK
OUTSTANDING
Shares of Capital Stock sold ................... 11,732,265 21,199,452
Shares issued to shareholders
upon reinvestment of dividends
and distributions ............................ 3,253,664 2,740,769
Shares of Capital Stock repurchased ............ (20,998,240) (15,730,014)
------------- -------------
Increase (decrease) in Capital Stock
outstanding .................................. (6,012,311) 8,210,207
------------- -------------
------------- -------------
</TABLE>
See notes to financial statements.
39
<PAGE>
NOTES TO FINANCIAL STATEMENTS
September 30, 1999
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 Fund's investment
objective is to seek current income and long-term total return. The following is
a summary of significant accounting policies consistently followed by the Fund
in the prepara- tion 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. Securities for which market quotations are not
readily available are valued at fair value as determined in good faith by, or
under the direction of, the Board of Directors.
B. Federal Income Tax
No provision for federal income tax is required because the Fund has
elected to be taxed as a "regulated investment company" under the Internal
Revenue Code and intends to maintain this qualification and to distribute each
year to its shareholders, in accordance with the minimum distribution
requirements of the Code, all of its taxable net investment income and taxable
net realized gains on investments.
C. Securities Transactions and Related Investment Income
Securities transactions are accounted for on the date the securities are
purchased or sold. Dividend income and distributions to shareholders are
recorded on the ex-dividend date. Interest income and expenses are recorded on
an accrual basis.
D. Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported. Actual results could differ from
these estimates.
NOTE 2 -- PURCHASES OF INVESTMENT SECURITIES
Cost of purchases of investment securities (excluding short-term
investments with maturities of 60 days or less) aggregated $173,518,631 for the
year ended September 30, 1999. Realized gains or losses are based on the
specific-certificate identification method. Cost of investment securities owned
at September 30, 1999 was the same for federal income tax and financial
reporting purposes. Gross unrealized appreciation and depreciation for all
securities at September 30, 1999 for federal income tax purposes was $1,978,029
and $16,295,812, respectively.
NOTE 3 -- ADVISORY FEES AND OTHER AFFILIATED TRANSACTIONS
Pursuant to an Investment Advisory Agreement, advisory fees were paid by
the Fund to First Pacific Advisors, Inc. (the "Adviser"). Under the terms of
this Agreement, the Fund pays the Adviser a monthly fee calculated at the annual
rate of 0.5% 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.
40
<PAGE>
NOTES TO FINANCIAL STATEMENTS
September 30, 1999
For the year ended September 30, 1999, the Fund paid aggregate fees of
$35,584 to all Directors who are not affiliated persons of the Adviser. Legal
fees were for services rendered by O'Melveny & Myers LLP, counsel for the Fund.
A Director of the Fund is of counsel to, and a retired partner of, that firm.
Certain officers of the Fund are also officers of the Adviser and FPA Fund
Distributors, Inc.
NOTE 4 -- DISTRIBUTOR
For the year ended September 30, 1999, FPA Fund Distributors, Inc.
("Distributor"), a wholly owned subsidiary of the Adviser, received $70,027 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, 1999, the Board of Directors declared a dividend from net
investment income of $0.17 per share payable October 7, 1999 to shareholders of
record on September 30, 1999. For financial statement purposes, this dividend
and distribution was recorded on the ex-dividend date, October 1, 1999.
41
<PAGE>
REPORT OF 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. (the "Fund"), including the portfolio of investments, as of
September 30, 1999, the related statement of operations for the year then ended,
the statement of changes in net assets for each of the two years in the period
then ended, and the financial highlights on page 20 of the Prospectus for each
of the five years in the period then ended. These financial statements and
financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements and financial highlights, including confirmation of securities owned
as of September 30, 1999 by correspondence with the custodian and brokers. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of FPA
New Income, Inc. at September 30, 1999, the results of its operations for the
year then ended, the changes in its net assets for each of the two years in the
period then ended, and the financial highlights on page 20 of the Prospectus,
for each of the five years in the period then ended in conformity with generally
accepted accounting principles.
/s/ ERNST & YOUNG LLP
ERNST & YOUNG LLP
Los Angeles, California
November 12, 1999
42
