-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IFfeXncZ95KGvB+xHZN1oixBsqcUKtms7+YUu5gkmON10+lHo+8gmkr3H4zOTl54 jhis6pALUgE9lcPAlJphNQ== 0000950156-98-000217.txt : 19980309 0000950156-98-000217.hdr.sgml : 19980309 ACCESSION NUMBER: 0000950156-98-000217 CONFORMED SUBMISSION TYPE: N-30D PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980306 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: NEW ENGLAND FUNDS TRUST II CENTRAL INDEX KEY: 0000052136 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 041990692 STATE OF INCORPORATION: MA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: N-30D SEC ACT: SEC FILE NUMBER: 811-00242 FILM NUMBER: 98558590 BUSINESS ADDRESS: STREET 1: 399 BOYLSTON ST STREET 2: 4TH FLOOR CITY: BOSTON STATE: MA ZIP: 02116 BUSINESS PHONE: 8002831155 MAIL ADDRESS: STREET 1: 399 BOYLSTON STREET STREET 2: 4TH FLOOR CITY: BOSTON STATE: MA ZIP: 02116 FORMER COMPANY: FORMER CONFORMED NAME: INVESTMENT TRUST OF BOSTON FUNDS DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: WORLD INVESTMENT TRUST DATE OF NAME CHANGE: 19680529 N-30D 1 NEF TRUST II ADJUSTABLE RATE U.S. GOV'T FUND - -------------------------------------------------------------------------------- ANNUAL REPORT - -------------------------------------------------------------------------------- [LOGO] NEW ENGLAND FUNDS(R) Where The Best Minds Meet(R) - -------------------------------------------------------------------------------- New England Adjustable Rate U.S. Government Fund [Graphic Omitted] - ------------------ December 31, 1997 - ------------------ - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- FEBRUARY 1998 - -------------------------------------------------------------------------------- [Photo of Henry L.P. Schmelzer] Dear Shareholder: "Even in 1997 . . . investors saw some sharp, short-term drops, whether they were invested in the United States or overseas, in bonds or stocks." In 1997, many investors once again had reason to be pleased with the performance of their mutual fund holdings. However, in times such as these, expectations tend to grow along with prices. It pays to remind ourselves that no trend is permanent, and we should keep our goals realistic and long-term needs in focus. In the third straight year of outstanding returns, the Dow Jones Industrial Average and the Standard & Poor's 500 Stock Index -- two widely followed indicators of the performance of large-company stocks -- gained 24.9% and 33.3% respectively. At the same time, smaller-company stocks, as measured by the Russell 2000 Index, were up 22.4%. Meanwhile, bond investors also were rewarded as declining interest rates and rising prices meant solid gains. The Lehman Long Treasury Index, for example, posted a 15.1% return for the year. Results were less favorable for international investors, especially those exposed to emerging markets or the financial turmoil in Asia. Gratifying though it has been, the markets' surge of the past few years obscures the historic norm: Downturns and volatility also are regular features of investing. Even in 1997, notwithstanding the impressive overall results, investors saw some sharp, short-term drops, whether they were invested in the United States or overseas, in bonds or stocks. Market fluctuations remind us of some valuable lessons. First, volatility is inevitable, and should not disrupt long-term programs without sufficient evaluation. Those who sold in response to downturns -- October 1987 is an obvious example -- may have missed out on the subsequent uptrend. Second, sound diversification can reduce risk. A useful exercise is to review your asset allocation regularly with your financial representative. Starting in 1998, you have one more reason to consult with your representative: Newly expanded retirement options, including the new Roth IRA, could play an important role in your retirement and tax planning for years to come. With this in mind, New England Funds has introduced programs specially designed to help you make the most of the newest retirement vehicles. [Dalbar logo] 1995 o 1996 o 1997 In addition to offering quality mutual fund choices and tax-advantaged plans, we focus on providing the highest quality customer service. This is why I am pleased to report that we have received DALBAR's Mutual Fund Service Award for "providing the highest tier of service excellence in the mutual fund industry." New England Funds is one of just three mutual fund companies to receive this award for the third consecutive year from DALBAR, an independent evaluator of mutual fund service. We are continuing to work to provide even more effective services. Two examples are: the Personal Access Line(TM) -- our enhanced automated telephone account service (800-346-5984) -- and the account information section of the New England Funds web site (www.mutualfunds.com). Each provides convenient, 24-hour access to current information about your New England Funds accounts. All of us at New England Funds thank you for your continued support and look forward to serving you in the years ahead. Sincerely, /s/ Henry L.P. Schmelzer Henry L.P. Schmelzer President - -------------------------------------------------------------------------------- NEW ENGLAND ADJUSTABLE RATE U.S. GOVERNMENT FUND - -------------------------------------------------------------------------------- INVESTMENT RESULTS THROUGH DECEMBER 31, 1997 - -------------------------------------------------------------------------------- Putting Performance in Perspective The charts comparing your Fund's performance to a benchmark index provide you with a general sense of how your Fund performed. To put this information in context, it may be helpful to understand the special differences between the two. Your Fund's total return for the period shown appears with and without sales charges and includes Fund expenses and management fees. A securities index measures the performance of a theoretical portfolio. Unlike a fund, the index is unmanaged; there are no expenses that affect the results. In addition, few investors could purchase all of the securities necessary to match the index. And, if they could, they would incur transaction costs and other expenses. [A chart in the form of a line graph appears here illustratng a $10,000 investment in the Fund compared to the Lehman Adjustable Rate Mortgage Index and the Cost of Living since 12/31/91. The data for this chart are as follows:] - -------------------------------------------------------------------------------- GROWTH OF A $10,000 INVESTMENT IN CLASS A SHARES - -------------------------------------------------------------------------------- DECEMBER 1991 THROUGH DECEMBER 1997 Compared to Lehman Adjustable Rate Mortgage (ARM) Index(4) and the Cost of Living(5) Net With Maximum Lehman ARM(4) Cost Asset Sales (index extablished of Value(1) Charge(2) 12/31/91) Living(5) - -------------------------------------------------------------------------------- 12/31/91 $10,000 $ 9,900 $10,000 $10,000 1992 $10,494 $10,389 $10,502 $10,290 1993 $10,916 $10,807 $11,131 $10,573 1994 $11,000 $10,890 $11,132 $10,855 1995 $11,948 $11,829 $12,437 $11,131 1996 $12,645 $12,518 $13,263 $11,501 1997 $13,430 $13,296 $14,142 $11,711 This illustration represents past performance of Class A shares and cannot predict future results. Investment return and principal value may vary, resulting in a gain or loss on the sale of shares. Class B and Class C share performance will be greater or less than that shown based on differences in inception date, fees and sales charges. All Index and Fund performance assumes reinvested distributions. - -------------------------------------------------------------------------------- NEW ENGLAND ADJUSTABLE RATE U.S. GOVERNMENT FUND - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS 12/31/97 - -------------------------------------------------------------------------------- CLASS A (Inception 10/18/91) 1 YEAR 5 YEARS SINCE INCEPTION Net Asset Value(1) 6.21% 5.06% 5.07% With Max. Sales Charge(2) 5.21 4.83 4.89 Lehman ARM Index(4) 6.63 6.07 N/A Lipper ARM Average(6) 6.07 4.90 4.82 (calculated from 10/31/91) CLASS B (Inception 9/13/93) 1 YEAR 3 YEARS SINCE INCEPTION Net Asset Value(1) 5.42% 6.03% 4.17% With CDSC(3) 0.42 5.14 3.77 Lehman ARM Index(4) 6.63 8.27 5.94 (calculated from 9/30/93) Lipper ARM Average(6) 6.07 6.75 4.83 (calculated from 9/30/93) These returns represent past performance. Investment return and principal value will fluctuate so that shares, upon redemption, may be worth more or less than their original cost. NOTES TO CHARTS (1) Net Asset Value (NAV) performance assumes reinvestment of all distributions and does not reflect the payment of a sales charge at the time of purchase. (2) With Maximum Sales Charge performance assumes reinvestment of all distributions and reflects the maximum sales charge of 1% at the time of purchase of Class A shares. (3) With Contingent Deferred Sales Charge (CDSC) performance assumes a maximum 5% sales charge is applied to a redemption of Class B shares. The sales charge will decrease over time, declining to zero six years after the purchase of shares. (4) Lehman Adjustable Rate Mortgage (ARM) Index is an unmanaged index of adjustable rate mortgages of short to intermediate maturities. The Index performance has not been adjusted for ongoing management, distribution and operating expenses and sales charges applicable to mutual fund investments. (5) Cost of Living is based on the Consumer Price Index, a widely recognized measure of the cost of goods and services in the United States, calculated by the U.S. Bureau of Labor Statistics. (6) Lipper Adjustable Rate Mortgage (ARM) Average is an average of the total return performance (calculated on the basis of net asset value) of funds with similar investment objectives as calculated by Lipper Analytical Services, an independent mutual fund ranking service. - ------------------------------------------------------------------------------- NEW ENGLAND ADJUSTABLE RATE U.S. GOVERNMENT FUND - ------------------------------------------------------------------------------- QUESTIONS & ANSWERS WITH YOUR PORTFOLIO MANAGER - ------------------------------------------------------------------------------- Q. How did New England Adjustable Rate U.S. Government Fund perform over the past 12 months? [Photo of Scott Nicholson Back Bay Advisors, L.P.] The Fund posted competitive returns while demon-strating a high degree of share price stability. For the 12-month period ending December 31, 1997, New England Adjustable Rate U.S. Government Fund's Class A shares generated a total return of 6.21%, reflecting a $0.02 per share gain in net asset value to $7.39 per share and the reinvestment of $0.426 per share in dividend distributions. During the year, the Fund's Class A net asset value remained very stable, fluctuating between $7.36 and $7.42. For the same period, Class B shares produced a total return of 5.42%, based on net asset value. Q. What was the environment like for adjustable rate mortgage securities (ARMS)? Favorable -- for most of 1997. But recently, condi-tions for ARMS have deteriorated markedly. The combination of declining long-term interest rates and a substantial flattening of the yield curve -- that is, a significant decline in long-term rates compared to relatively stable short-term rates -- fostered a dramatic increase in ARMS prepayment activity. Prepayments occur when owners of the underlying mortgages pay off their mortgages -- typically to lower their borrowing costs -- and refinance at lower prevailing interest rates. Rising levels of prepayments tend to lower the market value of ARMS. In the first quarter of 1997, bond investors pushed up long-term interest rates, concerned that strong economic growth might cause inflationary pressures to escalate, eroding bond values. The Federal Reserve Board, in fact, raised the federal funds rate -- the rate at which banks lend to each other overnight -- by one-quarter of a percentage point in March. Yet the rise was short-lived as both short- and long-term interest rates soon fell below their levels at the start of 1997. Signs of slower economic growth, a shrinking federal budget deficit, strong foreign demand for U.S. securities and, most significantly, continued low inflation fueled the decline in rates. The yield gap between long- and short-term bonds narrowed as yields on longer-maturity bonds continued to drop sharply through the second half of the year. While the decline in short-term rates was much less pronounced, falling long-term rates caused mortgage prepayments to increase and prices of existing ARMS to drop. Q. How did you manage the Fund amidst these conditions? As interest rates rose early in the year, I shortened the Fund's duration by reducing its holdings in ARMS and increasing its positions in U.S. Treasuries and cash. (Expressed in years, duration measures a portfolio's sensitivity to interest rate changes.) A shorter duration enhanced the Fund's price stability by reducing its sensitivity to changes in interest rates. During the second half of the year, I concentrated on managing exposure to prepayments while taking steps to capture additional income as a way to offset the prepayment-related decline in the Fund's income earnings stream. For example, I reduced holdings in ARMS somewhat while changing the composition of the holdings to include older ARMS and GNMA (Government National Mortgage Association) ARMS. These securities have demonstrated a resiliency to prepayments during past periods of declining interest rates. To boost income, I increased investments in U.S. agency callable notes, which have typically offered higher coupons -- or fixed rates of interest -- than U.S. Treasury securities with similar maturities. The yield advantage of callable issues is intended to compensate investors for the possibility that these issues can be called -- that is, redeemed -- before their maturity dates. Finally, I moderately extended the average maturity of U.S. Treasury note holdings to pursue price gains fostered by declining interest rates. When interest rates decline, the prices of bonds with longer maturities tend to rise more than those with shorter maturities. As always, the Fund invests in the most creditworthy securities available and continues to carry the highest Standard & Poor's rating for mutual funds -- AAAf. Q. What is your outlook for ARMS? We remain cautious; the recent interest rate pattern, characterized by sharper declines in long-term rates than in short-term rates, could keep prepayment activity at elevated levels. While prices of ARMS have dropped significantly, they may have further to go before their values look better than other securities with similar durations. On the other hand, the lack of new supply is working in favor of ARMS. The popularity of fixed rate mortgages, a consequence of falling interest rates, is curbing new issuance of ARMS and thereby helping to support ARMS prices. Looking ahead, the lingering effects of Asia's financial difficulties could restrain economic growth in the United States. In the event of a substantial slowdown, the Federal Reserve Board probably will lower short-term interest rates. But, if the Asian influence proves negligible and the Federal Reserve leaves interest rates unchanged, long-term interest rates could rise and widen the gap between long-term and short-term interest rates. In either case, however, the overall attractiveness of ARMS stands to improve. - -------------------------------------------------------------------------------- PORTFOLIO COMPOSITION - -------------------------------------------------------------------------------- Investments as of December 31, 1997 BONDS AND NOTES--95.9% OF TOTAL NET ASSETS
FACE AMOUNT DESCRIPTION VALUE (a) - --------------------------------------------------------------------------------------- GOVERNMENT AGENCIES (c)--81.1% $ 5,000,000 Federal Farm Credit Bank Consolidated, 6.400%, 10/02/00 $ 4,996,100 1,694,213 Federal Home Loan Mortgage Corp., 6.592%, 11/01/35 (d) . 1,754,577 4,087,036 Federal Home Loan Mortgage Corp., 7.244%, 1/01/25, (d) . 4,215,410 1,655,627 Federal Home Loan Mortgage Corp., 7.303%, 4/01/22, (d) . 1,696,505 4,666,715 Federal Home Loan Mortgage Corp., 7.411%, 1/01/20, (d) . 4,848,997 1,273,924 Federal Home Loan Mortgage Corp., 7.625%, 10/01/21, (d) 1,328,868 2,309,005 Federal Home Loan Mortgage Corp., 7.661%, 3/01/25, (d) . 2,358,440 2,714,393 Federal Home Loan Mortgage Corp., 7.680%, 5/01/19, (d) . 2,821,693 2,037,412 Federal Home Loan Mortgage Corp., 7.701%, 1/01/23, (d) . 2,130,053 3,058,175 Federal Home Loan Mortgage Corp., 7.707%, 7/01/26, (d) . 3,134,629 6,864,678 Federal Home Loan Mortgage Corp., 7.725%, with various maturities to 2/01/22, (d) ........................... 7,186,451 1,288,906 Federal Home Loan Mortgage Corp., 7.734%, 6/01/22, (d) . 1,344,290 4,549,128 Federal Home Loan Mortgage Corp., 7.839%, 4/01/25, (d) . 4,738,190 1,179,854 Federal Home Loan Mortgage Corp., 7.858%, 6/01/22, (d) . 1,225,939 3,268,323 Federal Home Loan Mortgage Corp., 7.875%, with various maturities to 12/01/22, (d) .......................... 3,399,940 2,499,282 Federal Home Loan Mortgage Corp., 7.876%, 5/01/23, (d) . 2,606,677 2,947,010 Federal Home Loan Mortgage Corp., 7.932%, 10/01/23, (d) 3,040,961 837,093 Federal Home Loan Mortgage Corp., 7.959%, 9/01/22, (d) . 861,418 1,322,063 Federal Home Loan Mortgage Corp., 7.984%, 12/01/25, (d) 1,354,705 4,462,558 Federal Home Loan Mortgage Corp., 7.989%, 9/01/23, (d) . 4,633,385 3,974,274 Federal Home Loan Mortgage Corp., 7.990%, 4/01/29, (d) . 4,115,242 2,851,521 Federal Home Loan Mortgage Corp., 7.995%, 5/01/23, (d) . 2,939,747 1,729,582 Federal Home Loan Mortgage Corp., 8.000%, 8/01/24, (d) . 1,753,363 2,094,600 Federal Home Loan Mortgage Corp., 8.005%, 7/01/25, (d) . 2,148,934 2,116,019 Federal Home Loan Mortgage Corp., 8.057%, 9/01/23, (d) . 2,191,413 4,689,674 Federal Home Loan Mortgage Corp., 6.698%, 10/15/23, (d)(e) ................................................ 4,718,984 450,469 Federal National Mortgage Association, 5.941%, 9/01/23, (d) .................................................. 445,050 5,000,000 Federal National Mortgage Association, 6.100%, 10/06/00 5,004,700 1,860,839 Federal National Mortgage Association, 6.360%, 7/01/19, (d) .................................................. 1,875,372 5,000,000 Federal National Mortgage Association, 6.540%, 9/08/00 . 5,009,350 458,770 Federal National Mortgage Association, 6.597%, 6/01/19, (d) .................................................. 464,646 2,941,827 Federal National Mortgage Association, 6.602%, 7/01/27, (d) .................................................. 2,992,838 1,289,764 Federal National Mortgage Association, 6.716%, 1/01/20, (d) .................................................. 1,310,517 3,905,932 Federal National Mortgage Association, 7.000%, 4/01/26, (d) .................................................. 3,999,908 423,575 Federal National Mortgage Association, 7.557%, 5/01/20, (d) .................................................. 438,069 302,569 Federal National Mortgage Association, 7.600%, 8/01/17, (d) .................................................. 313,159 2,092,714 Federal National Mortgage Association, 7.652%, 4/01/23, (d) .................................................. 2,170,207 3,493,142 Federal National Mortgage Association, 7.659%, 7/01/24, (d) .................................................. 3,624,694 1,194,448 Federal National Mortgage Association, 7.667%, 5/01/22, (d) .................................................. 1,238,118 3,621,113 Federal National Mortgage Association, 7.700%, 4/01/24, (d) .................................................. 3,768,782 2,469,251 Federal National Mortgage Association, 7.714%, 11/01/20, (d) .................................................. 2,589,627 6,102,950 Federal National Mortgage Association, 7.750%, 10/01/18, (d) .................................................. 6,435,743 2,310,308 Federal National Mortgage Association, 7.751%, 5/01/25, (d) .................................................. 2,360,119 2,268,853 Federal National Mortgage Association, 7.797%, 11/01/25, (d) .................................................. 2,313,164 2,993,074 Federal National Mortgage Association, 7.817%, 9/01/25, (d) .................................................. 3,077,718 1,178,176 Federal National Mortgage Association, 7.850%, 7/01/17, (d) .................................................. 1,228,802 3,166,068 Federal National Mortgage Association, 7.855%, 6/01/22, (d) .................................................. 3,294,706 1,163,662 Federal National Mortgage Association, 7.956%, 7/01/23, (d) .................................................. 1,194,569 2,176,140 Federal National Mortgage Association, 7.978%, 1/01/24, (d) .................................................. 2,286,644 10,057,932 Government National Mortgage Association, 7.000%, with various maturities to 8/20/25, (d) ................... 10,321,584 16,355,286 Government National Mortgage Association, 7.375%, with various maturities to 6/20/23, (d) ................... 16,863,768 ------------ 162,166,765 ------------ U.S. GOVERNMENT--14.8% 2,500,000 United States Treasury Note, 5.875%, 1/31/99 ........... 2,505,850 10,000,000 United States Treasury Note, 6.000%, 8/15/00 ........... 10,071,900 5,000,000 United States Treasury Note, 6.250%, 6/30/98 ........... 5,018,750 11,700,000 United States Treasury Note, 6.375%, 5/15/00 ........... 11,875,500 ------------ 29,472,000 ------------ Total Bonds and Notes (Identified Cost $190,509,353) ... 191,638,765 ------------ SHORT TERM INVESTMENT--2.1% - --------------------------------------------------------------------------------------- 4,200,000 Repurchase Agreement with Merrill Lynch & Co. dated 12/ 31/97 at 6.50% to be repurchased at $4,201,517 on 1/ 02/98. Collateralized by $4,185,000 U.S. Treasury Note 5.875% due 8/15/98 valued at $4,284,394 .............. 4,200,000 ------------ Total Short Term Investment (Identified Cost $4,200,000) 4,200,000 ------------ Total Investments--98.0% (Identified Cost $194,709,353), (b) ................................... 195,838,765 Other assets less liabilities ......................... 4,049,735 ------------ Total Net Assets--100% ................................. $199,888,500 ============ (a) See Note 1a to the financial statements. (b) Federal Tax Information: At December 31, 1997 the net unrealized appreciation on investments based on cost for federal income tax purposes of $194,709,353 was as follows: Aggregate gross unrealized appreciation for all investments in which there is an excess of value over tax cost ................... $ 1,435,961 Aggregate gross unrealized depreciation for all investments in which there is an excess of tax cost over value ................... (306,549) ------------ Net unrealized appreciation ........................................ $ 1,129,412 ============ At December 31, 1997 the Fund had a capital loss carryover of approximately $14,291,537 of which $5,625,994 expires on December 31, 2002, $6,075,626 expires on December 31, 2003, $2,134,629 expires on December 31, 2004 and $455,288 expires on December 31, 2005. This may be available to offset future realized capital gains, if any, to the extent provided by regulations. (c) The Fund's investments in mortgage backed securities of the Government National Mortgage Association, Federal Home Loan Mortgage Corporation and Federal National Mortgage Association are interests in separate pools of mortgages. All separate investments in securities of these issues which have the same coupon rate have been aggregated for the purpose of presentation in the schedule of investments. (d) Variable rate mortgage backed securities. The interest rates change on these instruments monthly based on changes in a designated base rate. The rates shown were those in effect at December 31, 1997. (e) Collateralized mortgage obligation.
See accompanying notes to financial statements. - -------------------------------------------------------------------------------- STATEMENT OF ASSETS & LIABILITIES - -------------------------------------------------------------------------------- December 31, 1997
ASSETS Investments at value ....................................... $195,838,765 Cash ....................................................... 113,852 Receivable for: Fund shares sold ......................................... 143,702 Securities sold .......................................... 157,354 Accrued interest ......................................... 5,039,566 Prepaid registration expense ............................... 7,000 ------------ 201,300,239 LIABILITIES Payable for: Fund shares redeemed ..................................... $989,456 Dividends declared ....................................... 163,012 Accrued expenses: Management fees .......................................... 174,802 Deferred trustees' fees .................................. 9,979 Accounting and administrative ............................ 3,607 Other .................................................... 70,883 --------- 1,411,739 ------------ NET ASSETS ................................................... $199,888,500 ============ Net Assets consist of: Capital paid in .......................................... $213,879,946 Distributions in excess of net investment income ......... (14,193) Accumulated net realized losses .......................... (15,106,665) Unrealized appreciation on investments ................... 1,129,412 ------------ NET ASSETS ................................................... $199,888,500 ============ Computation of net asset value and offering price: Net asset value and redemption price of Class A shares ($196,927,679 divided by 26,658,838 shares of beneficial interest) ................................................ $7.39 ===== Offering price per share (100/99 OF $7.39) ................... $7.46* ===== Net asset value and offering price of Class B shares ($2,960,821 divided by 400,964 shares of beneficial interest) .................................................. $7.38** ===== Identified cost of investments ............................... $194,709,353 ============ * Based upon single purchases of less than $1,000,000. Reduced sales charges apply for purchases in excess of this amount. **Redemption price per share is equal to net asset value less any applicable contingent deferred sales charges.
See accompanying notes to financial statements. - -------------------------------------------------------------------------------- STATEMENT OF OPERATIONS - -------------------------------------------------------------------------------- Year Ended December 31, 1997 INVESTMENT INCOME Interest ........................................ $15,716,868 Expenses Management fees ............................... $1,230,235 Service fees - Class A ........................ 556,721 Service and distribution fees - Class B ....... 28,482 Trustees' fees and expenses ................... 21,605 Accounting and administrative ................. 44,817 Custodian ..................................... 100,855 Transfer agent ................................ 133,398 Audit and tax services ........................ 31,070 Legal ......................................... 10,779 Printing ...................................... 23,513 Registration .................................. 32,328 Miscellaneous ................................. 11,607 Total expenses .................................. 2,225,410 ---------- Less fees waived by the investment adviser and subadviser ............................... (625,387) 1,600,023 ---------- ----------- Net investment income ........................... 14,116,845 REALIZED and UNREALIZED GAIN (LOSS) on INVESTMENTS Realized loss on: Investments - net ............................. (2,347,087) Unrealized appreciation on: Investments - net ............................. 1,792,855 ---------- Net loss on investment transactions ............. (554,232) ----------- NET INCREASE IN NET ASSETS FROM OPERATIONS ........ $13,562,613 =========== See accompanying notes to financial statements. - -------------------------------------------------------------------------------- STATEMENT OF CHANGES IN NET ASSETS - -------------------------------------------------------------------------------- YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, 1996 1997 ------------ ------------ FROM OPERATIONS Net investment income .................... $ 18,670,885 $ 14,116,845 Net realized loss on investments ......... (3,076,747) (2,347,087) Unrealized appreciation on investments ... 568,620 1,792,855 ------------ ------------ Increase in net assets from operations ... 16,162,758 13,562,613 ------------ ------------ FROM DISTRIBUTIONS TO SHAREHOLDERS Net investment income Class A ................................ (16,446,055) (12,791,602) Class B ................................ (127,062) (142,367) ------------ ------------ (16,573,117) (12,933,969) ------------ ------------ Decrease in net assets derived from capital share transactions ............... (107,440,637) (26,369,546) ------------ ------------ Total decrease in net assets ............... (107,850,996) (25,740,902) NET ASSETS Beginning of the year .................... 333,480,398 225,629,402 ------------ ------------ End of the year .......................... $225,629,402 $199,888,500 ============ ============ UNDISTRIBUTED (DISTRIBUTIONS IN EXCESS OF) NET INVESTMENT INCOME Beginning of the year .................... $ (204,379) $ 27,231 ============ ============ End of the year .......................... $ 27,231 $ (14,193) ============ ============ See accompanying notes to financial statements. - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS - --------------------------------------------------------------------------------
CLASS A -------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, -------------------------------------------------------------------------- 1993 1994 1995 1996 1997 ------ ------ ------ ------ ------ Net Asset Value, Beginning of Year ........ $ 7.46 $ 7.45 $ 7.20 $ 7.37 $ 7.37 ------ ------ ------ ------ ------ Income From Investment Operations Net Investment Income ..................... 0.33 0.37 0.47 0.43 0.47(c) Net Realized and Unrealized Gain (Loss) on Investments ............................. (0.03) (0.31) 0.14 (0.01) (0.02) ------ ------ ------ ------ ------ Total From Investment Operations .......... 0.30 0.06 0.61 0.42 0.45 ------ ------ ------ ------ ------ Less Distributions Distributions From Net Investment Income .. (0.31) (0.31) (0.44) (0.42) (0.43) ------ ------ ------ ------ ------ Total Distributions ....................... (0.31) (0.31) (0.44) (0.42) (0.43) ------ ------ ------ ------ ------ Net Asset Value, End of Year .............. $ 7.45 $ 7.20 $ 7.37 $ 7.37 $ 7.39 ====== ====== ====== ====== ====== Total Return (%)(b) ....................... 4.0 0.8 8.6 5.8 6.2 Ratio of Operating Expenses to Average Net Assets (%)(a) ........................... 0.60 0.60 0.66 0.70 0.70 Ratio of Net Investment Income to Average Net Assets (%) .......................... 4.39 4.85 6.29 6.39 6.27 Portfolio Turnover Rate (%) ............... 54 17 73 54 49 Net Assets, End of Year (000) ............. $734,251 $489,637 $331,112 $222,809 $196,928 (a) The ratio of operating expenses to average net assets without giving effect to voluntary expense limitations described in Note 4 to the Financial Statements would have been (%) ........ 0.86 0.88 0.89 0.94 0.98 (b) A sales charge is not reflected in total return calculations. (c) Per share net investment income does not reflect the periods reclassification of permanent differences between book and tax basis net investment income. See note 1d to the financial statements.
See accompanying notes to financial statements. - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS -- continued - --------------------------------------------------------------------------------
CLASS B --------------------------------------------------------------------------------- SEPTEMBER 13(a) THROUGH YEAR ENDED DECEMBER 31, DECEMBER 31, ---------------------------------------------------------- 1993 1994 1995 1996 1997 -------------- ------ ------ ------ ------ Net Asset Value, Beginning of Period ....................... $ 7.52 $ 7.45 $ 7.20 $ 7.37 $ 7.36 ------ ------ ------ ------ ------ Income From Investment Operations Net Investment Income .......... 0.08 0.29 0.41 0.37 0.41(e) Net Realized and Unrealized Gain (Loss) on Investments ........ (0.08) (0.29) 0.14 (0.02) (0.02) ------ ------ ------ ------ ------ Total From Investment Operations 0.00 0.00 0.55 0.35 0.39 ------ ------ ------ ------ ------ Less Distributions Distributions From Net Investment Income ............ (0.07) (0.25) (0.38) (0.36) (0.37) ------ ------ ------ ------ ------ Total Distributions ............ (0.07) (0.25) (0.38) (0.36) (0.37) ------ ------ ------ ------ ------ Net Asset Value, End of Period . $ 7.45 $ 7.20 $ 7.37 $ 7.36 $ 7.38 ====== ====== ====== ====== ====== Total Return (%)(d) ............ 0.0 0.1 7.8 4.9 5.4 Ratio of Operating Expenses to Average Net Assets (%)(b) .... 1.35(c) 1.35 1.41 1.45 1.45 Ratio of Net Investment Income to Average Net Assets (%) .... 3.50(c) 4.10 5.54 5.64 5.52 Portfolio Turnover Rate (%) .... 54(c) 17 73 54 49 Net Assets, End of Period (000) $855 $2,056 $2,368 $2,821 $2,961 (a) Commencement of operations. (b) The ratio of operating expenses to average net assets without giving effect to voluntary expense limitations described in Note 4 to the Financial Statements would have been (%) ........................ 1.61 1.63 1.65 1.69 1.73 (c) Computed on an annualized basis. (d) A contingent deferred sales charge is not reflected in total return calculations. Periods less than one year are not annualized. (e) Per share net investment income does not reflect the periods reclassification of permanent differences between book and tax basis net investment income. See note 1d to the financial statements.
See accompanying notes to financial statements. - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- December 31, 1997 1. The Fund is a series of New England Funds Trust II, a Massachusetts business trust (the "Trust"), and is registered under the Investment Company Act of 1940, as amended (the "1940 Act"), as an open-end management investment company. The Declaration of Trust permits the trustees to issue an unlimited number of shares of the Trust in multiple series (each series of shares a "Fund"). The Fund offers both Class A and Class B shares. The Fund commenced its public offering of Class A Shares on October 18, 1991 and Class B shares on September 13, 1993. Class A shares are sold with a maximum front end sales charge of 1.00%. Class B shares do not pay a front end sales charge, but pay a higher ongoing distribution fee than Class A shares for eight years (at which point they automatically convert to Class A shares), and are subject to a contingent deferred sales charge if those shares are redeemed within six years of purchase (or five years if purchased before May 1, 1997). Expenses of the Fund are borne pro-rata by the holders of both classes of shares, except that each class bears expenses unique to that class (including the Rule 12b-1 service and distribution fees applicable to such class), and votes as a class only with respect to its own Rule 12b-1 Plan. Shares of each class would receive their pro-rata share of the net assets of the Fund, if the Fund were liquidated. In addition, the trustees approve separate dividends on each class of shares. The following is a summary of significant accounting policies consistently followed by the Fund in the preparation of its financial statements. The policies are in conformity with generally accepted accounting principles for investment companies. The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts and disclosures in the financial statements. Actual results could differ from those estimates. A. SECURITY VALUATION. Debt securities (other than short-term obligations with a remaining maturity of less than sixty days) are valued on the basis of valuations furnished by a pricing service, selected by the Fund's adviser as authorized by the Board of Trustees, which service determines valuations for normal, institutional-size trading units of such securities using market information, transactions for comparable securities and various relationships between securities which are generally recognized by institutional traders. Short-term obligations with a remaining maturity of less than sixty days are stated at amortized cost, which approximates value. All other securities and assets are valued at their fair value as determined in good faith by the Fund's adviser, New England Funds Management, L.P., and the subadviser, under the supervision of the Fund's trustees. B. SECURITY TRANSACTIONS AND RELATED INCOME. Security transactions are accounted for on the trade date (the date the buy or sell is executed). Interest income is recorded on the accrual basis. Interest income is increased by the accretion of discount. In determining net gain or loss on securities sold, the cost of securities has been determined on the identified cost basis. C. FEDERAL INCOME TAXES. The Fund intends to meet the requirements of the Internal Revenue Code applicable to regulated investment companies, and to distribute to its shareholders all of its income and any net realized capital gains at least annually. Accordingly, no provision for federal income tax has been made. D. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS. Dividends are declared daily to shareholders of record at the time and are paid monthly. The timing and characterization of certain income and capital gains distributions are determined in accordance with federal tax regulations which may differ from generally accepted accounting principles. These differences relate primarily to differing treatments for income recognition for mortgage- backed securities. Permanent book and tax basis differences relating to shareholder distributions will result in reclassification to paid in capital. E. REPURCHASE AGREEMENTS. The Fund, through its custodian, receives delivery of the underlying securities collateralizing repurchase agreements. It is the Fund's policy that the market value of the collateral be at least equal to 100% of the repurchase price. The Fund's subadviser is responsible for determining that the value of the collateral is at all times at least equal to the repurchase price. Repurchase agreements could involve certain risks in the event of default or insolvency of the other party including possible delays or restrictions upon the Fund's ability to dispose of the underlying securities. 2. PURCHASE AND SALES OF SECURITIES (excluding short-term investments) for the Fund for the year ended December 31, 1997 were as follows: PURCHASES SALES --------------- --------------- U.S. GOVERNMENT U.S. GOVERNMENT --------------- --------------- $116,297,994 $144,285,369 3A. MANAGEMENT FEES AND OTHER TRANSACTIONS WITH AFFILIATES. The Fund pays management fees to its investment adviser, New England Funds Management, L.P. ("NEFM") at the annual rate of 0.55% of the first $200 million of the Fund's average daily net assets, 0.51% of the next $300 million and 0.47% of such assets in excess of $500 million. NEFM pays the Fund's investment subadviser, Back Bay Advisors L.P. ("Back Bay Advisors") at the rate of 0.275% of the first $200 million of the Fund's average daily net assets, 0.255% of the next $300 million and 0.235% of such assets in excess of $500 million. Certain officers and directors of NEFM are also officers or trustees of the Fund. NEFM and Back Bay Advisors are wholly owned subsidiaries of New England Investment Companies, L.P. ("NEIC"), which is a subsidiary of Metropolitan Life Insurance Company ("MetLife"). Fees earned by NEFM and Back Bay Advisors under the management agreement in effect during the year ended December 31, 1997 are as follows: FEES EARNED(a) - -------------- $615,118 New England Funds Management $615,117 Back Bay Advisors (a) Before reduction pursuant to voluntary expense limitations. See Note 4. B. ACCOUNTING AND ADMINISTRATIVE EXPENSE. New England Funds L.P. ("New England Funds"), the Fund's distributor, is a wholly owned subsidiary of NEIC and performs certain accounting and administrative services for the Fund. The Fund reimburses New England Funds for all or part of New England Funds' expenses of providing these services which include the following: (i) expenses for personnel performing bookkeeping, accounting, financial reporting functions and clerical functions relating to the Fund, and (ii) expenses for services required in connection with the preparation of registration statements and prospectuses, registration of shares in various states, shareholder reports and notices, proxy solicitation material furnished to shareholders of the Fund or regulatory authorities and reports and questionnaires for SEC compliance. For the year ended December 31, 1997 these expenses amounted to $44,817 and are shown separately in the financial statements as accounting and administrative. C. SERVICE AND DISTRIBUTION EXPENSE. Pursuant to Rule 12b-1 under the 1940 Act, the Trust has adopted a Service Plan relating to the Fund's Class A shares (the "Class A Plan") and a Service and Distribution Plan relating to the Fund's Class B shares (the "Class B Plan"). Under the Class A Plan, the Fund pays New England Funds a monthly service fee at the annual rate of up to 0.25% of the average daily net assets attributable to the Fund's Class A shares, as reimbursement for expenses (including certain payments to securities dealers, who may be affiliated with New England Funds) incurred by New England Funds in providing personal services to investors in Class A shares and/or the maintenance of shareholder accounts. For the year ended December 31, 1997, the Fund paid New England Funds $556,721 in fees under the Class A Plan. If the expenses of New England Funds that are otherwise reimbursable under the Class A Plan incurred in any year exceed the amounts payable by the Fund under the Class A Plan, the unreimbursed amount (together with unreimbursed amounts from prior years) may be carried forward for reimbursement in future years in which the Class A Plan remains in effect. The amount of unreimbursed expenses carried forward into 1998 is $1,929,283. Under the Class B Plan, the Fund pays New England Funds a monthly service fee at the annual rate of up to 0.25% of the average daily net assets attributable to the Fund's Class B shares, as compensation for services provided and expenses (including certain payments to securities dealers, who may be affiliated with New England Funds) incurred by New England Funds in providing personal services to investors in Class B shares and/or the maintenance of shareholder accounts. For the year ended December 31, 1997, the Fund paid New England Funds $7,121 in service fees under the Class B Plan. Also under the Class B Plan, the Fund pays New England Funds a monthly distribution fee at the annual rate of up to 0.75% of the average daily net assets attributable to the Fund's Class B shares, as compensation for services provided and expenses (including certain payments to securities dealers, who may be affiliated with New England Funds) incurred by New England Funds in connection with the marketing or sale of Class B shares. For the year ended December 31, 1997, the Fund paid New England Funds $21,361 in distribution fees under the Class B Plan. Commissions (including contingent deferred sales charges) on Fund shares paid to New England Funds by investors in shares of the Fund during the year ended December 31, 1997 amounted to $263,142. D. TRANSFER AGENT FEES. New England Funds is the transfer and shareholder servicing agent to the Fund. For the year ended December 31, 1997, the Fund paid New England Funds $94,537 as compensation for its services in that capacity. For the year ended December 31, 1997, the Fund received $4,432 in transfer agent credits. The transfer agent expense in the Statement of Operations is net of these credits. E. TRUSTEES FEES AND EXPENSES. The Fund does not pay any compensation directly to its officers or trustees who are directors, officers or employees of NEFM, New England Funds, NEIC or their affiliates, other than registered investment companies. Each other trustee is compensated by the Fund as follows: Annual Retainer $2,089 Meeting Fee $109/meeting Committee Meeting Fee $65/meeting Committee Chairman Retainer $95/year A deferred compensation plan is available to the trustees on a voluntary basis. Each participating trustee will receive an amount equal to the value that such deferred compensation would have had, had it been invested in the Fund on the normal payment date. 4. EXPENSE LIMITATIONS. Commencing June 1, 1995 and until further notice to the Fund, Back Bay Advisors and NEFM have voluntarily agreed to reduce management fees in order to limit the Fund's expenses to an annual rate of 0.70% of the Fund's Class A average daily net assets and, 1.45% of Class B average daily net assets. From May 1, 1995 through June 1, 1995 expenses were voluntarily limited to 0.65% of Class A average net assets and 1.40% of Class B average net assets. From April 1, 1992 through May 1, 1995 expenses were voluntarily limited to 0.60% of Class A average net assets and 1.35% of Class B average net assets. Prior to April 1, 1992 the Fund's expenses were subject to a 0.50% voluntary expense limitation agreed to by both Back Bay Advisors and New England Funds. As a result of the Fund's expenses exceeding the applicable voluntary expense limitation during the year ended December 31, 1997, Back Bay Advisors reduced its management fee of $615,117 by $312,693 and NEFM reduced its management fee of $615,118 by $312,694. 5. CAPITAL SHARES. At December 31, 1997 there was an unlimited number of shares of beneficial interest authorized, divided into two classes, Class A and Class B capital stock. Transactions in capital shares were as follows:
YEAR ENDED YEAR ENDED DECEMBER 31, 1996 DECEMBER 31, 1997 --------------------------- -------------------------- CLASS A SHARES AMOUNT SHARES AMOUNT - ------- ----------- ------------- ----------- ------------ Shares sold .................... 9,423,564 $ 69,389,156 10,184,271 $ 75,205,511 Shares issued in connection with the reinvestment of: Distributions from net investment income ............ 1,009,552 7,430,124 901,119 6,657,982 ----------- ------------- ----------- ------------ 10,433,116 76,819,280 11,085,390 81,863,493 Shares repurchased ............. (25,080,230) (184,716,449) (14,678,342) (108,373,107) ----------- ------------- ----------- ------------ Net decrease ................... (14,647,114) $(107,897,169) (3,592,952) $(26,509,614) ----------- ------------- ----------- ------------ YEAR ENDED YEAR ENDED DECEMBER 31, 1996 DECEMBER 31, 1997 --------------------------- -------------------------- CLASS B SHARES AMOUNT SHARES AMOUNT ----------- ------------- ----------- ------------ Shares sold .................... 157,929 $ 1,162,842 104,271 $ 777,704 Shares issued in connection with the reinvestment of: Distributions from net investment income ............ 14,541 107,004 17,276 127,549 ----------- ------------- ----------- ------------ 172,470 1,269,846 121,547 905,253 Shares repurchased ............. (110,554) (813,314) (103,688) (765,185) ----------- ------------- ----------- ------------ Net increase ................... 61,916 456,532 17,859 140,068 ----------- ------------- ----------- ------------ Decrease derived from capital shares transactions .......... (14,585,198) $(107,440,637) (3,575,093) $(26,369,546) =========== ============= ========== ============
- ------------------------------------------------------------------------------- New England Funds, L.P., Distributor 399 Boylston Street Boston, MA 02116 Toll Free 800-225-5478 This material is authorized for distribution to prospective investors when it is preceded or accompanied by the Fund's current prospectus, which contains information about distribution charges, management and other items of interest. Investors are advised to read the prospectus carefully before investing. - ------------------------------------------------------------------------------- REPORT OF INDEPENDENT ACCOUNTANTS - ------------------------------------------------------------------------------- To the Trustees of New England Funds Trust II and Shareholders of NEW ENGLAND ADJUSTABLE RATE U.S. GOVERNMENT FUND In our opinion, the accompanying statement of assets & liabilities, including the portfolio composition, and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of New England Adjustable Rate U.S. Government Fund ("the Fund"), a series of New England Funds Trust II, at December 31, 1997, and the results of its operations, the changes in its net assets and the financial highlights for the year then ended, in conformity with generally accepted accounting principles. These financial statements and the financial highlights (hereafter referred to as "financial statements") are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these financial statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit, which included confirmation of securities owned at December 31, 1997 by correspondence with the custodian and brokers and the application of alternative auditing procedures where confirmations from brokers were not received, provides a reasonable basis for the opinion expressed above. The statement of changes in net assets for the period ended December 31, 1996 and the financial highlights for each of the periods then ended were audited by other independent accountants whose report dated February 10, 1997 expressed an unqualified opinion on those statements. PRICE WATERHOUSE LLP Boston, Massachusetts February 12, 1998 --------------- Bulk Rate U.S. Postage PAID Brockton, MA Permit No. 770 --------------- [LOGO] NEW ENGLAND FUNDS(R) Where The Best Minds Meet(R) - ---------------------- 399 Boylston Street Boston, Massachusetts 02116 - ---------------------- - --------------------- [Logo] MUTUAL FUND SERVICE AWARD - --------------------- DALBAR HONORS COMMITMENT TO: INVESTORS - --------------------- 1995 o 1996 o 1997 AR56-1297 [Recycle Logo] Printed On Recycled Paper -----END PRIVACY-ENHANCED MESSAGE-----