10-Q 1 dff2.txt DIVESIFIED FUTURES FUND 2 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2004 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to__________________ Commission File Number 0-17446 DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. (Exact name of registrant as specified in its charter) Delaware 13-3490286 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) Demeter Management Corporation 330 Madison Avenue, 8th Floor New York, NY 10017 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (212) 905-2700 825 Third Avenue, 9th Floor, New York, NY 10022 (Former name, former address, and former fiscal year, if changed since last report) Indicate by check-mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No___________ Indicate by check-mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No X DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. INDEX TO QUARTERLY REPORT ON FORM 10-Q September 30, 2004
PART I. FINANCIAL INFORMATION Item 1. Financial Statements Statements of Financial Condition as of September 30, 2004 (Unaudited) and December 31, 2003..........................2 Statements of Operations for the Three and Nine Months Ended September 30, 2004 and 2003 (Unaudited)..............3 Statements of Changes in Partners' Capital for the Nine Months Ended September 30, 2004 and 2003 (Unaudited)..4 Statements of Cash Flows for the Nine Months Ended September 30, 2004 and 2003 (Unaudited)....................5 Notes to Financial Statements (Unaudited)...............6-11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......12-24 Item 3. Quantitative and Qualitative Disclosures about Market Risk.........................................25-37 Item 4. Controls and Procedures................................38 PART II. OTHER INFORMATION Item 5. Other Information......................................39 Item 6. Exhibits and Reports on Form 8-K....................39-41
PART I. FINANCIAL INFORMATION Item 1. Financial Statements DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. STATEMENTS OF FINANCIAL CONDITION
September 30, December 31, 2004 2003 $ $ (Unaudited) ASSETS Equity in futures interests trading accounts: Cash 5,432,986 6,963,743 Net unrealized gain on open contracts (MS&Co.) 329,138 225,039 Net unrealized gain (loss) on open contracts (MSIL) (10,389) 151,334 Total net unrealized gain on open contracts 318,749 376,373 Total Trading Equity 5,751,735 7,340,116 Interest receivable (Morgan Stanley DW) 6,267 4,115 Total Assets 5,758,002 7,344,231 LIABILITIES AND PARTNERS' CAPITAL Liabilities Redemptions payable 241,488 295,570 Accrued management fees (MSFCM) 14,395 18,361 Total Liabilities 255,883 313,931 Partners' Capital Limited Partners (1,783.637 and 1,928.408 Units, respectively) 5,303,351 6,794,754 General Partner (66.850 Units) 198,768 235,546 Total Partners' Capital 5,502,119 7,030,300 Total Liabilities and Partners' Capital 5,758,002 7,344,231 NET ASSET VALUE PER UNIT 2,973.34 3,523.50 The accompanying notes are an integral part of these financial statements.
DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. STATEMENTS OF OPERATIONS (Unaudited)
For the Three Months For the Nine Months Ended September 30, Ended September 30, 2004 2003 2004 2003 $ $ $ $ REVENUES Trading profit (loss): Realized (633,663) (1,101,795) (692,671) 747,007 Net change in unrealized 766,345 369,349 (57,624) (582,459) 132,682 (732,446) (750,295) 164,548 1,548 - 1,548 - Total Trading Results 134,230 (732,446) (748,747) 164,548 Interest income (Morgan Stanley DW) 17,355 16,136 44,808 62,017 Total 151,585 (716,310) (703,939) 226,565 EXPENSES Brokerage commissions (Morgan Stanley DW) 53,812 124,058 222,482 393,388 Management fees (MSFCM) 42,559 62,015 144,773 218,156 Transaction fees and costs 2,733 5,816 10,488 17,610 Incentive fee (MSFCM) - - - 178,017 Total 99,104 191,889 377,743 807,171 NET INCOME (LOSS) 52,481 (908,199) (1,081,682) (580,606) NET INCOME (LOSS) ALLOCATION Limited Partners 50,665 (879,311) (1,044,904) (577,659) General Partner 1,816 (28,888) (36,778) (2,947) NET INCOME (LOSS) PER UNIT Limited Partners 27.17 (432.13) (550.16) (294.71) General Partner 27.17 (432.13) (550.16) (294.71) The accompanying notes are an integral part of these financial statements.
DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. STATEMENTS OF CHANGES IN PARTNERS' CAPITAL For the Nine Months Ended September 30, 2004 and 2003 (Unaudited)
Units of Partnership Limited General Interest Partners Partner Total $ $ $ Partners' Capital, December 31, 2002 2,272.038 8,651,504 415,009 9,066,513 Net Loss - (577,659) (2,947) (580,606) Redemptions (192.895) (636,874) (165,000) (801,874) Partners' Capital, September 30, 2003 2,079.143 7,436,971 247,062 7,684,033 Partners' Capital, December 31, 2003 1,995.258 6,794,754 235,546 7,030,300 Net Loss - (1,044,904) (36,778) (1,081,682) Redemptions (144.771) (446,499) - (446,499) Partners' Capital, September 30, 2004 1,850.487 5,303,351 198,768 5,502,119 The accompanying notes are an integral part of these financial statements.
DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. STATEMENTS OF CASH FLOWS (Unaudited)
For the Nine Months Ended September 30, 2004 2003 $ $ CASH FLOWS FROM OPERATING ACTIVITIES Net loss (1,081,682) (580,606) Noncash item included in net loss: Net change in unrealized 57,624 582,459 (Increase) decrease in operating assets: Interest receivable (Morgan Stanley DW) (2,152) 2,283 Due from Morgan Stanley DW - (6,259) Decrease in operating liabilities: Accrued management fees (MSFCM) (3,966) (4,060) Accrued incentive fee (MSFCM) - (279,771) Net cash used for operating activities (1,030,176) (285,954) CASH FLOWS FROM FINANCING ACTIVITIES Increase (decrease) in redemptions payable (54,082) 42,014 Redemptions of Units (446,499) (801,874) Net cash used for financing activities (500,581) (759,860) Net decrease in cash (1,530,757) (1,045,814) Balance at beginning of period 6,963,743 8,415,187 Balance at end of period 5,432,986 7,369,373 The accompanying notes are an integral part of these financial statements.
DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. NOTES TO FINANCIAL STATEMENTS September 30, 2004 (Unaudited) The unaudited financial statements contained herein include, in the opinion of management, all adjustments necessary for a fair presentation of the results of operations and financial condition of Dean Witter Diversified Futures Fund II L.P. (the "Partnership"). The financial statements and condensed notes herein should be read in conjunction with the Partnership's December 31, 2003 Annual Report on Form 10-K. 1. Organization Dean Witter Diversified Futures Fund II L.P. is a Delaware limited partnership organized to engage primarily in the speculative trading of futures and forward contracts on physical commodities, and other commodity interests, including, but not limited to, foreign currencies, financial instruments, metals, energy, and agricultural products. The Partnership's general partner is Demeter Management Corporation ("Demeter"). The non-clearing commodity broker is Morgan Stanley DW Inc. ("Morgan Stanley DW"). The clearing commodity brokers are Morgan Stanley & Co. Incorporated ("MS & Co.") and Morgan Stanley & Co. International Limited ("MSIL"). The trading manager is Morgan Stanley Futures & Currency DEAN WITTER DIVERSIFIED FUTURES FUND II NOTES TO FINANCIAL STATEMENTS (CONTINUED) Management Inc.("MSFCM" or the "Trading Manager"). Demeter, Morgan Stanley DW, MS & Co., MSIL, and MSFCM are wholly-owned subsidiaries of Morgan Stanley. On February 27, 2002, the Partnership received notification of a preliminary entitlement to payment from the Sumitomo Copper Litigation Settlement Administrator, and the Partnership has received settlement award payments in the amount of $157,127 as of August 30, 2002 and $1,548 as of July 30, 2004. Any amounts received are accounted for in the period received, for the benefit of the limited partners at the date of receipt. 2. Related Party Transactions The Partnership's cash is on deposit with Morgan Stanley DW, MS & Co., and MSIL in futures and forwards trading accounts to meet margin requirements as needed. Monthly, Morgan Stanley DW pays the Partnership interest income equal to 80% of its average daily Net Assets for the month at a rate equal to the average yield on 13-week U.S. Treasury bills. The Partnership pays brokerage commissions to Morgan Stanley DW. Management fees and incentive fees (if any) incurred by the Partnership are paid to MSFCM. DEAN WITTER DIVERSIFIED FUTURES FUND II NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. Financial Instruments The Partnership trades futures and forward contracts on physical commodities and other commodity interests, including, but not limited to, foreign currencies, financial instruments, metals, energy, and agricultural products. Futures and forwards represent contracts for delayed delivery of an instrument at a specified date and price. Risk arises from changes in the value of these contracts and the potential inability of counterparties to perform under the terms of the contracts. There are numerous factors which may significantly influence the market value of these contracts, including interest rate volatility. The market value of exchange-traded contracts is based on the settlement price quoted by the exchange on the day with respect to which market value is being determined. If an exchange-traded contract could not have been liquidated on such day due to the operation of daily limits or other rules of the exchange, the settlement price shall be the settlement price on the first subsequent day on which the contract could be liquidated. The market value of off-exchange-traded contracts is based on the fair market value quoted by the counterparty. DEAN WITTER DIVERSIFIED FUTURES FUND II NOTES TO FINANCIAL STATEMENTS (CONTINUED) The Partnership's contracts are accounted for on a trade-date basis and marked to market on a daily basis. The Partnership accounts for its derivative investments in accordance with the provisions of Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 defines a derivative as a financial instrument or other contract that has all three of the following characteristics: 1) One or more underlying notional amounts or payment provisions; 2) Requires no initial net investment or a smaller initial net investment than would be required relative to changes in market factors; 3) Terms require or permit net settlement. Generally, derivatives include futures, forward, swaps or options contracts, and other financial instruments with similar characteristics such as caps, floors, and collars. The net unrealized gains (losses) on open contracts, reported as a component of "Equity in futures interests trading accounts" on the DEAN WITTER DIVERSIFIED FUTURES FUND II NOTES TO FINANCIAL STATEMENTS (CONTINUED) Statements of Financial Condition, and their longest contract maturities were as follows: Net Unrealized Gains (Losses) on Open Contracts Longest Maturities Exchange- Off-Exchange- Exchange- Off-Exchange- Date Traded Traded Total Traded Traded $ $ $ Sep. 30, 2004 426,969 (108,220) 318,749 Jun. 2006 Jan. 2005 Dec. 31, 2003 357,722 18,651 376,373 Mar. 2004 Mar. 2004 The Partnership has credit risk associated with counterparty non- performance. The credit risk associated with the instruments in which the Partnership trades is limited to the amounts reflected in the Partnership's Statements of Financial Condition. The Partnership also has credit risk because Morgan Stanley DW, MS & Co., and MSIL act as the futures commission merchants or the counterparties, with respect to most of the Partnership's assets. Exchange-traded futures and forward contracts are marked to market on a daily basis, with variations in value settled on a daily basis. Morgan Stanley DW, MS & Co., and MSIL, each as a futures commission merchant for the Partnership's exchange-traded futures and forward contracts, are required, pursuant to regulations of the Commodity Futures Trading Commission ("CFTC"), to segregate from their own assets, and for the sole benefit of their commodity customers, all funds held by them with respect to DEAN WITTER DIVERSIFIED FUTURES FUND II NOTES TO FINANCIAL STATEMENTS (CONTINUED) exchange-traded futures and forward contracts, including an amount equal to the net unrealized gains (losses) on all open futures and forward contracts, which funds, in the aggregate, totaled $5,859,955 and $7,321,465 at September 30, 2004 and December 31, 2003, respectively. With respect to the Partnership's off-exchange-traded forward currency contracts, there are no daily exchange-required settlements of variation in value nor is there any requirement that an amount equal to the net unrealized gains (losses) on open forward contracts be segregated. However, the DEAN WITTER DIVERSIFIED FUTURES FUND II NOTES TO FINANCIAL STATEMENTS (CONCLUDED) Partnership is required to meet margin requirements equal to the net unrealized loss on open contracts in the Partnership accounts with the counterparty, which is accomplished by daily maintenance of the cash balance in a custody account held at Morgan Stanley DW for the benefit of MS & Co. With respect to those off-exchange- traded forward currency contracts, the Partnership is at risk to the ability of MS & Co., the sole counterparty on all such contracts, to perform. The Partnership has a netting agreement with MS & Co. This agreement, which seeks to reduce both the Partnership's and MS & Co.'s exposure on off-exchange-traded forward currency contracts, should materially decrease the Partnership's credit risk in the event of MS & Co.'s bankruptcy or insolvency. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Liquidity. The Partnership deposits its assets with Morgan Stanley DW as non-clearing broker, and MS & Co. and MSIL as clearing brokers in separate futures and forwards trading accounts established for the Trading Manager, which assets are used as margin to engage in trading and may be used as margin solely for the Partnership's trading. The assets are held in either non- interest bearing bank accounts or in securities and instruments permitted by the CFTC for investment of customer segregated or secured funds. Since the Partnership's sole purpose is to trade in futures and forwards, it is expected that the Partnership will continue to own such liquid assets for margin purposes. The Partnership's investment in futures and forwards may, from time to time, be illiquid. Most U.S. futures exchanges limit fluctuations in prices during a single day by regulations referred to as "daily price fluctuations limits" or "daily limits". Trades may not be executed at prices beyond the daily limit. If the price for a particular futures contract has increased or decreased by an amount equal to the daily limit, positions in that futures contract can neither be taken nor liquidated unless traders are willing to effect trades at or within the limit. Futures prices have occasionally moved the daily limit for several consecutive days with little or no trading. These market conditions could prevent the Partnership from promptly liquidating its futures contracts and result in restrictions on redemptions. There is no limitation on daily price moves in trading forward contracts on foreign currencies. The markets for some world currencies have low trading volume and are illiquid, which may prevent the Partnership from trading in potentially profitable markets or prevent the Partnership from promptly liquidating unfavorable positions in such markets, subjecting it to substantial losses. Either of these market conditions could result in restrictions on redemptions. For the periods covered by this report, illiquidity has not materially affected the Partnership's assets. There are no known material trends, demands, commitments, events or uncertainties at the present time that are reasonably likely to result in the Partnership's liquidity increasing or decreasing in any material way. Capital Resources. The Partnership does not have, nor expects to have, any capital assets. Redemptions of units of limited partnership interest ("Unit(s)") in the future will affect the amount of funds available for investment in futures and forwards in subsequent periods. It is not possible to estimate the amount, and therefore the impact, of future redemptions of Units. There are no known material trends, favorable or unfavorable, that would affect, nor any expected material changes to, the Partnership's capital resource arrangements at the present time. Off-Balance Sheet Arrangements and Contractual Obligations. The Partnership does not have any off-balance sheet arrangements, nor does it have contractual obligations or commercial commitments to make future payments that would affect its liquidity or capital resources. Results of Operations General. The Partnership's results depend on the Trading Manager and the ability of the Trading Manager's trading programs to take advantage of price movements in the futures and forwards markets. The following presents a summary of the Partnership's operations for the three and nine month periods ended September 30, 2004 and 2003 and a general discussion of its trading activities during each period. It is important to note, however, that the Trading Manager trades in various markets at different times and that prior activity in a particular market does not mean that such market will be actively traded by the Trading Manager or will be profitable in the future. Consequently, the results of operations of the Partnership are difficult to discuss other than in the context of the Trading Manager's trading activities on behalf of (page> the Partnership during the period in question. Past performance is no guarantee of future results. The Partnership's results of operations set forth in the financial statements on pages 2 through 11 of this report were prepared in accordance with accounting principles generally accepted in the United States of America, which require the use of certain accounting policies that affect the amounts reported in these financial statements, including the following: The contracts the Partnership trades are accounted for on a trade- date basis and marked to market on a daily basis. The difference between their cost and market value is recorded on the Statements of Operations as "Net change in unrealized trading profit (loss)" for open (unrealized) contracts, and recorded as "Realized trading profit (loss)" when open positions are closed out. The sum of these amounts, along with the "Proceeds from Litigation Settlement", constitutes the Partnership's trading results. The market value of a futures contract is the settlement price on the exchange on which that futures contract is traded on a particular day. The value of foreign currency forward contracts is based on the spot rate as of the close of business, New York City time, on a given day. Interest income revenue, as well as management fees, incentive fees, and brokerage commission expenses of the Partnership are recorded on an accrual basis. Demeter believes that, based on the nature of the operations of the Partnership, no assumptions relating to the application of critical accounting policies other than those presently used could reasonably affect reported amounts. For the Three and Nine Months Ended September 30, 2004 The Partnership recorded revenues including interest income totaling $151,585 and expenses totaling $99,104, resulting in net income of $52,481 for the three months ended September 30, 2004. The Partnership's net asset value per Unit increased from $2,946.17 at June 30, 2004 to $2,973.34 at September 30, 2004. The most significant trading gains of approximately 4.6% were generated in the energy markets, primarily during July and September, from long positions in crude oil as prices strengthened due to continuing fears about potential terrorist attacks against the production and refining facilities in Saudi Arabia and Iraq, concerns that top Russian oil producer, Yukos, may break up or stop selling oil, major disruptions in oil production in the Gulf of Mexico due to Hurricane Ivan, and growing civil unrest in Nigeria. Elsewhere in the energy markets, gains were recorded during August from short positions in natural gas futures as prices drifted lower due to record reserves and heavily reduced market demand. Additional gains of approximately 1.7% were recorded in the global interest rate futures markets, primarily during August and September, from long positions in European interest rate futures as prices trended higher, boosted by a surge in oil prices, uncertainty in the global equity markets, and testimony by U.S. Federal Reserve Chairman Alan Greenspan depicting a somewhat less optimistic view about the immediate future of the U.S. economy. Smaller gains of approximately 0.5% were experienced in the agricultural markets during July and September from short positions in corn futures as prices weakened due to ideal weather conditions in the growing region of the U.S. midwest, reports of increased inventories by the U.S. Department of Agriculture, and weak export demand. A portion of the Partnership's overall gains for the quarter was offset by losses of approximately 3.9% recorded in the currency markets during July and September from positions in the Australian dollar relative to the U.S. dollar as the value of the Australian dollar moved without consistent direction due to volatility in gold prices, geopolitical concerns regarding terror warnings in the Pacific Rim, and the decision by the Reserve Bank of Australia to raise interest rates. Elsewhere in the currency markets, losses resulted from positions in the euro versus the U.S. dollar and the Japanese yen as the value of the euro experienced short-term price volatility throughout the quarter due to higher energy prices and uncertainty about the direction of the "euro-zone" economy. Smaller losses were incurred, primarily during September, from short positions in the Swiss franc against the U.S. dollar as the Swiss currency's "safe-haven" status pushed its value higher in reaction to major geopolitical concerns. Within the metals markets, losses of approximately 1.0% were experienced during September from short positions in nickel futures as base metals prices increased on continued demand from China and reports of lower-than-expected inventories. Elsewhere in the metals markets, losses were recorded primarily during July from short positions in copper futures as prices moved higher due to speculation of increased demand and reduced supply from Mexico. Smaller losses of approximately 0.6% were recorded in the global stock index futures markets during July and August from short positions in S&P 500 Index futures as prices temporarily bounced higher due to better-than-expected U.S. economic data. The Partnership recorded losses net of interest income totaling $703,939 and expenses totaling $377,743, resulting in a net loss of $1,081,682 for the nine months ended September 30, 2004. The Partnership's net asset value per Unit decreased from $3,523.50 at December 31, 2003 to $2,973.34 at September 30, 2004. The most significant trading losses of approximately 17.5% were recorded in the currency markets from positions in the Japanese yen versus the U.S. dollar. These losses were experienced primarily during the first and second quarters from both long and short positions in the yen relative to the U.S. dollar as the value of the yen experienced significant short-term price volatility. Conflicting economic data regarding a Japanese economic recovery, uncertainty regarding a currency market intervention by the Bank of Japan, geopolitical concerns stemming from instability in Iraq and uncertainty regarding the direction of U.S. and Japanese interest rates contributed to the yen's trendless price movement. Losses were also recorded from positions in the Singapore dollar against the U.S. dollar as the value of the Singapore dollar experienced significant "whipsawing" during the first and second quarters in tandem with the Japanese yen. The price volatility in the Japanese yen also resulted in losses from crossrate positions in the euro versus the Japanese yen for the aforementioned reasons. In the third quarter, however, volatility in the euro was responsible for losses in euro/Japanese yen crossrate positions as the value of the euro moved in a trendless pattern throughout the quarter due to higher energy prices and uncertainty about the direction of the "euro- zone" economy. Additional losses of approximately 1.7% were incurred in the metals markets, primarily during April, from long futures positions in gold as precious metals prices weakened due to the strength in the U.S. dollar. Elsewhere in the metals markets, losses were recorded primarily during September from short positions in nickel futures as base metals prices increased on continued demand from China and reports of lower-than-expected inventories. Smaller losses of approximately 0.8% were recorded in the global stock index futures markets during March and May from long positions in S&P 500 Index futures as equity prices decreased on geopolitical concerns. During July and August, short positions in S&P 500 Index futures resulted in further losses as prices temporarily bounced higher due to better-than- expected U.S. economic data. A portion of the Partnership's overall losses for the first nine months of the year was offset by gains of approximately 3.0% in the energy markets. During February, May, July, and September, long positions in crude oil profited as prices trended higher due to consistent news of tight supply, continuing geopolitical concerns in the Middle East, concerns that top Russian oil producer, Yukos, may break up or stop selling oil, major disruptions in oil production in the Gulf of Mexico due to Hurricane Ivan, and growing civil unrest in Nigeria. Additional gains of approximately 2.5% were experienced in the agricultural markets during January, March, and June from long positions in corn futures as prices increased on news of strong demand from Asia. Further gains were experienced during July and August from short positions in corn futures as prices weakened due to ideal weather conditions in the growing regions of the U.S. midwest, reports of increased inventories by the U.S. Department of Agriculture, and weaker export demand. Elsewhere in the agricultural complex, gains were recorded from short positions in cotton futures, primarily during March, April, June, and July, as prices trended lower amid rising supplies and news of a consistent decline in demand from China. Smaller gains of approximately 1.2% were recorded in the global interest rate futures markets from long positions in European interest rate futures during February, March, August, and September as prices rallied on uncertainty in the global equity markets, disappointing economic data, "safe-haven" buying amid major geopolitical concerns, and a surge in oil prices. For the Three and Nine Months Ended September 30, 2003 The Partnership recorded losses net of interest income totaling $716,310 and expenses totaling $191,889, resulting in a net loss of $908,199 for the three months ended September 30, 2003. The Partnership's net asset value per Unit decreased from $4,127.90 at June 30, 2003 to $3,695.77 at September 30, 2003. The most significant trading losses of approximately 5.7% were recorded in the global interest rate markets primarily during September from short positions in Japanese, European, and U.S. interest rate futures as bond prices reversed higher due to renewed skepticism regarding a global economic recovery and lower global equity prices. Additional losses of approximately 2.5% were recorded in the agricultural markets, primarily during September, from short coffee futures positions, as weak coffee crop estimates coupled with dry Brazilian weather caused prices to reverse higher. Elsewhere in the agricultural markets, losses were recorded from positions in cotton futures, primarily during August, as prices moved without consistent direction. Losses of approximately 1.0% were recorded in the currency markets, from long positions in the Australian dollar versus the U.S. dollar during July as the value of the U.S. currency strengthened amid better-than-expected U.S. earnings data. In the metals markets, losses of approximately 0.9% resulted during August from long futures positions in aluminum and copper as base metals prices were weighed down by heavy technically-based selling and expectations for increased output during the year 2004. Smaller losses of approximately 0.5% were recorded in the global stock index markets during early August and late September from long positions in S&P 500 Index futures as global equity prices retreated amid a broad-based sell-off prompted by a steady stream of economic data that raised concerns about the strength of the global economy. The Partnership recorded revenues including interest income totaling $226,565 and expenses totaling $807,171, resulting in a net loss of $580,606 for the nine months ended September 30, 2003. The Partnership's net asset value per Unit decreased from $3,990.48 at December 31, 2002 to $3,695.77 at September 30, 2003. The most significant trading losses of approximately 5.7% were incurred in the metals markets during May and June from short positions in aluminum and copper futures as prices reversed higher, buoyed by a rebound in U.S. equity prices and hopes for increased industrial demand. During August, long futures positions in aluminum and copper experienced losses as prices were weighed down by heavy technically-based selling and expectations for increased output during the year 2004. Additional losses of approximately 4.4% were recorded in the agricultural markets from positions in coffee and cotton futures as prices experienced short-term volatile price movement throughout a majority of the year. Smaller losses of approximately 3.4% were experienced in the global interest rate markets from short positions in Japanese, Australian, and European interest rate futures during September as bond prices reversed higher due to renewed skepticism regarding a global economic recovery and lower equity prices. Further losses in this sector stemmed from long positions in Australian interest rate futures during March as prices reversed sharply lower amid reports of advancing Coalition forces in the Persian Gulf region. A portion of the Partnership's overall losses during the first nine months of the year was offset by gains of approximately 6.8% in the energy markets stemming from long positions in natural gas futures as prices trended higher during January and February in response to prolonged frigid temperatures in the northeastern and midwestern U.S. Additional gains in the energy markets were recorded during the same time period from long positions in crude oil futures as prices increased amid the looming threat of military action against Iraq and an overall decline in inventories. During July, short positions in natural gas futures yielded gains as prices declined amid increased reserves and mild summer weather conditions. In the currency markets, gains of approximately 4.4% were produced from long positions in the euro versus the British pound during January as the value of the pound decreased due to weak economic data out of the U.S. and an interest rate cut by the Bank of England. Additional currency gains were recorded from long positions in the Australian dollar versus the U.S. dollar during January, February, April, and May as the value of the Australian currency increased on the heels of higher commodity prices and a significant interest rate differential between the two countries. During May, gains resulted from long positions in the euro versus the Japanese yen as the value of the euro continued to trend higher following the European Central Bank's decision to leave interest rates unchanged. Item 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Introduction The Partnership is a commodity pool engaged primarily in the speculative trading of futures and forwards. The market-sensitive instruments held by the Partnership are acquired for speculative trading purposes only and, as a result, all or substantially all of the Partnership's assets are at risk of trading loss. Unlike an operating company, the risk of market-sensitive instruments is inherent to the primary business activity of the Partnership. The futures and forwards traded by the Partnership involve varying degrees of related market risk. Market risk is often dependent upon changes in the level or volatility of interest rates, exchange rates, and prices of financial instruments and commodities, factors that result in frequent changes in the fair value of the Partnership's open positions, and consequently in its earnings, whether realized or unrealized, and cash flow. Gains and losses on open positions of exchange-traded futures and forward contracts are settled daily through variation margin. Gains and losses on off-exchange-traded forward currency contracts are settled upon termination of the contract, however, the Partnership is required to meet margin requirements equal to the net unrealized loss on open contracts in the Partnership accounts with the counterparty, which is accomplished by daily maintenance of the cash balance in a custody account held at Morgan Stanley DW for the benefit of MS & Co. The Partnership's total market risk may increase or decrease as it is influenced by a wide variety of factors, including, but not limited to, the diversification among the Partnership's open positions, the volatility present within the markets, and the liquidity of the markets. The face value of the market sector instruments held by the Partnership is typically many times the applicable margin requirements. Margin requirements generally range between 2% and 15% of contract face value. Additionally, the use of leverage causes the face value of the market sector instruments held by the Partnership to typically be many times the total capitalization of the Partnership. The Partnership's past performance is no guarantee of its future results. Any attempt to numerically quantify the Partnership's market risk is limited by the uncertainty of its speculative trading. The Partnership's speculative trading and use of leverage may cause future losses and volatility (i.e., "risk of ruin") that far exceed the Partnership's experience to date under the "Partnership's Value at Risk in Different Market Sectors" section and significantly exceed the Value at Risk ("VaR") tables disclosed. Limited partners will not be liable for losses exceeding the current net asset value of their investment. Quantifying the Partnership's Trading Value at Risk The following quantitative disclosures regarding the Partnership's market risk exposures contain "forward-looking statements" within the meaning of the safe harbor from civil liability provided for such statements by the Private Securities Litigation Reform Act of 1995 (set forth in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934). All quantitative disclosures in this section are deemed to be forward- looking statements for purposes of the safe harbor, except for statements of historical fact. The Partnership accounts for open positions on the basis of mark to market accounting principles. Any loss in the market value of the Partnership's open positions is directly reflected in the Partnership's earnings and cash flow. The Partnership's risk exposure in the market sectors traded by the Trading Manager is estimated below in terms of VaR. The Partnership estimates VaR using a model based upon historical simulation (with a confidence level of 99%) which involves constructing a distribution of hypothetical daily changes in the value of a trading portfolio. The VaR model takes into account linear exposures to risk including equity and commodity prices, interest rates, foreign exchange rates, and correlation among these variables. The hypothetical changes in portfolio value are based on daily percentage changes observed in key market indices or other market factors ("market risk factors") to which the portfolio is sensitive. The one-day 99% confidence level of the Partnership's VaR corresponds to the negative change in portfolio value that, based on observed market risk factors, would have been exceeded once in 100 trading days, or one day in 100. VaR typically does not represent the worst case outcome. Demeter uses approximately four years of daily market data (1,000 observations) and revalues its portfolio (using delta-gamma approximations) for each of the historical market moves that occurred over this time period. This generates a probability distribution of daily "simulated profit and loss" outcomes. The VaR is the appropriate percentile of this distribution. For example, the 99% one-day VaR would represent the 10th worst outcome from Demeter's simulated profit and loss series. The Partnership's VaR computations are based on the risk representation of the underlying benchmark for each instrument or contract and do not distinguish between exchange and non-exchange dealer-based instruments. They are also not based on exchange and/or dealer-based maintenance margin requirements. VaR models, including the Partnership's, are continually evolving as trading portfolios become more diverse and modeling techniques and systems capabilities improve. Please note that the VaR model is used to numerically quantify market risk for historic reporting purposes only and is not utilized by either Demeter or the Trading Manager in their daily risk management activities. Please further note that VaR as described above may not be comparable to similarly titled measures used by other entities. The Partnership's Value at Risk in Different Market Sectors The following table indicates the VaR associated with the Partnership's open positions as a percentage of total net assets by primary market risk category at September 30, 2004 and 2003. At September 30, 2004 and 2003, the Partnership's total capitalization was approximately $6 million and $8 million, respectively. Primary Market September 30, 2004 September 30, 2003 Risk Category Value at Risk Value at Risk Interest Rate (1.73)% (0.08)% Currency (1.01) (1.89) Equity - - Commodity (2.38) (1.93) Aggregate Value at Risk (3.91)% (2.85)% The VaR for a market category represents the one-day downside risk for the aggregate exposures associated with this market category. The Aggregate Value at Risk listed above represents the VaR of the Partnership's open positions across all the market categories, and is less than the sum of the VaRs for all such market categories due to the diversification benefit across asset classes. Because the business of the Partnership is the speculative trading of futures and forwards, the composition of its trading portfolio can change significantly over any given time period, or even within a single trading day, which could positively or negatively materially impact market risk as measured by VaR. The table below supplements the quarter-end VaR set forth above by presenting the Partnership's high, low, and average VaR, as a percentage of total net assets for the four quarter-end reporting periods from October 1, 2003 through September 30, 2004. Primary Market Risk Category High Low Average Interest Rate (2.04)% (0.84)% (1.65)% Currency (2.80) (1.01) (1.79) Equity (0.52) - (0.16) Commodity (4.32) (0.59) (2.29) Aggregate Value at Risk (5.52)% (2.32)% (3.80)% Limitations on Value at Risk as an Assessment of Market Risk VaR models permit estimation of a portfolio's aggregate market risk exposure, incorporating a range of varied market risks; reflect risk reduction due to portfolio diversification or hedging activities; and can cover a wide range of portfolio assets. However, VaR risk measures should be viewed in light of the methodology's limitations, which include, but may not be limited to the following: ? past changes in market risk factors will not always result in accurate predictions of the distributions and correlations of future market movements; ? changes in portfolio value caused by market movements may differ from those of the VaR model; ? VaR results reflect past market fluctuations applied to current trading positions while future risk depends on future positions; ? VaR using a one-day time horizon does not fully capture the market risk of positions that cannot be liquidated or hedged within one day; and ? the historical market risk factor data used for VaR estimation may provide only limited insight into losses that could be incurred under certain unusual market movements. In addition, the VaR tables above, as well as the past performance of the Partnership, give no indication of the Partnership's potential "risk of ruin". The VaR tables provided present the results of the Partnership's VaR for each of the Partnership's market risk exposures and on an aggregate basis at September 30, 2004 and 2003, and for the four quarter-end reporting periods from October 1, 2003 through September 30, 2004. VaR is not necessarily representative of the Partnership's historic risk, nor should it be used to predict the Partnership's future financial performance or its ability to manage or monitor risk. There can be no assurance that the Partnership's actual losses on a particular day will not exceed the VaR amounts indicated above or that such losses will not occur more than once in 100 trading days. Non-Trading Risk The Partnership has non-trading market risk on its foreign cash balances. These balances and any market risk they may represent are immaterial. The Partnership also maintains a substantial portion (approximately 98% as of September 30, 2004) of its available assets in cash at Morgan Stanley DW. A decline in short-term interest rates would result in a decline in the Partnership's cash management income. This cash flow risk is not considered to be material. Materiality, as used throughout this section, is based on an assessment of reasonably possible market movements and any associated potential losses, taking into account the leverage, optionality, and multiplier features of the Partnership's market- sensitive instruments, in relation to the Partnership's net assets. Qualitative Disclosures Regarding Primary Trading Risk Exposures The following qualitative disclosures regarding the Partnership's market risk exposures - except for (A) those disclosures that are statements of historical fact and (B) the descriptions of how the Partnership manages its primary market risk exposures - constitute forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act. The Partnership's primary market risk exposures, as well as the strategies used and to be used by Demeter and the Trading Manager for managing such exposures, are subject to numerous uncertainties, contingencies, and risks, any one of which could cause the actual results of the Partnership's risk controls to differ materially from the objectives of such strategies. Government interventions, defaults and expropriations, illiquid markets, the emergence of dominant fundamental factors, political upheavals, changes in historical price relationships, an influx of new market participants, increased regulation, and many other factors could result in material losses, as well as in material changes to the risk exposures and the risk management strategies of the Partnership. Investors must be prepared to lose all or substantially all of their investment in the Partnership. The following were the primary trading risk exposures of the Partnership at September 30, 2004, by market sector. It may be anticipated, however, that these market exposures will vary materially over time. Interest Rate. The Partnership's primary market exposure at September 30, 2004 was to the global interest rate futures sector. Exposure was primarily spread across the European, Japanese, and U.S. interest rate sectors. Interest rate movements directly affect the price of the sovereign bond futures positions held by the Partnership and indirectly affect the value of its stock index and currency positions. Interest rate movements in one country, as well as relative interest rate movements between countries, materially impact the Partnership's profitability. The Partnership's primary interest rate exposure is generally to interest rate fluctuations in the U.S. and the other G-7 countries. The G-7 countries consist of France, the U.S., Britain, Germany, Japan, Italy, and Canada. However, the Partnership also takes futures positions in the government debt of smaller countries - e.g., Australia. Demeter anticipates that the G-7 countries and Australian interest rates will remain the primary interest rate exposure of the Partnership for the foreseeable future. The speculative futures positions held by the Partnership may range from short to long-term instruments. Consequently, changes in short, medium or long-term interest rates may have an effect on the Partnership. Currency. The second largest market exposure at September 30, 2004 was to the currency sector. The Partnership's currency exposure is to exchange rate fluctuations, primarily fluctuations which disrupt the historical pricing relationships between different currencies and currency pairs. Interest rate changes, as well as political and general economic conditions influence these fluctuations. The Partnership trades a number of currencies, including cross-rates - i.e., positions between two currencies other than the U.S. dollar. At September 30, 2004, the Partnership's major exposures were to the euro, Japanese yen, and British pound currency crosses, as well as to outright U.S. dollar positions. Outright positions consist of the U.S. dollar vs. other currencies. These other currencies include major and minor currencies. Demeter does not anticipate that the risk associated with the Partnership's currency trades will change significantly in the future. Commodity. Energy. The Partnership's energy exposure at September 30, 2004 was shared primarily by futures contracts in crude oil and natural gas. Price movements in these markets result from geopolitical developments, particularly in the Middle East, as well as weather patterns and other economic fundamentals. Significant profits and losses, which have been experienced in the past, are expected to continue to be experienced in the future. Natural gas has exhibited volatility in price resulting from weather patterns and supply and demand factors and will likely continue in this choppy pattern. Metals. The Partnership's metals exposure at September 30, 2004 was to fluctuations in the price of precious metals, such as gold, and base metals, such as aluminum, copper, and zinc. Economic forces, supply and demand inequalities, geopolitical factors, and market expectations influence price movements in these markets. The Trading Manager utilizes the trading system(s) to take positions when market opportunities develop, and Demeter anticipates that the Partnership will continue to do so. Soft Commodities and Agriculturals. At September 30, 2004, the Partnership had exposure to the markets that comprise these sectors. Most of the exposure was to the coffee, cocoa, corn, and soybean markets. Supply and demand inequalities, severe weather disruptions, and market expectations affect price movements in these markets. Qualitative Disclosures Regarding Non-Trading Risk Exposure The following was the only non-trading risk exposure of the Partnership at September 30, 2004: Foreign Currency Balances. The Partnership's primary foreign currency balances at September 30, 2004 were in the Japanese yen and Australian dollar. The Partnership controls the non-trading risk of foreign currency balances by regularly converting them back into U.S. dollars upon liquidation of their respective positions. Qualitative Disclosures Regarding Means of Managing Risk Exposure The Partnership and the Trading Manager, separately, attempt to manage the risk of the Partnership's open positions in essentially the same manner in all market categories traded. Demeter attempts to manage market exposure by diversifying the Partnership's assets among different market sectors and trading approaches, and by monitoring the performance of the Trading Manager daily. In addition, the Trading Manager establishes diversification guidelines, often set in terms of the maximum margin to be committed to positions in any one market sector or market- sensitive instrument. Demeter monitors and controls the risk of the Partnership's non- trading instrument, cash. Cash is the only Partnership investment directed by Demeter, rather than the Trading Manager. Item 4. CONTROLS AND PROCEDURES (a) As of the end of the period covered by this quarterly report, the President and Chief Financial Officer of Demeter, the general partner of the Partnership, have evaluated the effectiveness of the Partnership's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act), and have judged such controls and procedures to be effective. (b) There have been no significant changes during the period covered by this quarterly report in the Partnership's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. PART II. OTHER INFORMATION Item 5. OTHER INFORMATION Management. The following changes have been made to the Board of Directors and Officers of Demeter: Mr. Kevin Perry, Chief Financial Officer of Demeter, was confirmed as a principal of Demeter by the National Futures Association on September 3, 2004. Mr. William D. Seugling, Director of Demeter, was confirmed as a principal of Demeter by the National Futures Association on October 11, 2004. Item 6. EXHIBITS AND REPORTS ON FORM 8-K (A) Exhibits 3.01 Limited Partnership Agreement of the Partnership, dated as of October 28, 1988, is incorporated by reference to Exhibit 3.01 and Exhibit 3.02 of the Partnership's Registration Statement on Form S-1 (File No. 33-24662). 10.01 Management Agreement among the Partnership, Demeter Management Corporation and Dean Witter Futures & Currency Management Inc., dated as of October 28, 1988, is incorporated by reference to Exhibit 10.02 of the Partnership's Registration Statement on Form S-1 (File No. 33-24662). 10.02 Amended and Restated Customer Agreement between the Partnership and Morgan Stanley DW Inc., dated as of May 19, 2000, is incorporated by reference to Exhibit 10.01 of the Partnership's Form 8-K (File No. 0-17446) filed with the Securities and Exchange Commission on November 13, 2001. 10.03 Commodity Futures Customer Agreement between Morgan Stanley & Co. Incorporated and the Partnership, and acknowledged and agreed to by Morgan Stanley DW Inc., dated as of May 1, 2000, is incorporated by reference to Exhibit 10.02 of the Partnership's Form 8-K (File No. 0- 17446) filed with the Securities and Exchange Commission on November 13, 2001. 10.04 Customer Agreement between the Partnership and Morgan Stanley & Co. International Limited, dated as of May 1, 2000, is incorporated by reference to Exhibit 10.04 of the Partnership's Form 8-K (File No. 0-17446) filed with the Securities and Exchange Commission on November 13, 2001. 10.05 Foreign Exchange and Options Master Agreement between Morgan Stanley & Co. Incorporated and the Partnership, dated as of April 30, 2000, is incorporated by reference to Exhibit 10.05 of the Partnership's Form 8-K (File No. 0-17446) filed with the Securities and Exchange Commission on November 13, 2001. 10.06 Securities Account Control Agreement among the Partnership, Morgan Stanley & Co. Incorporated, and Morgan Stanley DW Inc., dated as of May 1, 2000, is incorporated by reference to Exhibit 10.03 of the Partnership's Form 8-K (File No. 0-17446) filed with the Securities and Exchange Commission on November 13, 2001. 31.01 Certification of President of Demeter Management Corporation, the general partner of the Partnership, pursuant to rules 13a-15(e) and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.02 Certification of Chief Financial Officer of Demeter Management Corporation, the general partner of the Partnership, pursuant to rules 13a-15(e) and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.01 Certification of President of Demeter Management Corporation, the general partner of the Partnership, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.02 Certification of Chief Financial Officer of Demeter Management Corporation, the general partner of the Partnership, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (B) Reports on Form 8-K - None. SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dean Witter Diversified Futures Fund II L.P. (Registrant) By: Demeter Management Corporation (General Partner) November 15, 2004 By:/s/Kevin Perry Kevin Perry Chief Financial Officer The General Partner which signed the above is the only party authorized to act for the Registrant. The Registrant has no principal executive officer, principal financial officer, controller, or principal accounting officer and has no Board of Directors.