UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT
INVESTMENT COMPANIES
Investment Company Act file number 811-2631
-----------------
Chestnut Street Exchange Fund
--------------------------------------------------------
(Exact name of registrant as specified in charter)
400 Bellevue Parkway
Wilmington, DE 19809
------------------------------------------------
(Address of principal executive offices) (Zip code)
Edward J. Roach
400 Bellevue Parkway
Wilmington, DE 19809
------------------------------------------------
(Name and address of agent for service)
Registrant's telephone number, including area code: 302-792-2555
------------
Date of fiscal year end: December 31, 2003
-----------------
Date of reporting period: June 30, 2003
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Form N-CSR is to be used by management investment companies to file reports with
the Commission not later than 10 days after the transmission to stockholders of
any report that is required to be transmitted to stockholders under Rule 30e-1
under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may
use the information provided on Form N-CSR in its regulatory, disclosure review,
inspection, and policymaking roles.
A registrant is required to disclose the information specified by Form N-CSR,
and the Commission will make this information public. A registrant is not
required to respond to the collection of information contained in Form N-CSR
unless the Form displays a currently valid Office of Management and Budget
("OMB") control number. Please direct comments concerning the accuracy of the
information collection burden estimate and any suggestions for reducing the
burden to Secretary, Securities and Exchange Commission, 450 Fifth Street, NW,
Washington, DC 20549-0609. The OMB has reviewed this collection of information
under the clearance requirements of 44 U.S.C. Section 3507.
Item 1. REPORTS TO STOCKHOLHERS
CHESTNUT STREET EXCHANGE FUND
(A CALIFORNIA LIMITED PARTNERSHIP)
ROBERT R. FORTUNE
Chairman
July 25, 2003
Fellow Partner:
Our Fund earned $2.13 per share of net investment income in the six months
ended June 30, 2003. Earnings in the same period of 2002 were $1.86 per share.
Dividend income continues to do well and expense accruals were lower in the
first half of 2003.
After providing for the $0.95 per share distribution to partners of record
on June 27, 2003, the net asset value per partnership share at June 30, 2003 was
$288.88. The net asset value at March 31, 2003, our last report date, was
$261.10.
During the second quarter of 2003, approximately 70 percent (120,000
shares) of our investment in Schering-Plough Corp. was sold at a loss of
$3,016,976. The remaining shares were sold in July 2003. The loss on this sale
was partially offset by the receipt of $624,855 which is our Fund's share of the
settlement of a suit against Cendant Corp., shares of which we owned until the
year 2000.
Commentary on market conditions and a comparison of our Fund's performance
to the Standard & Poor's 500 Index and the Dow Jones Industrial Average will be
found in the accompanying Investment Adviser's Report.
Your comments or questions concerning Chestnut Street Exchange Fund are
welcomed.
Yours sincerely,
/s/ Robert R. Fortune
Robert R. Fortune
INVESTMENT ADVISER'S REPORT
2ND QUARTER 2003 U.S. EQUITY MARKET REVIEW
ECONOMIC REVIEW
The second quarter of 2003 saw equity prices around the globe rally
strongly. In the U.S., the S&P 500 Index returned 15.4%, its largest quarterly
gain since the fourth quarter of 1998. Other domestic equity indexes also
performed well, with the Dow Jones Industrial Average returning 13.1%, its
biggest gain since the fourth quarter of 2001, and the NASDAQ Composite Index
climbing 21.1%, thanks in large part to its heavy weighting in technology
stocks, which soared during the period. Small cap stocks in the U.S. also
benefited from the improving investor sentiment as the Russell 2000 Index gained
over 23% for the quarter.
Several of the factors that hampered stocks in the first quarter unwound in
the second: the war in Iraq came to a swift conclusion, weather patterns in the
Northeast normalized, the hysteria over the SARS epidemic subsided, corporate
profits were generally better than expected and the economy finally began to
show signs of improvement.
With the announcement in April of the conclusion of major combat in Iraq,
investors turned their attention from geopolitical issues to the domestic
economy and corporate earnings and, for the first time since the fourth quarter
of 2001, there were enough positive signs to cause a significant change in
sentiment. On the economic front, the situation is improving gradually. In the
first quarter, GDP growth was a paltry 1.4% and it appears as if the second
quarter figures will come in at the same level or below. Towards the end of the
quarter, however, several other economic indicators, including consumer
confidence and personal income and spending showed healthy improvement. The
housing market also remained strong, due to favorable mortgage rates, which are
currently at 45-year lows. New home sales were at an all time record in May
while existing home sales also remained near record highs. The news on
manufacturing, however, was less encouraging. The Institute for Supply
Management's (ISM) index of U.S. manufacturing activity, despite coming in
higher than expected in May, showed that manufacturing contracted for a third
consecutive month. Other signs of weakness included soft durable goods orders
and industrial production and stubbornly high unemployment and weekly jobless
claims.
Despite some signs of improvement, the economy is clearly mired in a slump.
The Federal Reserve has proven to be unwilling to wait passively for signs of a
pick-up before acting to boost activity. Given the Fed's emphasis on the risks
of deflation in its May 6th statement and the consistently dovish commentary
emanating from committee members, investors widely anticipated the June 25th
rate cut. However, the expected magnitude of the cut, as well as the form of Fed
action (rate cuts versus open market bond purchases), was hotly debated. In the
end, the Fed voted to cut the Fed Funds target by 0.25%, which disappointed the
bond market but indicated to equity investors that there is reasonable hope for
a second half economic recovery. Fiscal policy has also been stimulative with
the Federal government running significant deficits and Congress enacting a
substantial tax cut that took effect July 1st. In addition to these factors, the
dollar's continued decline versus other currencies, particularly the Euro,
should help to stimulate export activity for U.S. companies and has already
provided a lift to profits for U.S. based multinationals.
Corporate earnings took a back seat to geopolitical events during most of
the first quarter, but have since come back into focus. According to First Call,
first quarter reported earnings for S&P 500 constituents came in at $12.55 per
share for an 11.5% gain over the first quarter of 2002. While this
2
appeared encouraging on the surface, and was ahead of expectations, a closer
look revealed that the earnings gains came from a combination of continued cost
cutting, the weaker U.S. dollar and easy comparisons rather than sales growth,
which was disappointing. The weaker dollar helps U.S. multinationals through
currency translation gains but these are not normally paid for with stock gains,
as they tend to be transitory. On the other hand, the weaker dollar clearly
benefits U.S. companies in terms of global competitiveness. At this point, First
Call indicates that S&P 500 companies' average earnings are expected to be up 4%
for the second quarter and 8% for the entire year. These estimates may be too
low based on the low level of negative "pre-announcements" to date and the
expected pick-up in economic activity in the second half of the year.
MARKET REVIEW
Small cap stocks outperformed large cap stocks for the quarter with the
Russell 2000 Index of small cap stocks returning 23.4%, while the large cap
Russell 1000 Index returned 15.7%. In the large cap market, value stocks
outperformed growth stocks for the quarter with the Russell 1000 Value Index
gaining 17.3% while the Russell 1000 Growth Index returned 14.3%. In the small
cap arena, growth stocks modestly outperformed value stocks with the Russell
2000 Growth Index rising 24.1% while the Russell 2000 Value Index gained 22.7%.
In the large cap segment of the market, every economic sector managed a
positive return for the quarter. The traditionally defensive sectors lagged in
the quarter as investors began to believe that economic activity would finally
start to respond to the flood of stimulus. Reversing last quarter's terrible
performance, telecomm stocks rallied strongly and finished up 20.4%. Not far
behind were utilities (+20.1%), consumer discretionary (+18.8%), technology
(+18.1%) and financials (+17.8%). Among the underperforming sectors were
healthcare (+9.5%), consumer staples (+8.5%) and energy (+6.4%) as the stable,
predictable earnings of these companies became less appealing to investors than
stocks with greater earnings leverage in an improving economy. In the small cap
segment, every sector in the small cap index posted double-digit gains in the
quarter with the exception of the relatively small, integrated oil group, which
fell 1.8%.
OUTLOOK
The rally in equity prices that began in mid-March has been largely fueled
by liquidity. Investor confidence has grown driven partially by the belief that
there are enough stimuli in the economy to spur growth and the belief that the
Fed will stay on hold as it guards against deflation. As a result, money has
been flowing back into equity mutual funds and some investor sentiment indexes
have moved back to very bullish levels. Institutional investors have likewise
been adding to equities as they search for higher returns than those offered by
money funds and bonds, whose yields have dropped to historically low levels.
We are unenthusiastic about the direction of the U.S. equity markets from
these levels based on current fundamentals. In short, we do not believe
corporate profits will increase enough in the near future to justify the recent
gains in equity prices. We also remain concerned about whether or not U.S.
consumers will continue spending long enough to support the economy until a
corporate spending cycle emerges, despite the record levels of mortgage
refinancings, which continue to provide consumers with access to cash. Capital
spending remains very weak and it's difficult to see when a significant pick-up
will begin as most industrial companies continue to see a difficult earnings
environment. That being said, we do acknowledge that liquidity driven rallies
can continue for long periods of time, stretching valuations beyond reasonable
levels
3
PORTFOLIO REVIEW
During the second quarter, the Fund underperformed the broad market by 4.4%
with a return of 11.0% compared to the S&P 500 Index, which returned 15.4%. Year
to date, the Fund has returned 10.1% versus 11.8% for the S&P 500. Stocks with
the most significant positive contribution to performance included Intel, Bank
of America, and JP Morgan. Johnson and Johnson and 3M had the most significant
negative effect in dollar terms, and were the only two stocks with negative
returns for the period.
A significant portion of the Fund's underperformance for the quarter
resulted from the portfolio's structure rather than from security specific
issues. During the quarter, the stocks that performed the best were the names
that have been exhibiting the highest degree of volatility over the past several
quarters. In addition, smaller cap stocks generally outperformed larger stocks
within most benchmarks. Evidence of these trends can be seen in the significant
bounce in the prices of numerous stocks that had been severely depressed during
the bear market. The Fund typically has very little exposure to higher
volatility stocks, opting instead for stocks with more stable price histories,
and is also typically concentrated in large cap companies. However, rotational
trends such as this, where depressed, volatile stocks significantly outperform,
typically do not last long so we would not expect to be negatively impacted by
these factors for a sustained period of time.
On a stock specific basis, Johnson and Johnson fell 10.7% during the
quarter, significantly underperforming the market and the drug group.
Approximately one half of the drop occurred immediately following the company's
earnings release in mid-April. There were no major misses relative to
expectations as JNJ announced a 13% increase in earnings on a quarterly sales
increase of 12% (8.1% excluding currency translation), however, investors were
somewhat disappointed with the slowing growth in Procrit and the European
version of the drug called Eprex. Increased competition, as well as reports that
the drug has been linked to a rare blood disorder in some European patients,
caused the company to trim growth forecasts for the drug over the next several
quarters. The stock also struggled in May and June as the company faced
inventory shortages in the new Cypher drug-eluting stent, which hit the market
in great demand. Analysts have worried that production issues will result in
less robust results for the stent and that missteps could allow competition to
gain ground more quickly than anticipated. We viewed the stock as highly valued
based on the attention the new stent product generated but with the recent
weakness we have been hesitant to trim the position. We anticipate reducing the
size of the position in the portfolio on future price strength.
3M performed very well in the early part of the year, appreciating to
roughly $135 by early April on positive fundamental improvements in the business
resulting from several new initiatives put in place by the company's CEO, James
McNerny. In April, 3M announced first quarter results that were in line with
estimates and showed an 11% revenue increase and 15% earnings growth. The
company also issued earnings guidance for the remainder of the year of $1.47 to
$1.53 per share while consensus estimates call for $1.50. Subsequently, several
analysts downgraded near-term ratings based on the significant boost in sales
related to the weaker dollar, the muted near term economic growth forecasts and
continued asbestos liability risk. As a result, the stock traded off to
approximately $120, but has since rebounded.
On the positive side, Intel rallied strongly in the quarter, returning 28%.
With the stock accounting for approximately 14% of the portfolio's value, it had
the largest impact on the Fund's return by a wide margin. In general, Intel's
business seems to have turned the corner with estimates of future earnings
stabilizing. Intel's first quarter earnings were flat compared to last year and
the company indicated that
4
the outlook for the remainder of the year would be modestly positive. Although
the situation has improved, we continue to believe that Intel faces a difficult
road given the technology capital spending environment. Earnings estimates for
2004 have come down modestly but still discount a 31% growth rate from this
year. With a P/E ratio of 46x last year's earnings and 28x 2004 earnings, we
believe that the risk outweighs the potential reward in the stock given its very
large size in the portfolio.
Financial stocks, and banks in particular, performed modestly better than
the S&P 500 Index for the quarter. Within the Fund, JP Morgan and Bank of
America performed well. These positions advanced steadily throughout the quarter
off of depressed valuations as investors moved back into financial stocks to
participate in the market's move. Bank of America gained 18% and, as one of the
larger positions in the Fund, it had a strong positive effect on returns. JP
Morgan was the single best performing stock in the Fund for the quarter,
rallying 44%, but it's impact on performance was limited given its relatively
small position (2%) in the portfolio. JP Morgan's first quarter earnings were
ahead of expectations and analysts are expecting a strong earnings rebound from
2002's depressed levels.
PERFORMANCE SUMMARY
<Table>
<Caption>
CHESTNUT STREET S&P 500 DJIA
AS OF JUNE 30, 2003 EXCHANGE FUND INDEX INDEX
- ------------------- --------------- -------- --------
2nd Quarter, 2003.............................. 11.00% 15.39% 13.12%
1 Year......................................... 2.55% 0.28% -0.48%
3 Years*....................................... -9.86% -11.19% -3.01%
5 Years*....................................... -0.83% -1.59% 1.94%
10 Years*...................................... 9.56% 10.08% 12.16%
Inception (12/29/76)
Annualized*.................................. 12.74% 12.37% 12.64%
Cumulative................................... 2,327.07% 2,097.46% 2,243.96%
</Table>
The performance data represent past performance and should not be
considered indicative of future performance which will fluctuate with changes in
market conditions. These performance fluctuations will cause an investor's
shares, when redeemed, to be worth more or less than their original cost.
In addition, the data does not reflect the deduction of taxes that a
shareholder would pay on distributions or redemption of Fund shares.
BLACKROCK INSTITUTIONAL MANAGEMENT CORPORATION
5
CHESTNUT STREET EXCHANGE FUND
(A CALIFORNIA LIMITED PARTNERSHIP)
STATEMENT OF NET ASSETS
JUNE 30, 2003
(UNAUDITED)
<Table>
<Caption>
SHARES VALUE
- ----------- ------------
COMMON STOCKS--95.4 %
BASICS--3.7 %
106,123 Air Products & Chemicals,
Inc. ....................... $ 4,414,717
90,747 Cabot Corporation ............ 2,604,439
54,752 *Cabot Microelectronics
Corp. ...................... 2,763,333
17,696 MeadWestvaco Corp. ........... 437,091
------------
10,219,580
------------
CAPITAL EQUIPMENT--6.0 %
109,527 Emerson Electric Company ..... 5,596,830
384,000 General Electric Co. ......... 11,013,120
------------
16,609,950
------------
CONSUMER CYCLICALS--4.7 %
154,187 Disney (Walt) Company ........ 3,045,193
76,000 3M Co. ....................... 9,802,480
------------
12,847,673
------------
ENERGY--3.8 %
44,280 BP plc ADR ................... 1,860,646
155,296 Exxon Mobil Corp. ............ 5,576,679
60,432 Schlumberger, Ltd. ........... 2,874,750
11,699 Transocean, Inc. ............. 257,027
------------
10,569,102
------------
FINANCIAL--21.6 %
117,433 American Express Co. ......... 4,909,874
208,286 Bank of America Corp. ........ 16,460,843
70,000 Fannie Mae ................... 4,720,800
116,352 Marsh & McLennan Companies,
Inc. ....................... 5,942,097
50,647 Moody's Corporation .......... 2,669,603
148,000 J.P. Morgan Chase & Co. ...... 5,058,640
97,200 Wachovia Corporation ......... 3,884,112
314,532 Wells Fargo & Co. ............ 15,852,413
------------
59,498,382
------------
</Table>
<Table>
<Caption>
SHARES VALUE
- ----------- ------------
HEALTHCARE--28.5 %
243,928 Abbott Laboratories, Inc. .... $ 10,674,289
78,354 Baxter International, Inc. ... 2,037,204
79,516 IMS Health, Inc. ............. 1,430,493
758,416 Johnson & Johnson, Inc. ...... 39,210,107
401,729 Merck & Company, Inc. ........ 24,324,691
52,000 Schering - Plough Corp. ...... 967,200
------------
78,643,984
------------
RETAIL--0.4 %
57,133 Albertson's, Inc. ............ 1,096,954
------------
STAPLES--4.2 %
251,406 Coca Cola (The) Company ...... 11,667,753
------------
TECHNOLOGY--18.2 %
61,097 Hewlett-Packard Company ...... 1,301,366
41,884 International Business
Machines Corporation ....... 3,455,430
1,884,095 Intel Corp. .................. 39,159,030
110,800 Microsoft Corp. .............. 2,837,588
357,354 Motorola, Incorporated ....... 3,369,848
------------
50,123,262
------------
TRANSPORTATION--2.1 %
119,796 Burlington Northern Santa Fe
Corp. ...................... 3,406,998
40,000 Union Pacific Corp. .......... 2,320,800
------------
5,727,798
------------
UTILITIES--2.2 %
151,713 Verizon Communications,
Inc. ....................... 5,985,078
------------
Total Common Stocks
(Cost: $31,358,976)......... 262,989,516
------------
<Caption>
PAR
- -----------
SHORT-TERM OBLIGATIONS--4.8 %
$13,200,000 Federal Home Loan Mortgage
Corp. 07/01/03, 0.95%
(Cost: $13,200,000)......... 13,200,000
------------
</Table>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
6
STATEMENT OF NET ASSETS (CONCLUDED)
<Table>
<Caption>
VALUE
------------
TOTAL INVESTMENT IN SECURITIES
(Cost: $44,558,976)............ 100.2% 276,189,516
Distributions payable............ (0.3)% (906,142)
Other assets in excess of other
liabilities.................... 0.1% 263,458
----- ------------
NET ASSETS (Applicable to 953,834
partnership shares
outstanding)................... 100.0% $275,546,832
===== ============
NET ASSET VALUE PER SHARE........ $ 288.88
============
NET ASSETS APPLICABLE TO SHARES
OWNED BY:
Limited partners
(949,108 shares)............... $274,181,569
Managing general partners
(4,726 shares)................. 1,365,263
------------
Total net assets
(953,834 shares)............... $275,546,832
============
</Table>
* Non-Income Producing
Investment Abbreviations:
ADR--American Depository Receipt
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
7
CHESTNUT STREET EXCHANGE FUND
(A CALIFORNIA LIMITED PARTNERSHIP)
STATEMENT OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2003
(UNAUDITED)
<Table>
INVESTMENT INCOME
Dividends............................................................... $ 2,561,414
Interest................................................................ 58,173
-----------
Total investment income.............................................. 2,619,587
-----------
EXPENSES
Investment advisory fee................................................. 446,034
Managing general partners' compensation and officer's salary............ 42,550
Legal................................................................... 28,508
Audit................................................................... 14,914
Custodian............................................................... 11,569
Printing................................................................ 10,354
Transfer agent.......................................................... 6,766
Insurance............................................................... 1,755
Miscellaneous........................................................... 1,926
-----------
Total expenses....................................................... 564,376
-----------
NET INVESTMENT INCOME.............................................. 2,055,211
-----------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Realized loss on sale of investment securities (for federal tax purposes
net loss of $2,392,129).............................................. (2,392,129)
Realized gain from security transactions: distributed upon redemption of
partnership shares................................................... 14,167,852
Unrealized appreciation of investments:
Beginning of period.................................... $219,286,594
End of period.......................................... 231,630,540
------------
12,343,946
Net change in unrealized appreciation..............................
-----------
24,119,669
Net realized and unrealized gain on investments....................
-----------
$26,174,880
Net increase in net assets resulting from operations.................
===========
</Table>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
8
CHESTNUT STREET EXCHANGE FUND
STATEMENTS OF CHANGES IN NET ASSETS
<Table>
<Caption>
SIX MONTHS
ENDED YEAR ENDED
JUNE 30, 2003 DECEMBER 31,
(UNAUDITED) 2002
------------- ------------
INCREASE (DECREASE) IN NET ASSETS
Operations:
Net investment income.................................. $ 2,055,211 $ 4,117,025
Net realized loss from security transactions (for
federal income tax purposes net loss is $2,392,129
and $2,288,260....................................... (2,392,129) (2,288,260)
Excess of market value over book value of securities
distributed upon redemption of partnership shares.... 14,167,852 9,902,097
Increase/(decrease) in unrealized appreciation of
investments.......................................... 12,343,946 (86,724,968)
------------ ------------
Increase/(decrease) in net assets resulting from
operations........................................... 26,174,880 (74,994,106)
------------ ------------
DISTRIBUTIONS TO PARTNERS FROM:
Net investment income..................................... (1,835,908) (4,122,735)
------------ ------------
CAPITAL SHARE TRANSACTIONS:
Net asset value of 804 and 1,144 shares issued in lieu of
cash distributions..................................... 216,819 348,519
Cost of 60,975 and 44,897 shares repurchased.............. (16,995,662) (13,299,768)
------------ ------------
Decrease in net assets from capital share transactions.... (16,778,843) (12,951,249)
------------ ------------
Total increase/(decrease) in net assets................... 7,560,129 (92,068,090)
NET ASSETS:
Beginning of period....................................... 267,986,703 360,054,793
------------ ------------
End of period............................................. $275,546,832 $267,986,703
============ ============
</Table>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
9
CHESTNUT STREET EXCHANGE FUND
FINANCIAL HIGHLIGHTS
(FOR A SHARE OF THE FUND OUTSTANDING THROUGHOUT EACH PERIOD)
<Table>
<Caption>
SIX MONTHS
ENDED YEARS ENDED DECEMBER 31,
JUNE 30, 2003 ----------------------------------------------------
(UNAUDITED) 2002 2001 2000 1999 1998
------------- -------- -------- -------- -------- --------
Net Asset Value, Beginning of
Period..................... $ 264.29 $ 340.39 $ 362.68 $ 369.83 $ 347.51 $ 293.03
-------- -------- -------- -------- -------- --------
Income From Investment
Operations:
Net investment income...... 2.13 3.99 3.79 3.76 3.64 3.76
Net gain (loss) on
securities (both
realized and
unrealized)............. 24.36 (76.09) (22.30) (7.15) 22.39 54.49
-------- -------- -------- -------- -------- --------
Total from investment
operations............ 26.49 (72.10) (18.51) (3.39) 26.03 58.25
-------- -------- -------- -------- -------- --------
Less Distributions:
From net investment
income.................. (1.90) (4.00) (3.78) (3.76) (3.65) (3.77)
From realized gains........ 0.00 0.00 0.00 0.00 (0.06) 0.00
-------- -------- -------- -------- -------- --------
Total distributions..... (1.90) (4.00) (3.78) (3.76) (3.71) (3.77)
-------- -------- -------- -------- -------- --------
Net Asset Value,
End of Period.............. $ 288.88 $ 264.29 $ 340.39 $ 362.68 $ 369.83 $ 347.51
======== ======== ======== ======== ======== ========
Total Return................. 10.05% (21.25)% (5.05)% (0.92)% 7.52% 20.25%
Ratios/Supplemental Data:
Net Assets, End of Period
(000's)................. $275,547 $267,987 $360,055 $398,580 $422,604 $409,019
Ratios to average net
assets:
Operating expenses...... 0.43% 0.41% 0.39% 0.38% 0.38% 0.38%
Net investment income... 1.56% 1.31% 1.12% 0.96% 1.00% 1.18%
Portfolio Turnover Rate.... 0.00% 0.98% 0.00% 1.77% 2.48% 0.76%
</Table>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
10
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
(A) Chestnut Street Exchange Fund (the "Fund") is registered under the
Investment Company Act of 1940, as amended, as a diversified open-end
management company. The Fund's investment objective is to seek long-term
growth of capital and, secondarily, current income. Significant accounting
policies are as follows: Investments are stated at value in the accompanying
financial statements. Securities listed on a securities exchange are valued
at the close of trading on June 30, 2003. Securities not so listed or not
traded on that date are valued at the latest bid price. Short-term
obligations are valued at amortized cost which approximates market. Security
transactions are accounted for on the trade date. The cost of investments
sold or redeemed in kind is determined by the use of the specific
identification method for both financial reporting and income tax purposes.
For securities received in the Exchange at inception of the Fund in 1976,
cost for financial reporting purposes is the value of the securities as used
in the Exchange and for income tax purposes, the tax basis of the individual
investor. Interest income is recorded on an accrual basis; dividend income
is recorded on the ex-dividend date. It is the Fund's policy to continue to
comply with the requirements of the Internal Revenue Code applicable to
regulated investment companies and to make the requisite distribution of
taxable investment income and capital gains to its shareholders which will
relieve it from all or substantially all federal income and excise taxes.
The preparation of financial statements in conformity with generally
accepted principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period, Actual results could differ from these
estimates.
(B) Effective January 1,1998, the Fund changed its tax status from a partnership
to a regulated investment company. The change results from the enactment of
the "Publicly Traded Partnership" rules to the Internal Revenue Code in
1987, which first applied to the Fund after 1997. Commencing in 1998, the
Fund will not distribute net long-term capital gains, but will retain the
gains and pay the applicable corporate income tax rate. On the last day of
the year, the partners are entitled to a proportionate credit of the tax
payment and the tax basis of their shares is increased by the amount of
undistributed gains less the tax paid by the Fund. The Fund had no net
realized long-term capital gains in the six months ended June 30, 2003.
(C) PNC Bank and BlackRock Institutional Management Corporation ("BIMC"), a
majority-owned subsidiary of PNC Bank, are co-investment advisers to the
Fund pursuant to an Advisory Agreement dated January 1, 1998. In June 1998,
PNC Bank and BIMC restructured their operations and BlackRock Financial
Management, Inc. ("BFM"), a majority-owned subsidiary of PNC Bank, assumed
the rights and obligations of PNC Bank under the Advisory Agreement. The
Fund pays BIMC an investment advisory fee for the services of BIMC and BFM.
The Advisory Agreement provides for a fee at the annual rate of 4/10ths of
1% of the first $100,000,000 of the Fund's average daily net assets plus
3/10ths of 1% of net assets exceeding $100,000,000.
The managing general partners each receive a fixed fee as compensation for
their services. PFPC Inc., an affiliate of PNC Bank, is the Fund's transfer
agent. PFPC Trust Company, a subsidiary of PFPC Inc., is the Fund's
custodian.
11
(D) Purchases and sales of investment securities (excluding short-term
obligations) were $0 and $2,207,524, respectively, for the six months ended
June 30, 2003.
During the year 2002, the Fund realized a loss of $2,288,260 on sale of
securities. This loss may be carried forward up to eight years to reduce the
tax effect of future gains on sales of securities. This loss will expire in
2010.
(E) At June 30, 2003, net assets consisted of:
<Table>
Undistributed net investment income......................... $ 220,321
Net unrealized appreciation of investments.................. 231,630,540
Other capital -- paid-in or reinvested...................... 43,695,971
------------
$275,546,832
============
</Table>
12
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- ---------------------------------------------------
MANAGING GENERAL PARTNERS
Richard C. Caldwell
Robert R. Fortune
Edward J. Roach
Langhorne B. Smith
David R. Wilmerding, Jr.
INVESTMENT ADVISERS
BlackRock Financial Management, Inc.
and
BlackRock Institutional
Management Corporation
100 Bellevue Parkway
Wilmington, Delaware 19809
TRANSFER AGENT
PFPC Inc.
P.O. Box 8950
Wilmington, Delaware 19899
(800) 852-4750
(302) 791-2532 (Delaware)
- ---------------------------------------------------
- ---------------------------------------------------
- ---------------------------------------------------
- ---------------------------------------------------
[CHESTNUT STREET LOGO]
Semi-Annual Report
June 30, 2003
Chestnut Street Exchange
Fund
400 Bellevue Parkway
Wilmington, Delaware 19809
(302) 792-2555
Edward J. Roach, President & Treasurer
- ---------------------------------------------------
- ---------------------------------------------------
ITEM 2. CODE OF ETHICS.
Not applicable.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
Not applicable.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Not applicable.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
Not applicable.
ITEM 6. [RESERVED]
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.
Not applicable.
ITEM 8. [RESERVED]
ITEM 9. CONTROLS AND PROCEDURES.
(a) The registrant's principal executive and principal financial
officers, or persons performing similar functions, have concluded
that the registrant's disclosure controls and procedures (as defined
in Rule 30a-3(c) under the Investment Company Act of 1940, as
amended (the "1940 Act") (17 CFR 270.30a-3(c))) are effective, as of
a date within 90 days of the filing date of the report that includes
the disclosure required by this paragraph, based on their evaluation
of these controls and procedures required by Rule 30a-3(b) under the
1940 Act (17 CFR 270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b)
under the Exchange Act (17 CFR 240.13a-15(b) or 240.15d-15(b)).
(b) There were no changes in the registrant's internal control over
financial reporting (as defined in Rule 30a-3(d) under the 1940 Act
(17 CFR 270.30a-3(d)) that occurred during the registrant's last
fiscal half-year (the registrant's second fiscal half-year in the
case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting.
ITEM 10. EXHIBITS.
(a)(1) Not applicable.
(a)(2) Certifications pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 are attached hereto.
(b) Certifications pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 are attached hereto.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
(registrant) Chestnut Street Exchange Fund
--------------------------------------------------------------------
By (Signature and Title)* /s/ Edward J. Roach
-------------------------------------------------------
Edward J. Roach, President & Treasurer
(principal executive officer)
Date AUGUST 20, 2003
----------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By (Signature and Title)* /s/ Edward J. Roach
-------------------------------------------------------
Edward J. Roach, President & Treasurer
(principal executive and principal financial officer)
Date AUGUST 20, 2003
----------------------------------------------------------------------------
* Print the name and title of each signing officer under his or her signature.